How to Angel Invest, Part 2

The episode begins by discussing the importance of judgment in angel investing. The speaker emphasizes that judgment is crucial for building a successful portfolio, attracting other investors, and maintaining a strong brand. They explain that judgment is more important than access to deals or capital. The speaker also highlights the Dunning-Kruger effect, where people with poor judgment often fail to recognize their own limitations. They emphasize that judgment is a long-term process and it takes years to determine if someone has good judgment.

The speaker outlines a two-step process for improving judgment in early stage investing: calibration and improvement. They explain that diversification is a hedge against a lack of knowledge, especially in the early stages where data is limited. The speaker compares the judgment required for seed stage investing to playing the lottery, where investors can increase their odds by using their judgment to identify potential winning numbers. They emphasize that judgment is a long-term game and requires a portfolio effect.

The speaker addresses the concern that deals move quickly in the seed stage, leaving little time for careful judgment. They argue that with experience, investors develop an instinct that allows them to make assessments with less data. They also discuss the FOMO effect, where investors feel pressured to make quick decisions, and how the best investors are immune to this pressure. The speaker shares their personal rule of a 24-hour cooling-off period even after deciding to invest.

The speaker addresses the argument that judgment is overrated in the seed stage due to the prevalence of pivots. They explain that while pivots occur, they are typically within the same broader market and involve keeping one leg of the business in place while moving the other. They emphasize that judgment still applies in evaluating the team, execution, and market potential, and that valuations and cash planning should reflect the possibility of pivots.

The speaker provides examples of successful companies that underwent pivots, including Twitter, Instagram, Slack, Uber, and Lift. They argue that some of these changes were not true pivots but rather extensions or steps. They highlight the importance of betting on great individuals who stay within their space, even when they pivot. The speaker also emphasizes the importance of betting on exceptional individuals like David Sachs and Stuart Butterfield, who have a history of success across different ventures.

The speaker discusses methods for calibrating judgment in angel investing. They acknowledge that it takes years to determine if an investment was successful, and that the industry evolves rapidly. They suggest looking at intermediate markups by later stage investors as a potential metric, but acknowledge that this is a Keynesian beauty contest where investors are rewarded based on the preferences of others. The speaker also suggests looking at the investors who join a round after you as a proxy for your judgment.

The speaker advises investors to ask others for feedback on their weaknesses, rather than asking if they have good judgment. They emphasize the importance of surrounding yourself with people who have good judgment in all aspects of life. They describe the characteristics of people with good judgment, including humility, critical thinking, broad knowledge, a low ego, and a willingness to be unpopular. They also warn against groupthink and over-socialization of judgment.

The speaker discusses the nature of great deals in angel investing, which often appear strange, socially unacceptable, or niche. They emphasize that the best deals have something broken, strange, or different about them. They use the analogy of the fine line between genius and madness, where both may appear crazy until validated. The speaker advises investors to be iconoclastic enough to recognize genius founders without letting in too many crazy ones.

The speaker provides an example of a fund, Promonos Venture Capital, that invests in experiments in governance, such as new city states or localities. They argue that these investments, while seemingly difficult, have the potential for huge returns if they stumble into the next Singapore or Hong Kong. They emphasize that these non-consensus investments benefit from a unique brand and the potential for exceptional returns from a few genius outliers.

The speaker discusses the importance of identifying fatal flaws in deals. They advise investors to be wary of deals with more than one fatal flaw. They emphasize that startups are rewarded for innovating on something new, and that those who try to innovate on existing things are taking on additional risk. The speaker uses Uber and Google as examples of companies that broke the rules and were successful. They highlight the importance of understanding technology to identify which rules can be broken.

The speaker emphasizes the importance of humility in angel investing, advising investors to be comfortable saying "I don't know." They argue that conviction should be reserved for a few select deals, and that even then, investors should be cautious about the level of conviction they have. They also discuss the relationship between conviction and access, suggesting that the better the deal, the less access you will have.

The speaker warns against chasing hot markets in angel investing. They use examples like consumer social and food delivery to illustrate how investing in a hot market at the tail end can lead to losses. They emphasize the importance of being at the beginning of a market, not the end. They also discuss the importance of timing in crypto investing, highlighting that the early market was in 2009-2015, not 2017.

The speaker warns against the trap of fantasizing about what you could do with a company instead of listening to the founder's vision. They emphasize that the founder is the one running the company, and that investors should take them at their word. They explain that this is the opposite of value investing, where investors look for companies that even a fool can run. In startups, the founder's involvement is crucial for value creation.

The speaker discusses multiple ways to build judgment in angel investing. They emphasize the importance of experience and reading great works that intersect science, business, and philosophy. They also highlight the importance of building specific knowledge within a field by diving in and learning everything as quickly as possible. They advise against relying on news sources like TechCrunch or Bloomberg News and encourage investors to go to the source, which often includes research papers.

The speaker emphasizes the importance of understanding science and technology in angel investing. They encourage investors to read scientific papers, brush up on their mathematics, and stay informed about scientific journals. They also advise investors to connect with and invest in the smartest scientists in their field, even if they don't necessarily make money. They explain that these scientists can perform due diligence, validate deals, and refer the best scientists to the investor.

The speaker highlights the value of surrounding yourself with honest and distinguished scientists and technologists. They explain that these individuals tend to be no-bullshit and will provide objective feedback on new technologies. They acknowledge that investors need to use their own judgment to calibrate when these experts are being overly negative or jealous, but emphasize that technical people are often more objective due to their experience with real-world scientific results.

The speaker proposes breaking down judgment into four categories: team, product and market, traction, and social proof. They emphasize the importance of investing in technology teams with a strong technologist as part of the core founding team. They also discuss the importance of having strong sales and community building skills within the founding team.

The speaker outlines Warren Buffett's three-part test for evaluating teams: high energy, high intelligence, and high integrity. They explain that high energy is essential for startups, which are like the Olympics of business. They emphasize the importance of high intelligence for making sound decisions and set a high bar for intellectual caliber. They also highlight the importance of high integrity, warning against investing in smart and hardworking crooks.

The speaker discusses the difficulty of assessing integrity in founders, but suggests looking at how they treat others, including co-founders, employees, and investors. They emphasize that niceness is a signal that can be easily faked and that integrity is tested when the stakes are high. They also argue that coachability is an overrated metric, as great founders often listen to advice but follow very little of it.

The speaker advises angel investors to avoid putting too much money into any deal that they will care about if they lose it. They explain that your reputation is built in the companies that are doing poorly, and that your long-term returns are influenced by how you behave with founders when things are tough. They also discuss the art of reference checking, warning that it is something most people do not do well.

The speaker emphasizes that founders are non-fungible and that a founder who is great for one business may be terrible for another. They explain that references tend to be more generic and may not be as helpful for evaluating founders as they are for evaluating employees. The speaker shares their personal experiences of passing on Twilio and Ethereum early on due to negative references, highlighting the limitations of this approach.

The speaker warns against relying on references from VCs, as they often have different perspectives and may pass on deals that other firms pursue. They emphasize the importance of developing an independent point of view and avoiding groupthink. They also highlight the negative indicator of a team that hints at selling the company early, as this suggests a lack of commitment to long-term growth.

The speaker emphasizes that angel investing is a game of exceptional outcomes, not averages. They argue that investors are better off with a portfolio where a few investments generate huge returns, even if most go to zero. They discuss the concept of a "grand slam business" where investors are looking for extreme outliers. They also explain that investing in companies where the founder is likely to sell early can lead to missed opportunities for compounding interest and reduced downstream investment.

The speaker discusses the ongoing debate about first-time founders versus repeat founders. They acknowledge that most of the value in the industry is created by first-time founders, but also recognize that many of these founders have prior experience with projects that didn't succeed. They explain that repeat founders tend to be better at execution, recruiting, and market selection, but may lack the passion and specific knowledge of first-time founders.

The speaker discusses the "sweet spot" of repeat founders who have had a previous success but haven't lost their first-time founder mentality. They use the example of a team that failed with a robot project but is now coming back with a renewed determination and access to new technology. They argue that these bets can be very interesting, as they combine the experience of repeat founders with the passion and drive of first-time founders.