The Oracle of Omaha is known for his strict adherence to what others call value investing based on the principles of Ben Graham (his mentor). A quick primer: value investing's mantra is to rigorously identify through analysis the intrinsic value of a company and the subsequent purchase of securities in that company where that intrinsic value far outweighs the purchase value of the same security. Some call it safe, some call it boring, and Buffett calls it smart.
But are there any lessons in the principles of value investing that translate over to the scary side of angel investing?
Buffet likes companies with recurring revenue where the basic need for the products is not in question and thus the revenue trajectory given great execution is a forgone conclusion. Think ketchup and trains delivering materials and soda.
Top tier executives are another key component in his analysis. When you combine the simple, product need (stated above) with great execution you get great results. Great executive and executive teams outperform their peers and this make for great investment partners.
Patience is another key trait with a notion to take the long view. Buffett stills holds Coca Cola (since 1988). When you combine simple and solid products that everyone needs (not wants) with a great executive team and a patient outlook, you are bound to be right more times than not.
So how would you try to align the "Oracle of Omaha" and his strategy for value investing with the challenge of making seed stage investments?
- Identify companies that fulfill a distinct and obvious need. There are many levels to this advice. First, invest in what you know. Which means either you have industry experience (more than 10 years) or you spent a considerable amount of time researching this area. Do not take the founders word about the dynamics of the target industry especially if they have no experience in the industry as well. Why? There is no way to properly evaluate the fundamental needs of the target customers if neither you nor the founder has any experience with those customers. (This is why I am not in favor of taking seed money from doctors.)
- Identify and partner with outstanding founding teams. Great executives deliver better results than their weaker peers. But how can you identify great executives at such an early stage. One strategy would be to only invest in founders that are embarking on their 2nd or 3rd startup. Implied in that strategy is the idea that the experiences (good or bad) in those previous companies will make them better operators. Another strategy would be to work with the founders for a period of time (1-2 months) to determine their startup character. Personalities are revealed over time and there is not one personality that wins but there are personalities that blend with you and your style better than others. Angel investing results are skewed positive when you spend 3-4x per month working with the founding team. To that end, you best determine if there is a match. All of these strategies have the same goal in mind; separate the great from the average.
- Take a long-term view. Seed and early-stage companies take 7-10 years to reach some type of exit (if there is an exit in its future). An unrealistic view of your return on investment can place undo pressure on you and the company, in effect creating more friction for a more natural exit. Both you as an investor and you as an operator have to create a clear alignment on timing.
These three principles borrow directly from Warren Buffett's approach. Apply these to your angel investment style and you will increase your ability to create a return. Are you an entrepreneur? Knowing these investment principles can also help you determine who are the better angel investors and who are not.