There are two ways to acquire massive wealth: Inherit money, and obtain ownership equity in a very early stage company that becomes a phenomenal success. The first one you can do nothing about. That leaves you only with option 2: angel investing.
There is a huge amount of money that can be made through angel investing. In all kinds of investing the basic rule is: buy low, sell high. Angel investors usually are in the position to buy very low. Equity in early stage companies comes at a very cheap price compared to equity in late stage companies that are publicly traded.
For example: Famous Angel Investor Peter Thiel acquired a 10.2% stake in Facebook for just $500,000 in 2004. He bought 45 Mio. shares. Today, Facebook trads at around $220 a share. Thiel’s initial $500,000 investment would be worth well over $10 billion now.
But not many people bought at this price. the reason was: risk!
Investing in start-ups is an enormous risk. There are many things that can go wrong at the early stage: low market demand, high cash burn, inability to capture market share from competitors, poor management, lack of financing, unsustainable business model among many other factors. In fact, 20% of start-ups fail in the first 2 years. And 50% fail after 4 years. Ultimately, 90% of all start-ups fail.
Among the heavy risk an angel investor carries, start-up investing is highly rewarding. But for most people, the high risk is enough to prevent them from investing altogether. But that is a massive error. The most important lesson in investing is this: To become a billionaire, you have to be willing to take risks.
The most successful angel investors do not have the crystal ball. They have no guarantee which companies will be successful in the future. Just like anybody else, they face uncertainty.
But take a calculated risk. Here is why:
1.) Assume you make a bet with a friend. You flip a coin, and if it lands on tails, you have to pay the friend $50. If it lands on heads, then the friend pays you $500. Would you make the bet? Of course, you should. The upside of $500 far outweighs the downside of losing $50. And the odds are 50/50 for each to occur.
2.) Say it lands on tails, and you lose $50. Did you make a bad decision? Most people feel that of course they made a bad decision. They lost $50. But the truth is you made a great decision. You just got a bad outcome.
3.) Would you then flip the coin again? You certainly should. If you flipped the coin 100 times. The statistical probability is you would win 50% of the time. Your cumulative gain would be $25,000 and your total loss would be $2,500. That’s a net gain of $22,500.
4.) Consider a more risky scenario, involving dice. If you roll a die and it lands on a 6, then you win $50,000. If it lands on any other number, you lose $500. Would you roll the die? Of course, you should! It’s true that the odds of losing are higher than the odds of winning. But the potential upside of $50,000 is still much higher than the downside of $500. You would have to lose 100 consecutive times to lose $50,000. But just one good roll can gain it. Statistically, you should win every sixth throw. That’s called asymmetric risk. As an angel investor, asymmetric risk is the risk you want to take. You should always take the asymmetric risk if the probable return is higher than the probable loss. That’s what good investors realize.
There is no risk-free investment with high returns. Eliminating the risk eliminates the reward. To create massive wealth, you have to get comfortable with risk. But never invest money you can’t afford to lose.
Sven Franssen