The seven secrets of Silicon Valley’s angel investors

New tax breaks for angel investors offer high risk and high rewards. Here’s how to use them.

Wyatt Roy suggests a punt on start-ups instead of the Melbourne Cup.

On July 1 this year, the federal government introduced tax incentives for angel investors, including an exemption from capital gains tax on shares in early-stage innovation companies held for between one and 10 years. Some 20 per cent of the purchase price of the investment can also be claimed as a tax offset.

But angel investing requires a very different style of thinking to evaluating more traditional opportunities in listed equities or real estate. Typically, the Turnbull start-up tax breaks will be going to investors in unlisted, early stage companies that need capital to get an idea off the ground.

To encourage more targeted risk-taking, former assistant innovation minister Wyatt Roy used to regularly quote figures showing Australians spent $200 million betting on the Melbourne Cup, but only $100m in venture capital investing in start-ups. (Roy is now an non-executive director at venture capital group H2Ocean.)

Angel investors and venture capitalists typically back a range of ambitious companies, expecting most will fail and a small proportion will be so successful that they will make up for the losses and still provide a compelling return. This is a stark contrast to legendary investor Warren Buffett’s well-known line on the two rules of investing: “Rule 1: Never lose money. Rule 2: Never forget rule 1.”

The epicentre of entrepreneurial activity is the Silicon Valley tech scene, and the ranks of Australians there have swelled in recent years. These expats have seven outstanding suggestions for prospective angel investors in Australia to think about before getting started:

1. Consider your reasons

Imagine a family member or family friend approaches you and pitches their new business idea. In this situation, are you investing to support someone you care about, or are you investing with the hopes of generating a financial return?

“If it’s for relationship reasons and because you just want to be a supportive person, that’s completely valid,” says Ash Fontana, managing director at Zetta Venture Partners and former Macquarie banker.

“But just be honest with yourself and write off that cheque from day one.”

If you don’t expect a financial return, then you won’t get frustrated and ruin the relationship when a financial return doesn’t materialise, he says.

2. Aim to diversify

Just as a serious investor wouldn’t pick a single stock and consider their equity exposure complete, picking several start-ups instead of only one is a way of spreading risk.

“Ninety-nine per cent of these companies never see the light of day,” points out Tim Olshansky, who founded cloud software company Worksite before it was acquired by Aconex, where he is now the head of engineering. A former derivatives trader, he recommends investors only spend money they can afford to lose when backing early stage companies.

“If you’re not willing to lose a cent then you should definitely not be in that game,” he told The Weekend Australian in San Francisco. “If I wanted to invest $25,000 in start-ups, hypothetically, I personally would do — if I could — $5000 in five start-ups rather than $25,000 in one.”

3. Back the person, not the idea

Many start-ups begin with one idea and then refine or completely change their product as they take feedback from customers. For example, social network Twitter began life as a podcasting company, while photo-sharing service Flickr started as an online game.

Do the founders have the skills and experience to execute their idea? And are they able to pivot if their original idea doesn’t work?

4. Think about your own expertise

Is there an industry you understand where you might be better able to evaluate prospective opportunities? For example, a background working in finance could offer an edge in fintech investing, while experience in agriculture could suggest a focus on agtech. Also consider if there are opportunities for you to partner with a start-up you invest in, by joining the board or acting as a mentor.

Zetta’s Ash Fontana usually joins the boards of companies his fund backs and helps coach their chief executives.

Zetta specialises in picking companies that focus on artificial intelligence, which he says offers the opportunity to build up knowledge in one area and understand where the cutting edge of innovation lies.

5. Be prepared to say no

If you’re investing for a return and not to maintain a relationship, expect to see a number of average ideas or ill-suited teams. Every start-up worth its salt will tell you that it is the best in its space, but in practice most will fail.

Mr Fontana recommends to his friends who are new to angel investments that they meet 100 companies before investing in one.

6. Double down

Start-up veteran Mick Liubinskas, who has just moved to Silicon Valley to run Telstra’s muru-D accelerator there, points out that professional venture investors make more than one round of investment in a single company.

“Keep backing the ones who are succeeding,” rather than only making one investment and concluding start-ups don’t work, he says. He offers the analogy of someone at a horse race who backs a range of horses before the start, then halfway through the race puts more money on those out in front, then late in the race puts even more cash on the top few.

7. Keep learning

Insiders recommend reading the tech press and going to networking events to build knowledge and keep up with the industry. Organisations such as AngelList also offer educational resources for new angel investors. Instead of looking to Warren Buffett, angels might be better served to study the writing of Paul Graham, co-founder of the well-known Silicon Valley accelerator, Y Combinator:

“The most successful angel investors I know are all basically good people. Once they invest in a company, all they want to do is help it.”