Chinese elaborated version on Jun 12, 2016
Angel investment is perhaps the most complex form of performance art, marked by its strange and illogical nature:
There are controllable aspects and uncontrollable ones; making money is rare, while losing money is common; success often owes to luck, yet failures can't solely blame bad luck; the value of angel investors can be partly quantified, and yet, not entirely; angel investment often profits from "common sense", but sometimes it's the "naïve and simple" approach that yields massive returns, and at other times, "being too clever by half" leads to mistakes.
Angel investment is whimsical, defying conventional wisdom, which leads me to summarize: "The essence of angel investment is a game of probability," because:
1) It's impossible to accurately quantify a project's failure rate;
2) It's impossible to control an investment's success rate precisely;
3) It's impossible to predict a fund's return rate exactly.
Success for a project in the future, despite various methodologies for basic judgments, involves three gambles due to "uncontrollable situations". These three gambles include:
1) The timing of potential energy release;
2) The progress of the entrepreneurial team;
3) The strengths and weaknesses of competitors.
We can predict trends, but not when they will take off; we can choose teams with high starting points, but can't be sure if they will continue to progress at "maximum acceleration"; once we choose a team, we hope their competitors' "acceleration of progress" is slower than ours. It's not about how high the starting point is, but the acceleration of progress that counts. In the information age, competition often results in "winner takes all", striving for monopoly, or else it's impossible to "land ashore".
Understanding the nature of angel investment as a probabilistic game allows one to face investment gains and losses calmly, using the best "probabilistic game methodology" for business practice.
However, there's a common misconception that often misleads angel investors:
Success Rate ≠ Return Rate
Success Rate ≠ Return Rate is a crucial conceptual distinction between angel investment and VC/PE investments. VC and PE are also probabilistic games, but they emphasize more on the success rate (reducing the failure rate) because they invest larger amounts per deal and have data for decision-making and risk control. In contrast, angel investment differs from VC and PE in that teams are just starting, lacking data for judging team capability and direction accuracy, making valuation assessments and calculations challenging. Most decisions are made on gut feelings, "rational decisions" at least have no data support, and the so-called "investing in people" lacks the luxury of time to "see people's hearts over time", often requiring conclusions within an hour.
Using PE and VC methodologies in angel investing might indeed ensure a higher "success rate" and lower "failure rate". Still, the likely outcome is that successful projects are only 10 or 100 times more profitable. The entire fund, although possibly above average, is definitely not top three in the market; because outstanding angel investment projects often return at least a thousand times or even tens of thousands of times.
Let's do a calculation assuming a fund invests in 100 projects over 5 years:
Scenario 1: 100% success rate with every project returning 10 times, total fund return 10 times;
Scenario 2: 50% success rate with each project returning 40 times, total fund return 20 times;
Scenario 3: 20% success rate with each project returning 200 times, total fund return 40 times;
Scenario 4: 1% success rate with one project like Facebook, returning 15,000 times, total fund return 150 times.
Although this calculation is very rough and real-world fund performance is much more complex, my point is: the real charm of angel investing is "Scenario 4" - a 1% success rate with returns in the tens of thousands. In reality, those angel investors who achieve huge success also earn massive returns on a very few projects. However, most funds in the market adopt and pursue "Scenario 1" strategies because it's safe and stable, a strategy proven by VC and PE to be mistake-free. Not making mistakes is the main strategy for many GPs.
In fact, according to my observation, most outstanding angel investors strive for "Scenario 3", aligning with the investment logic of most frontline angel investors, involving some risk but also considerable returns.
"Scenario 4" is truly frightening, and no one dares to base their investment strategy on it. However, many have achieved it, and they didn't even need to invest in 100 projects; perhaps the first 10 could yield a ten-thousand-fold return. They may attribute their success to luck, and observers might see it as "divine selection". Regardless, their success gives tremendous courage to those entering the industry.
However, the reality is, although most enter the angel investment industry attracted by the charm of "Scenario 4", they eventually adopt "Scenario 1" or "Scenario 2" as their investment strategies.
This represents a "gap between words and actions".
Choosing "Scenario 3" or "Scenario 4" as your main investment strategy requires understanding another crucial factor: the strength of self-control and the ability to delay gratification, which Warren Buffet refers to as "the pleasure of a later harvest". Patience through solitude is essential to enjoy the long-term benefits.
Let's do another calculation:
You invest 1 million in a project, and after 7 years, when the project goes public, you earn a return of 200 million RMB, a 200-fold increase - quite impressive. If you are a value investor, this is already a significant step up. However, in the 7 years following the IPO, a value-driven project might see a return increase of 10 times or more, turning 200 million into 2 billion. The first 7 years, though the toughest, yield only 200 million, but the following 7 years, relatively easier, add 1.8 billion in value. This demonstrates the "charm of long-term investment".
Amazon's stock increased 643 times in the 19 years after its IPO; Tencent's, 200 times in 12 years; Google's, 22 times in 12 years; and even Facebook, priced high at IPO, tripled in value over 4 years.
Guided by this philosophy, I have formulated my six-word mantra for angel investing: "Invest in trends, bet on people, cultivate the mind".
Invest in trends - I don't just throw money at any team that seems powerful. My first choice is the "unstoppable tidal wave of the market", as capital can only leverage and appreciate significantly under the push of the "market's great waves". Heroes are made by the times, and true heroes know how to "choose" trends and opportunities. Only when "trends and timing" are favorable do I consider "placing my bets" on the team I believe in.
Bet on people - the "team" is key to success or failure. The greater the wave, the higher the demands on the entrepreneurs' "surfing ability and entrepreneurial spirit". People are the biggest variables. Underdogs can rise rapidly in the tide of the times, growing stronger with each challenge; but the privileged may fall to arrogance and hubris, losing to the younger generation. So, no matter which team you bet on, you're gambling on their "acceleration of growth" being the fastest among competitors.
Cultivate the mind - this refers to oneself. After investing in trends and betting on people, one must weather the storms alongside the business. The development of a company is tumultuous, with no day of complete ease. As an observer without "control", an angel investor must cultivate inner peace. Once invested, assume it's already lost. If you can't change the world, at least you can change your inner world. Wait, wait, and wait, without exiting before the project's peak.
Under the guidance of "Invest in trends, bet on people, cultivate the mind", how does one win this probabilistic gamble? Since it's a game of probability, a "number" base is necessary. 100 projects are a basic starting point.
Therefore, PreAngel adopts a "mass breeding" strategy for seed-stage investments, similar to a reproductive strategy widely used in biological evolution. To date, PreAngel's fund family has invested in 300 startups across mobile internet, smart hardware, vertical e-commerce, consumer upgrades, shared economy, medical, education, robotics, drones, artificial intelligence, biotechnology, algorithms, new energy, ARVR, and more. These areas represent our judgments on future trends, fitting "investing in trends". In each field, we have selected our "dark horses", placing our "bets", with most having humble beginnings. Our practice has shown that investing in the privileged often results in a higher failure rate (due to their lower cost of giving up) and lower return rate (due to high investment valuations and costs). After countless life-and-death experiences, we are now in the stage of "cultivating the mind", accompanying companies through roller-coaster growth, with joys and sorrows, bitterness, and happiness.
The past 5 years, with investments in 300 startups, have been a learning journey. We paid a lot of tuition fees to gain these experiences. Our first institutionalized angel investment fund, Shanghai Rayli, has an annualized return of only about 38%, achieved under very favorable industry conditions, which is quite a failure. This fund, established in 2012, should have invested all 30 million in "mobile games" for the maximum cash return from that perspective. However, at the time, I neither understood nor was interested in games, and ethical considerations led me to completely forgo investing in the gaming field. Ironically, one of the fund's top-performing projects, ChenZhiKe, was initially a mobile browser project that later pivoted to mobile gaming and then evolved into the secondary community platform GuluGulu after becoming profitable.
Yesterday, I did a calculation:
40 projects were invested in with 30 million, and two were exited in the second year, returning a third of the capital to LPs (Limited Partners). Of the 30 projects still alive, 15 have the potential to break out, including Youyou Mobile, ChenZhiKe, United Entrepreneurship Board, Oxygen, Dobot, LavaRadio, Youjia, Kanshan Technology, Tuman Technology, and others I won't list here. The investment return from just Youyou Mobile alone could recoup the entire 30 million fund. Additionally, some projects are alive but may not have a great chance of success, or my stake is too small to significantly impact the fund's return rate. Investment is a marathon. This year and next, any development in these 15 projects could significantly enhance my earnings, embodying the "pleasure of a later harvest." The snowball always grows larger towards the end, with the last 2 years' 3x return outweighing the first 2 years' 10x.
Investment is an art of practice. With the vast experience of past failures, subsequent funds are more likely to succeed. Therefore, our later funds like Ningbo Rayli and Shanghai Jianrui invested in high-return projects like EHang, Medical Link, Jiu Ying Tian Xia, AntView, and others. Particularly noteworthy is Medical Link, which grew its valuation from 10 million RMB to 300 million USD in 16 months post our angel investment, a 180-fold increase, attracting top investment institutions like Sequoia, Tencent, Yunfeng, and Huaxing. Thanks to the outstanding performance of Jiu Ying Tian Xia, EHang, Basic Concept, Luo Bo Tai La, Super Monkey, Medical Link, English Fun Dubbing, Quick Express, 58 Freight, Xun Qiu, Ling Yu Zhi Kong, Hesai, Xi Jing, Teng Bao Insurance, Penguin Group, San Ti Technology, Sheng Shi Fang Zhou, Keyan Bao, and others, our 150 million Ningbo Rayli achieved a 67% book return rate; while the 40 million RMB Shanghai Jianrui more than quintupled its book value in just two years, finally letting me feel the charm of angel investing.
Through investment practice, introspection, and broader case studies of success and failure, I realized that a company's scale is 90% determined by industrial potential, 9% by the culture and system designed by its founders, and only 1% by the CEO's personal business capability. Even the most capable individuals can't "stir up a thousand waves"; a CEO's contribution to a company's success is at most 10%. Most people struggle with even that 9%.
Wise investors and entrepreneurs actively seek the next technological "giant wave", aligning with the times to become "tide players". This is how one achieves high returns despite high failure rates and low success rates because only under the push of the times' massive potential can those few successful companies bring returns in the tens of thousands. This realization led me to the insight of "Investing in trends".
With this clear methodology, investment practice becomes easier. If an entrepreneur sends you a plan about O2O, VR players, cross-border e-commerce, or used cars this year, I can outright reject it based on "the game's already over, the trend has passed" reasoning. No matter how good the team is, it's pointless. But if it's about medical, fintech, AI, robotics, or new IT technology, I'm more inclined to meet, saving time and energy focusing on the right tracks.
Regarding "betting on people", I've also summarized some experiences and distilled five principles:
1) Self-control;
2) Leadership;
3) Obsessiveness;
4) Unique thinking;
5) All-in, no retreat.
If an entrepreneur meets at least one of these five criteria within a 10 million RMB angel round valuation, they are worth the "bet". Numerous cases of success and failure tell us that successful people are diverse and quirky, and even those who fail often possess excellent qualities. However, these "excellent qualities" in failures become "silent evidence" as there's less reportage and study on failures.
When we know that all sorts of oddities can succeed and excellent talents can fail miserably, we realize traditional methods of judging people may be more suitable for corporate boards selecting professional managers in mature companies.
In the internet and information age, the entrepreneurial journey is filled with even more unknowns and uncertainties. Therefore, traditional methods based on Newtonian classical mechanics from the industrial era might lead to significant misjudgments when assessing and choosing entrepreneurs.
We now live in an era guided by quantum mechanics, where the core difference between quantum mechanics and classical mechanics is:
- Classical mechanics tells us that everything is calculable and predictable.
- Quantum mechanics, on the other hand, informs us that nothing is certain, and observation itself alters the outcome.
Which should we listen to? It's quite simple: they operate in different realms. Classical mechanics describe the macroscopic physical world with mass, whereas quantum mechanics deals with "quanta", the smallest units of the universe, with mass tending towards zero. So, when analyzing and predicting "thoughts", "stock markets", "trends", "community thinking", "internet virtual economy", and other "massless" matters, we should respect the internet market economy cognition taught by quantum mechanics:
Admit our ignorance, embrace uncertainty.
Therefore, an entrepreneur's success is first a choice of the times, followed by their dynamic evolution in competition. As entrepreneurs are constantly evolving, our initial "predictions" can only be "bets", not precise forecasts. How, then, can we increase the success rate of "betting on people"? Apart from choosing the right trend, we must look at a person's "acceleration of progress", fundamentally depending on their "thinking and behavioral styles". So, we choose not based on education, gender, age, or resume, but on those "special individuals".
"Self-control" is ranked first because, essentially, everyone "loses to their ideal self". Few can completely defeat their instincts in the struggle against them. Great achievements are always at the expense of sacrificing instincts. To lose weight, one must move more and eat less; to succeed, think more, act more, sleep less, give up "face", "pride", even "self-esteem", and all other instincts that hinder progress.
The American Psychological Association (APA) defines self-control in five aspects:
- The ability to delay gratification, resisting immediate temptations for long-term goals.
- The ability to overturn useless or harmful thoughts, feelings, and impulses.
- The ability to use a more rational cognitive system over an impulsive emotional system in actions.
- The ability to consciously set rules for oneself and strive to follow them.
The "obsessive" types, essentially a mental disorder, are more likely to succeed because they can give up everything, including life, for their goals. Elon Musk, Steve Jobs, Andy Grove, Jeff Bezos are perfect examples of such obsessives in the tech field.
Leadership needs no emphasis. To build great enterprises, one must first be a great leader, leading a group of "followers" towards a common, industry-trend-aligned goal.
Those with unique thinking can better understand the essence of things, finding ways to achieve more with less and progress faster. Finally, those who go "all-in" with no retreat are worth investing in because everyone has infinite potential; we just close the door on it ourselves, afraid of death, failure, and unable to withstand setbacks. Conservatism is a survival strategy, successful for thousands of years, but when one is pushed into a corner with no way out, they unlock their potential. Their learning ability increases significantly, and once their progress acceleration surpasses competitors, success is imminent. Going all-in is a courageous act of "actively giving up all escape routes and betting everything on oneself."
ALL-IN is the only winning magic for "ordinary people"!
Silicon Valley produces the world's greatest enterprises primarily because it also has the world's most failures. The core element for achieving great enterprises is "intense competition", the law of survival on this planet. Since competition breeds greatness, "betting on people" means betting on those whose "competitive power continuously increases", those who grow stronger with each battle. History tells us, whether in politics, military, or business, a "high starting point" never guarantees a high success rate. We need a dynamic view of entrepreneurs and competition. The five principles I distilled for "betting on people" are also from the perspective of "dynamic competitiveness" in judging the success probability of entrepreneurs.
Additionally, checking if founders deeply love what they do is crucial. Love is a magical force that not only fully engages a person but also instills determination and a sense of mission, entering a state of "maximized competitiveness".
With the right people and projects, what's left is to cultivate ourselves, which is "cultivating the mind". Cultivating the mind can be difficult and easy. At each critical moment in a company's development, reassess: is the market's "potential energy" still there? Is the team still the most competitive (with the fastest progress acceleration)? If the assessment of both is positive, continue holding without exiting until the potential energy fades or the team starts to stagnate (internal strife is also a major barrier to progress). This is the right time to exit. Of course, some companies offer fleeting exit opportunities, and missing them might mean getting "stuck with them". However, that's okay. As long as your judgment isn't significantly flawed, in the 10 projects you choose not to exit, no more than 5 will end up "stuck in your hand". The additional value brought by the successful companies will far outweigh the losses from those that failed.
Through communication with industry veterans, I've learned from a quantitative perspective that the most profitable funds are likely A-round funds, as the risk is somewhat controlled and there's still significant growth potential. Therefore, it's advisable to continue investing or follow-on investing in those projects that prove their "potential" and "team" are correct at the A round. This ensures the overall fund's return rate. If possible, continue investing in companies from the A to B rounds, and then to C rounds. This forms a pyramid-shaped investment strategy: casting a wide net from the seed stage, decreasing the number of projects and increasing quality at each round, continuing to follow up, eventually leading to 1-5% of companies going public, but maintaining a 10% or higher stake in these companies for substantial "return rates".
Inspired by this, PreAngel has implemented two strategies to test this methodology:
First, internal fission, allowing qualified angel investors within PreAngel to establish their own independently-decided sub-funds within the PreAngel system. This fission strategy enlarges PreAngel's fund size, improves decision-making efficiency, and expands our investment scope and seed round investment base. Thus, we have independent PA sub-funds like Shiwei Capital, Galileo Capital, and Rongming Capital, managed independently by partners like Zhang Jun, Hu Wei, Gu Hao, and Cui Huishen.
Second, establishing PreAngel's first A-round follow-on fund (He Duo Capital), managed by me, allowing the PreAngel fund family to doubly enjoy the value appreciation brought by project growth, securing the overall fund profitability.
In the future, PreAngel might also have B-round, C-round, and even IPO funds. Comprehensive full-stage investment capability is our goal and the convergence point for various funds in the future (many PE and VC firms are now entering the angel investment stage).
A few days ago, Amazon CEO Jeff Bezos said in his shareholder letter:
"Ten ventures might fail nine times, but if there's a ten percent chance of a hundredfold return, bet everything every time."
This statement reveals the essence of angel investing and tech entrepreneurship: "Though the success rate is low, the return rate, once successful, is virtually limitless." This is what distinguishes angel investing from gambling.
If I were to summarize angel investing in one sentence, it would be:
"In front of the market's hundred-billion-dollar waves,
Bet on a multitude of tide players;
Then cultivate oneself, waiting for the return of time,
Awaiting the miracle of compound interest."
This is PreAngel's investment methodology, hopefully offering insights to others.