Angel Investing in a Bear Market

With interest rates rising, recession looming in some economies, and capital markets in freefall, the thought of investing in early-stage companies might seem daunting. A flight to quality is the reaction for many - but what asset classes are safe? As inflation rates rise, are cash and bonds really a ‘safe’ investment?

Most angel investors allocate a small portion of available capital into early-stage investments, leaving 90%+ of their assets in regulated markets or property. As a result, most angel investors will have less capital available during down markets and are less likely to sell down to buy high-risk startup investments or even look to reduce exposure.

However, this may be the best time to consider increasing your exposure to early-stage investment opportunities to capture more value as the economy recovers from the recessionary cycle. For example, according to one of the leading investment firms in early-stage innovation, Ark Invest, innovation is not in a bubble, but rather “innovation solves problems and is expected to transform human lives at an accelerated rate during the next five to ten years.”

The current recession and bear market will not stem the flow of innovation but may slow its ability to enter markets and scale sufficiently in the short term.  Investing now and helping startups be ready for the economic recovery will ensure that they are well positioned to take advantage of the improving market conditions.

Angel Investing is a long game anyway, typically 5 to 7 years, and your entry price will determine the likely size of your returns if the startup is successful.

At the moment, if you’re angel investing during a bear market, you will probably find valuations closer to the bottom of the range rather than the frothy values in 2020 and 2021. Conversations with startup founders about sensible valuations are now possible, grounded firmly in their stage of development, rather than the hype of other frothy cap raises and comparable exits.

What investments should you look for during a down market?

You could look at what sectors do well in a recession. Healthcare, food, consumer staples, and basic transportation are examples of relatively inelastic industries that can perform well in recessions.

Some industries do well due to changing patterns of consumption, such as the willingness to change solutions to save money or gain efficiencies.

Although with startup investments, you need to be cautious of the timeframe. Most early-stage startups are 2-3 years away from scaling their product into a market and may be too late to take advantage of recession-based consumption changes.

According to economic data, recessions typically last between 8 to 18 months, and we are already some way into the bear market.

" Most simply looking at history suggests that we are already some way into the bear market. An analysis by First Trust of bear markets since 1942 finds that the average decline in a bear market is -32%, which would correspond to the S&P&500 falling to around 3,300 or about another -12% from current levels, and the bear market lasting about a year. That would suggest the bear market would end around December 2022. But, of course, keep in mind that we’re already some way into a bear market."

Therefore, rather than chasing recession-proof businesses, you best to stick with the sectors and thematics you already know and set your investments before the market turns.

What should you pay attention to when investing in early-stage startups?

If you are making new investments during a capital-constrained period, there are some due diligence items that you should pay more attention to:

• Runway / Burn-rate: it may be difficult for the startup to raise again in the short term, so you need to ensure that the startup is raising sufficient capital to get to cash flow positive or to a value inflection point to make the next round compelling.
• The walking dead - is the startup destined for failure and the recession/ capital market just brought this into focus. So the measure I would focus on is growth - has the startup consistently grown in terms of users, revenue or another significant metric to show that they are progressing?
• The resilience of the founders: checking with the Founders to see how they are holding up under challenging conditions and g them with the reliance to get through difficult times
• Founders dilution - since valuations are lower, the founders may accept much a higher dilution to get enough cash in the door. Think this through, and ensure that the Founder is not diluting themselves to the extent that future investors will question the Founders’ commitment and skin in the game.
• Support from the investor group: are existing investors willing to support the startup alongside the new investors?

If you are an angel investor, it is time to show support for your current investments. However, when capital raising is challenging, support from existing investors will create the conviction and momentum for new investors. Even better, if existing investors are willing to fill the round, it will provide a better story for future cap raises and underpin valuations.

Happy investing!

If you want to learn more about Angel Investing, we would love to have you along to our AngelsBootcamp in August. Register here: https://lu.ma/angelsbootcamp22