When it comes to angel investing, traditional wisdom might not always be the best approach. Daniel Dippold, a serial entrepreneur, sheds light on the unpredictability of startup investing and shares his insights he’s acquired through trial and error.
Embracing the Unpredictable: Chaos Theory in Angel Investing
Chaos theory is a branch of mathematics that deals with complex systems, where small changes in initial conditions can lead to drastically different outcomes. In the context of angel investing, it refers to the inherent uncertainty of which startups will succeed, given the sensitivity to various factors. As Daniel puts it,
"the risk is inversely proportional to the quantity. One startup investment is very, very risky. However, lots of sort of Investments are kind of like investing in the entire asset class of startups, and that is not necessarily more risky than investing in real estate sector”
Rather than trying to pinpoint the next big thing, Daniel suggests embracing this unpredictability and focusing on a few key strategies:
- Diversify your portfolio with at least 50 investments
- Be disciplined with your investment amounts
- Track your performance and confidence scores
Rethinking Portfolio Strategy: The Power Law Distribution
While many investors might strive for every portfolio company to generate returns, Daniel believes in the reality of the power law distribution in angel investing where by a small percentage of investments will drive the majority of returns, and it's nearly impossible to predict which ones will succeed. By making a large number of investments, investors can increase their chances of capturing high-returning opportunities. Daniel's theory is that statistical heavy tails are under-priced, but, by consistently investing in sufficiently enough heavy tail events, you can beat the market. The reason for this is psychological - a so-called cognitive bias called "probability distortion". As people behave predictably irrationally, to put it in Dan Ariely's terms, the smart investor can make use of behavioral science paired with the theory of statistical distributions.
Practical Tips for New Angel Investors
For those new to angel investing, Daniel offers some practical advice to gather more dealflow:
- Network with experienced angel investors to gain access to deals, and join relevant communities
- Reach out to founders you admire and try to help them before investing
- Build a personal brand through platforms like LinkedIn to attract investment opportunities
- Use communities like BADideas.fund to discover new startups
Tracking Your Performance: A Data-Driven Approach
It’s not always necessary to use advanced tools like Sharesight or Seraf for tracking your investments, returns, and confidence scores. For Daniel, a spreadsheet can work just as well to track your portfolio value and update when the company raises subsequent rounds.
By analyzing this data, investors can refine their decision-making processes and better understand their own investment patterns.
The Bottom Line
In the unpredictable world of angel investing, Daniel Dippold's insights offer a fresh perspective on risk-taking and decision-making. By embracing chaos theory, rethinking portfolio strategy, and adopting a data-driven approach, investors can navigate the uncertainties of startup investing and maximize their chances of success.
- How can new angel investors gain access to high-quality deal flow? New angel investors can gain access to high-quality deal flow by leveraging their networks, connecting with experienced investors, participating in platforms like BADideas.fund, and building a personal brand on social media platforms like LinkedIn.
- What is the role of chaos theory in angel investing? Chaos theory highlights the inherent unpredictability and uncertainty in startup investing due to the sensitivity of initial conditions. Accepting this uncertainty can help investors make more informed decisions and manage their portfolios effectively.
- How can confidence scores be used in evaluating investment opportunities? Confidence scores can be assigned to each investment opportunity to gain insight into an investor's decision-making process. By tracking these scores over time, investors can potentially identify patterns that could inform future investment decisions.
- What is the power law in angel investing, and why is it important? The power law in angel investing refers to the principle that a small number of investments will yield disproportionately large returns, while the majority will underperform. Understanding this principle helps investors diversify their portfolios and maintain realistic expectations about potential returns.
- How can an investor determine the right investment amount for each deal? An investor can determine the right investment amount for each deal based on the amount they are willing to allocate for investing throughout the year divided by the estimated number of investments expected to make.
- How can I diversify my angel investment portfolio? Invest in a large number of startups across different industries to spread your risk and increase the chances of finding a winner. Collaborate with other angel investors and join communities like BADideas.fund or platforms like AngelList to discover new investment opportunities.
- How can I improve my decision-making process in angel investing? Track your investments, analyze your confidence scores, and assess the correlation between your confidence scores and actual returns. Monitoring your performance and learning from your experiences will help you refine your judgment over time.