7 mistakes first-time angel investors make

A lot can go wrong if you’re not careful about where you make your angel investments. Making these mistakes is certainly going to force you to learn real-world economics the hard way, but if you’re not too friendly when met with big risks and losses, it becomes necessary to avoid making these mistakes in the first place.

We did some research on where inexperienced angel investors could go wrong when making first-time investments. Here’s what we came up with.

1. Investing outside your main expertise

While it’s good to diversify your portfolio, it’s a major mistake to invest heavily in industries you have no knowledge or experience in. Experts advise against investing in such domains. However, if you still prefer to add a little more diversity to your portfolio, make sure these are low-risk opportunities and close to your area of expertise.

2. Signing documents without a lawyer

We’ve all watched The Social Network, and even if we haven’t, we’ve probably heard about Mr. Zuckerberg’s friend, Eduardo Saverin, the original CFO of the business. Mr. Saverin was “screwed out” of a huge chunk of his Facebook stock owing to a contract clause Saverin failed to interpret. Signing any business deal without a lawyer is bad idea.

Also, make sure the lawyer is experienced in business law and finance.

3. Under diversifying

While you don’t want to diversify too much, particularly in domains that are not in your area of expertise, you want to avoid putting all your eggs in one basket. As an investor, you should be familiar with the concept of diversification to reduce risk. Experienced angel investors typically have investment portfolios with an average of 20 companies.

Also, where one start-up might run into a loss, another might be rewarded with high revenue and profit. This way, if one egg falls, you’ll still have another one (in another sector) to maintain the balance.

4. Investing at the first opportunity you get

Your first opportunity may be a good one, but avoid the urge to invest immediately.

The idea behind it is to wait until you can hear pitches from several different startups so that you can discern one from the other. When you think you finally have enough experience in hearing investor pitches, you can make your first swing.

5. Not doing your homework

A large part of making the right investment decisions deals with doing your research—and the right kind of research.

Avoid the urge to make a quick decision, regardless of how soon your investment may be required. The more in-depth your research, the easier it is to predict the outcome of your startup equity. Gather detailed information about the business and make sure you understand it. Look for startups where the entrepreneur is personally invested, has validated customers, is cash conservative, favors communication, and shows a strategic perspective.

6. Investing in the idea rather than the experience

Several first-time angel investors are focused on the idea rather than the profile of the entrepreneur.

It’s good to promote ideas, but there’s also plenty of risk involved in such investments, particularly if the startup entrepreneur has no prior experience. In many cases, a business founder with a mediocre idea, but who has had success in the past, is more likely to get returns than a rookie entrepreneur with big ideas but zero experience.

7. Not being committed