Neil Patel here. Today, I want to talk about the biggest mistake you could make as an angel investor.
When I first started out, more than ten years ago, I made a few choices that I wish I could go back and change.
Don’t get me wrong. I was still making good returns on my portfolio.
But I did put my money behind a couple of projects that didn’t quite flourish. Those cut into my bottom line.
I didn’t start making amazing returns until a few years later – once I honed my approach.
Those underwhelming investments taught me a critical lesson.
In fact, it’s the biggest piece of advice I can give you, as a fellow angel investor.
That’s why you’re here, after all – to learn from my experience, mistakes and all, so you don’t have to make them yourself.
Here’s what held some of my earlier investments back: the total addressable market (TAM) was too small, stunting revenue growth and undercutting my ROI.
Let me explain.
The total addressable market is basically the maximum revenue opportunity available to a business.
So, if you’re building a business that delivers ice cream sandwiches by drone in San Francisco, your TAM might be influenced by the following factors:
If you do that math, you end up with a TAM of $31,129,472 annually.
884,360 x 0.80 x 0.50 x $22.00 x 4 = 31,129,472
That’s not bad, but $31 million a year in revenue is small beans when you only own a tiny piece of a company.
Now suppose that the startup has a sound, actionable plan to expand. They intend to deliver to the entire United States.
Your multipliers will change a bit – outside of metropolitan San Francisco, an app like this is sure to do less business. For example:
These are rosy estimates, possibly influenced by my own love of ice cream sandwiches. A business like this, delivering just one product, would be unlikely to succeed in a world where consumers expect products and services to multitask. Not to mention the high cost of drone deliveries in rural America, where property lines can be several miles across.
But for the sake of explanation, let’s go with it. Even with lower margins, expanding nationally bumps our TAM up to $3,973,050,000.
That’s 127x more revenue… and a return on investment you’ll want to write home about.
Today, I only invest in startups with a huge TAM – a billion dollars or more.
Of course, every once in a while, you’ll come across a startup with a pretty small TAM that you’ll want to invest in anyways.
That’s okay too. The beautiful thing about angel investing is that it can be about more than just the money.
There are other types of “returns,” besides cash, that you can reap from this game (more about that here).
In fact, most angels will occasionally fund a “passion project” or two.
But the billion-dollar businesses are the ones that will make you your fortune.
So, when it comes to your core portfolio, always stick to startups that have the potential to grow really, super, insanely huge – startups with a big TAM.
Until next time,
65 responses to “The Best Lesson I Learned in Angel Investing”
March 24 2019