Angel Investing: The Gust Guide to Making Money and Having Fun Investing in Startups

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Valuations and Expectations

Discovering the Secret Economics of the Angels

EVERYTHING DISCUSSED so far, from finding new opportunities and identifying winning entrepreneurs to analyzing startups for their potential and carefully verifying the information they provide, serves one thing, and one thing only: making money from your investment. While this sounds obvious, getting the economics of a startup investment right is the most challenging aspect of angel investing, and the one in which most would-be angels go astray.

Unlike advanced books dealing with algorithmic, high-velocity day trading, I'm not going to delve into arcane subjects like Sharpe ratios, statistical mean reversion testing, and Black-scholes equations. Instead, i will limit our discussion to the math that you learned in the fifth grade: multiplication, division, and a touch of exponentiation.

The Four Simple Numbers: Basics of Investment Math

The core of making money as an angel investor is to purchase an ownership share in a company when it is still young, unproven, and inexpensive, and to sell that share at a later date when the company has effectively achieved its vision and demonstrated that it is worth a lot more money. To take an example, if you invest $100 and receive a 10 percent ownership share of a company, you can calculate that after your investment the whole company is worth $1,000 (because $100 ÷ 10 percent = $1,000). If one year later a bigger company comes along and purchases the company for $10,000, ...