Last Updated on April 10, 2024 by admin
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2023 was undoubtedly rocky for the startup world. There’s a widely known saying attributed to Baron Rothschild, an 18th-century British nobleman and member of the Rothschild banking family that “the time to buy is when there’s blood in the streets” to which Warren Buffet has added: “Be fearful when others are greedy and greedy when others are fearful.” Both of these hold true in traditional and angel investing.
But is there blood on the streets yet? And if so, how does this affect angel investing?
As we’re nearing the end of Q1 2024, let’s take a look at whether the economic downturn and high inflation are good news or bad news for angel investors.
Are things as bad as they seem in the startup world?
We’ve previously written about the tech sector’s mass layoffs, as well as the post-covid startup landscape. The verdict still holds – this is more of a correction than a collapse.
After the initial COVID shock, money pumped into startups skyrocketed. At the end of 2022, after one hell of a ride, this rocket landed back to pre-covid ground. We didn’t have a crash, but we definitely had a boom before. When the boom ended, the tech sector was forced to tighten its belt causing mass layoffs and recalibrations along the way.
And even though the cutbacks and layoffs can seem worrisome, they’re good news to the investors and the tech sector in general. When the market is booming, assets are often overpriced. Economic downturn bursts the bubble of startup valuations and helps separate the wheat from the chaff.
When others panic, it can open up many opportunities for investors who can stay rational and focus on the long game. The startups are struggling to weather the economic storm which means investors can potentially find good bargains.
When investing during an economic downturn is so great, why isn’t everyone doing it?
Angel investing during an economic downturn isn’t for the faint-hearted – the faint-hearted are panic-selling. Rough times aren’t just a post-holiday sale in the startup section. It’s a matter of survival for the startups, and rough waters to navigate for the investors as well. These times call for even more thorough due diligence and sticking to your investment strategy.
Do you have what it takes to invest during tough times? Here are 5 telltale signs.
Risk tolerance – angel investing is risky as it is, angel investing during a downturn is even riskier. You should be comfortable with the potential losses, bad news, and market fluctuations.Financial cushion – as per usual, only use funds that you can afford to lose. Have enough cushion to take potential losses or hold on to your positions a lot longer than usual. Portfolio resilience – it’s especially important to manage risks. Make sure your portfolio is well diversified to avoid getting hit too hard. Expertise and experience – you can’t call yourself an experienced investor unless you’ve sailed through at least one recession. The more experience you have, the better you understand the market, companies’ viability, and the inevitable truth that this, too, shall pass. Emotional resilience – market volatility tests the investors’ greed and fear, aka the ability to stay calm and rational, and resist the temptation to make impulsive decisions.
Pros and cons of economic downturn for the angel groups
But how do inflation and economic downturn affect the angel groups? It largely depends on your group’s experience, confidence, and ability to weather the storm. When other investors are hesitating, it can leave more attractive opportunities to you. Yet, there’s no use of those opportunities if you don’t have enough capital to seize them.
Here are the pros and cons.
Pros:
You can get a bargain – startup valuations become a lot more attractive for investors, meaning they can acquire larger equity stakes in promising companies at a lower cost and earn higher returns when the market recovers. Investors are more invested – without the hype and FOMO, investors have more realistic expectations about the returns. They’re also in it for the long run with their portfolio company, helping foster long-term relationships and provide additional value. It’s a learning and networking opportunity – as we said, thorough due diligence is especially important during uncertain times. It’s always a good idea to share the workload of due diligence, but collaborating within the startup ecosystem can help both improve your results and connect with like-minded investors and entrepreneurs.
Cons:
Filling rounds is harder – it’s only human that many investors get scared during high inflation and economic downturn. Or even if they’re not scared, it can cut back the capital available to them. Also, fewer new members join the investor community altogether. All in all, filling rounds can be a lot harder for the syndicates. Exiting investments is harder – during tough times, achieving growth and generating revenue is a challenge for startups. At the same time, inflation can increase operating costs, affecting the overall profitability even more. This makes it harder for investors to exit their investments, at least with considerable returns. Portfolio companies can struggle – with reduced profitability and higher inflation, the risk of startup failure and losing the invested capital completely is very real.
In conclusion, the impact of an economic downturn and high inflation on angel investor syndicates is a mixed bag. While it’s easier to access better deals and the deal quality can be higher, there are also significant challenges, such as reduced fundraising prospects and increased risk. Investing during a downturn isn’t for everyone and it largely depends on the investors’ risk tolerance, investment strategies, and specific conditions in their startup ecosystem.
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