I was recently talking with another member of LinkedIn’s founding team.  It’s been awhile since we worked together on a daily basis so a lot was just general catch up, but one of the primary reasons for our chat was that this person was starting to become a more active angel investor and was just looking for feedback.  I’ve had similar conversations in the last year or so with other folks looking to begin, or ramp up, their activity as angel investors.

I think the most important thing any new angel investor can do is to candidly assess their motivations for making startup investments.  Angel investing, particularly for entrepreneurs and others who’ve chosen a startup career path, can be rewarding in many different ways.  But really understanding yourself and what you’re hoping to get out of angel investing is critical… without candidly defining what “success” is, you’re unlikely to reach your goals.

There are broadly 5 reasons for individuals to invest in tech startups:

1) Pure ROI & Asset Allocation – Very successful angel investors can generate substantially better returns with their startup investments than most other asset classes.  For some angels, this pure return on investment and the diversification it can bring to an overall asset allocation is the main motivation.  But the reality is that on average, most angel investors are not highly successful in terms of their angel investment returns.  In addition, investing in startup tech companies turns out to provide only a modest level of diversification… angel investments tend to form a high beta portfolio, with reasonably close correlations to public equity markets.

If ROI and asset allocation are the sole objective for an angel investor, then they may be best served investing in late stage startups via secondary markets or investing in a VC fund (if they have access to high quality funds) rather than trying to find and pick a bunch of early-stage startups to invest in.  That’s not to say that angels primarily focused on ROI can’t do great on their own… many have, but again a large number do not and a would-be angel just starting to invest in startups would do well to ask themselves if they have an unfair advantage in finding and selecting great startup investments (topic for another post sometime).

2) Gain Market Insight – Another reason to invest in early stage tech startups is to gain additional market insight and connections to the entrepreneurial community.  This can include learning more about technologies, markets, and people that may be impactful to the angel’s other endeavors.  As a VC investing not only personal capital, but on behalf of limited partners, one can’t take this strategy.  My NextView partners & I have a fiduciary responsibility to invest and manage our LPs money… we cannot look them in the face and tell them “We lost a ton of dough on a bunch of companies, but man… we learned a bunch along the way.”

But as an angel one can overweight this factor.  Such insight tends to be most useful to entrepreneurs and startup types, since keeping up on new innovations and staying plugged in to new generations of founders can help them bring greater perspective to their own startup (or a future startup).  But I know a handful of angels who focus mainly on public market investing (either as part of a hedge fund or institution, or for their own account) who feel that learning about early-stage companies and trends as angels makes them better public investors.

While I believe that you can learn something from failure, I fall squarely in the camp of those who feel that startup successes teach you a hell of a lot more about generating future success.  So to the extent you invest in some great companies, you’ll probably be more successful in achieving your goal of gaining insights or connecting with great entrepreneurs that help you with your own startup.  But for angels primarily focused on insight, the scale of their investments matter less than having a more diversified portfolio and taking the time to connect with the startups they invest in (e.g. totally passive strategy won’t teach you much).

3) Pathway to VC Role – Many former entrepreneurs who ultimately become VCs had at least some experience as angels prior to joining a VC firm or starting their own firm.  If a path to a VC career is a primary motivator, then of course generating good returns is part of this.  But in this case an angel probably needs to focus on who the syndicate partners are in a particular investment, and also be sure to be an angel in large venture scale companies… even if they’re investing in a Ser B or Ser C round instead of a seed round.

4) Help Friends / Community – For angels who are successful entrepreneurs themselves, supporting former colleagues and/or the broader startup community can be a motivation for angel investing.  Most folks in this camp don’t think of this as “charity”… they’re not looking to lose money on their startup investments.  But if “paying it forward” or helping people who helped them build their own companies is a factor, then success may hinge more on impact on funding would-be companies than on pure ROI.

5) Something Interesting to Do – Finding an intellectually stimulating way to spend time is a perfectly legitimate reason to angel invest.  For some this is as good a way of “spending” money as doing anything else, and for these folks the best approach is simply to find businesses that appeal to them to invest in.

The reality is that none of these is really mutually exclusive, and most angels are motivated by some combination of them.  The primary motivation can inform the optimal strategy to some extent.  But the most important thing is to ask the question of what motivates you as an angel, because this will ultimately help you both define and maximize the chances of success.  Once you’ve done that, the next thing to do is to figure out what your angel “superpower” or unfair advantage is and how to put that to work (topic for another day).