Understanding Angel Investors

Believe it not, angels do exist. The term was born on Broadway to describe individuals who put up the high risk, early stage seed money to launch Broadway productions. At the Center for Venture Research based at the University of New Hampshire, the term applies to individual investors who back emerging entrepreneurial ventures. Angels are the most likely investors for early stage, high risk companies that need relatively small amounts of capital to get started.

I define angels as self-made, high net worth individuals. They have substantial business and financial experience, and are capable of evaluating the merits and risks of investment proposals presented by entrepreneurs, environmentally-oriented or otherwise. They can invest know-how as well as capital in new ventures, which, for new entrepreneurs, can be more important than money.

Like professional venture capitalists, angels are willing to take substantial risks with at least part of their assets to earn substantial returns. Unlike the professionals, they are also willing to tie up funds for long periods to earn substantial returns. Angel money is often called “patient money.”

The two major sources of private equity capital for businesses are angel investors and venture capital funds.

Angels are the oldest and largest source of seed and early stage capital. The institutional venture capital market invests primarily in the later stages of a firm’s development.

Seed financing is relatively small amounts of capital given to prove a concept and to qualify for start-up capital. The money is often used to explore a concept before the venture starts operating. Start-up capital typically enables the venture to proceed from the research and development phase to initial production and limited sales, including the completion of product development and initial marketing.


Angels come from all kinds of backgrounds, and they tend to back ventures in areas they know something about. Many companies they provide with seed money will never get professional venture money, will never become publicly owned, and never will be acquired. But these companies will be good solid middle market companies with 50-100 employees.

Typically angels invest as a group; someone suggested I ought to call them choirs of angels. Usually five or six of them will get together to come up with the amount necessary to fund a business. On average, angels spend four months considering an investment opportunity, whereas venture capitalists take 5-6 months.

Angels, as opposed to their venture capital counterparts, invest across a wide range of industries. In the table below, investor activity is distributed fairly evenly over most industry sectors. Since angel investing is usually associated with high tech, there is little preference for the retail sector. Venture capital funds tend to rush to invest in a particular “hot” sector, only to see the sector decline due to over-valuation, too much money chasing too few deals, and other reasons.

Industry Sector Preferences – 2001
Software 16%
Electronic/Hardware 13%
Biotechnology 13%
Telecommunications 11%
Life Sciences
11%
Manufacturing
10%
Other Technology
15%
Retail 1%


According to research conducted by the Center for Venture Research, 60 – 70% of angel investment is seed or start-up capital compared to 28% of venture capital in the US, UK and Canada. Most fledgling companies don’t need the kind of money that venture capitalists spend – usually $2 million or more. The moral of the story: if you are looking for seed financing, look for angels.

Angel money is cheaper than venture capital money. One reason is that angels invest for themselves. They are not trustees for other peoples’ money as venture capitalists are. They can be motivated by individual “hot buttons” or what I sometimes refer to as psychic income. The majority of self-made individuals have a deep sense of social responsibility or sense of obligation to the systems that helped them succeed and they want to reinvest some of that enthusiasm into new entrepreneurs.

Therefore, they tend to look at factors beyond financial risk/reward. Investments might include helping a woman or minority entrepreneur get started; developing a socially useful technology; getting an inner city area revitalized; creating jobs in a community that has high unemployment; or developing an ecologically sound venture.

Many, if not most angels, are active investors. They may sit on the board of directors and be available for on-going consultation at a minimum. As a consequence of their active involvement, angels tend to invest in companies close to home. If you’re looking for angels, don’t look further away than say 50 miles or a day’s drive at the most.

Both angels and venture funds view the integrity and qualifications of the entrepreneur as their first criteria. Next is commitment. After that comes managerial competence. Angels look for “hot buttons” and solid underlying economics. The business has to make sense as a business. If you want to do something useful as an ecological entrepreneur, it’s got to be good economics and good ecology.

Most angels don’t invest as frequently as they could because of a lack of suitable business proposals. Entrepreneurs often are not “investor ready.” The most common problems are that entrepreneurs create business plans with overblown assumptions of the business concept and growth prospects, and the entrepreneur/management team lacks credibility. Angels in the UK say the biggest barrier is the difficulty of the investor and entrepreneur to agree on the total amount of funding needed.

How do you find these individuals? There are some directories on the Web. In some research we did, we obtained names from the State Motor Vehicle Department of owners of expensive cars. If were to do that again, I would try it a little differently. I’d go after registered owners of sailboats not powerboats, and instead of looking for Mercedes, I might look for Porsches. Because I find these people are active in most everything they do, whether it is their lifestyle or their investments. A substantial number of angels
I’ve come across are private pilots!

But really, you want an angel who is familiar with the market and/ or technology that you’re working with. Angels are kind of like trolls; you have to look under every rock and every bridge and hope one will crawl out. In summary, look close to home for someone who’s made it in a similar field to the one you’re in. Look on the boards of directors of similar businesses or non-profits.

Think of the process as buying capital, not as selling stock – a subtle, but important distinction. Don’t try to peddle an equity investment in your venture to anyone who will sign a check, because finding the right investor is crucial to the future of your company. You will go through some very rough times together and you need an investor who not only has financial resources to bankroll you, but has the know-how and emotional experience to support you. The last thing you need is investor fatigue or someone with a personality that clashes with yours.

Angel Activity in 2002
The Center recently conducted a survey analysis on angel investment groups throughout the U.S. 37% of 174 groups responded with the following results.

Overall, the angel investment market appears to be gaining in popularity. The number of angels participating in angel groups is on the rise. The average number of angels in 2001 was 129 per group, an 18% increase from 2000, and a 24% increase from 1998. But 41% of investors had yet to make an investment in 2001, compared to 36% in 2000 and 32% in 1998. Many new investors have stayed on the sidelines during the economic downturn. Because of the difficult economy, angels are finding they need to provide follow-on financing for companies they are already invested in, lowering the amount available for new companies.

For seed financing, the average size of an angel deal is US$800,000 (2001), up from $150,000 (1998). The average size of Canadian angel investments is at least twice the size of those in the US, which stems from Canadian securities laws that financially penalize smaller deals.

Individual Investor Profile


Characteristics

2000

2001

Total $ Invested/year $267,500 $134,792
Average $ Invested/deal/investor $95,750 $49,807
Average Equity Received/deal 21% 23%

54% of respondents classify themselves as an “organization that facilitates the angel investment process.” Other classifications include: “a group of angels that meet regularly to review investment opportunities” (36%) and “a formal matching service that matches entrepreneurs with angels (9%). No respondent classifies his or her organization as an Internet-only network, yet 11% report the Internet is their primary matching method. Venture forums are the most popular matching method (38%) followed by personal networks (32%). This is a testament to the hands-on nature of the angel market.

Co-investment strategies provide a mechanism for angel investors to cope with the high risk associated with early stage ventures. The average syndication size is six angels. 84% of respondents say they prefer co-investing. And co-investment is on the rise. In 1998, 75% of deals were syndicated – in 2001, 82% were.

While many private investors who entered during the dot com expansion have now exited the angel market, the size of the market appears to be settling at a level higher than before the 1999 surge, but lower than the peaks of 2000. A conservative estimate suggests there are 400,000 angels who are investing $30-40 billion per year in close to 50,000 ventures.

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Authors:

William Wetzel is Director Emeritus of the Center for Venture Research, based at the University of New Hampshire.

Jeffrey Sohl is Director of the Center for Venture Research and Professor at the Whittemore School of Business and Economics, U. New Hampshire. jesohl@christa.unh.edu

Bruce Sommer is a Research Associate at the Center for Venture Research. Bruce.Sommer@unh.edu

Center for Venture Research: www.unh.edu/cvr


This article is a combination of two articles from In Business Magazine, a SustainableBusiness.com Content Partner. The article is also based on information in a working paper by Jeffrey Sohl and Bruce Sommer with preliminary 2002 data.

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