ANGEL INVESTING, EXTREME SPORTS IN THE OFFICE Quarter 1 2022

By ABU CASSIM, Published in M&A FEATURE

South Africa's innovation economy is beginning to show signs of maturity, with more corporate participation and international investors backing South African startups. Digital solutions are allowing for a convergence of industries, with telecom players operating in the FinTech space, and retailers introducing logistic solutions. Angel investing is a key component of any functional startup ecosystem, and it's an opportunity for individuals to participate in the innovation economy while remaining in their day jobs.

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First and foremost, angel investing is not for everyone. It's an extreme sport. It carries significant risk and it's not a parking bay for your children's education fund. It's a portfolio and a people's game. If you're going to get it right, you'll need to invest in a diverse portfolio of companies with the right people (founding team) behind the wheel. Young companies offer an attractive return on investment when chosen carefully, and you only have to be right once, according to famous angel investor Mark Cuban.

An angel investor is an individual who invests in a young business or startup, in return for a stake of equity. Jason Calacanis describes angel investing as the act of investing in a startup in the earliest round of investment, with the objective of gaining massive returns. These startups are usually less than three years old and still trying to find their way. Some angels invest at idea stage, but most require the business to be slightly further along. A working solution, albeit incomplete, and customer engagement go a long way to making a deal more attractive.

The term "Angel" is appropriate because angels provide the financial lifeline a company needs after using up all internal resources. Apart from money, angels also bring knowledge and networks. An angel derisks his or her investment by getting strategically involved alongside the entrepreneur, guiding through mentorship and opening doors when required. In this sense, angels can be seen as brave, daring and, at times, even crazy.

Angel investing is different from other forms of investing in several ways, but two stand out: firstly, their investments are on the far end of the risk spectrum, and secondly, the investor becomes a partner in the business and has a fair degree of oversight as a result. It should be noted that angel investing also requires patient capital. Even when things go right, the journey will take several years – an angel may have offramp opportunities along the way, but these are the exception rather than the norm. The outcome is usually binary, either the startup closes shop, and there are a number of reasons why this could happen, or the company exits. That is, the business is bought by a larger organisation.

South African landscape

Angel investing is still a relatively new concept in the South African market. The Southern African Venture Capital and Private Equity Association (SAVCA) reports that 5.5% of startup funding comes from angel investors (SAVCA 2021 Venture Capital Industry Survey, covering the 2020 calendar year). Our innovation economy is still young, but signs of maturity are starting to creep through with digital adoption on the rise post-COVID.

Historically, most of our biggest exits have come via American counterparts buying out local startups. Examples include: Thawte, Mark Shuttleworth's business which was sold to internet security firm Verisign in 1999 for $575-million and, more recently, GetSmarter which was sold to US edtech company 2U in 2017 for $123-million.

Over the past year or so, we are starting to see a nice run rate of local corporates acquiring homegrown startups. Massmart recently bought One Cart, while FNB recently acquired Selpal in a township push. Other examples include Mr Price buying YuppieChef, and Pick n Pay acquiring Bottles.

Is angel investing for you?

It's a question of risk appetite – failure comes with the territory – and investment capacity. If your overall investment strategy is viewed from a core-satellite approach, then startup investing should sit as a satellite alongside core holdings that include traditional asset classes, such listed equities and property. International best practice is for a maximum of 10% of your overall investment portfolio to be invested in startups.

Also recall that a portfolio approach is required to mitigate the risk of losses. Your aim as an angel investor should be to build out a portfolio of 20 or more companies over time. Syndication is an effective way of achieving diversification while bringing down the capital requirements to a manageable level. Syndication is simply when a group of investors club together to invest in a specific project. It gives you a seat at the table across a more diverse set of investments, and the potential to double down on portfolio companies that outperform.

Where to start?

Get a good sense of the lay of the land before committing to any deals. Reach out to your local angel investor network. Any network that's worth its salt will share regular deal flow with its members. Most networks operate as syndicates or as a fund. Both models allow you to dip your feet into the water to test if the temperature is to your liking.

All syndicates operate on a lead investor - backer basis. A lead investor is the angel investor who handles the majority of the administration and engagement with the founding team. These individuals are experienced and have a few investments under their belt. A backer tags along with investment opportunities. It gives new entrants an opportunity to shadow a lead and get a better sense of the deal process, as well as the viability of an opportunity.

Many more South Africans are beginning to explore entrepreneurship as a viable career opportunity. Those who want to participate in the rise of South Africa's innovation economy without leaving their day jobs have an opportunity, through angel investing, to leverage their knowledge and networks while investing for financial gain. South Africa's innovation economy needs investors with an appetite for risk, and patient capital. Ultimately, these contributions catalise real social change.

Cassim is the founder of Jozi Angels.