What is Angel Investing?
Note: This article was originally written and published for DailyDAC as the fourth installment in a series of articles.
Outside of the founders, and friends & family, angels are the most typical next step in the private equity continuum as shown below in Illustration 1. Whereas 79% of a first round capital came from the entrepreneur’s personal savings or family and friends, this made up only 11% of the second round, whereas angels provided 34% of the capital in the second round#. Angels provide the critical capital needed by an entrepreneur to grow the business and with venture capital funds to provide the next stage in capital. Angels are individual investors, sometimes organized within informal clubs or formalized angel groups, who invest their personal money into a company. Angels are distinct from venture capital or private equity funds, who have created investment partnerships that manage a pool of capital, typically with a significant portion from larger institutions such as insurance companies, pensions, and endowments.
Angels come in all shapes, sizes, as well as quality. Their experience, their financial ability to fund, and their ability to add value to a company is quite varied. One of the key aspects of an angel is whether such an individual is qualified as an accredited investor. In short, as defined by various securities laws, there are criteria by which individuals are measured against to see about the appropriateness for them to be investing in high risk opportunities, with small private companies being a key sector. When a company is raising capital from outside individuals, it will require the investor to complete an Investor Questionnaire that will qualify them as an accredited investor. Being an accredited investor does not necessarily make that person a better investor, but it is important for complying to securities regulations, for managing the communication with investors, and in working with future investors, notably venture capital investors.
From a company point of view, restricting investors to accredited investors or limiting non-accredited investors allows the company to comply with securities regulations and helps to reduce the additional burdens that would be required with respect to disclosure and the amount and frequency of information that would need to be shared. In addition, each additional investor brings with it administrative and other ongoing support, and by limiting the number of investors, especially ones where the loss of their investment may be particularly impactful on their life (typically non-accredited investors) or those that are just plain needy, the time commitment and difficulty servicing the investors will hopefully be reduced. Lastly, venture capital investors prefer “clean” cap tables (the schedule of ownership in company), and as such, entrepreneurs are encouraged to limit the number of angels, especially as this helps to reduce the complexity and difficulty in reaching and get investors to respond to any required shareholder approvals.
Investments from angel investors are significant, and have historically been at relatively comparable levels invested by venture capital firms. According to Angel Capital Association, there are approximately 330 angel groups in the United States and Canada. According to both the UNH Center for Venture Research and PWC Money Tree, angels invested $26 billion into 57,000 companies in 2007, most of which were early-stage. By comparison, institutional venture capital firms invested $30 Billion in 3,918 deals, most of which were at a later-stage. It is estimated that there were 258,000 active angel investors in the U.S. in 2007. The Angel Capital Association is a convenient way to search for angel groups, by both geography as well as sector areas of interest.
The typical angel according to a 2007 survey from the University of Washington is male (86%), middle-aged (57 years old), college educated (99% with degree), with an advanced degrees, and has a significant amount of entrepreneurial experience (14.5 years), with the founding of several companies (2.7 companies founded). As always, as an activity gets more mature, the standard changes, and as such, there is a much greater influx of female angels, and given the great success of recent companies with select examples of Google, Paypal, and EBay, there are a great number of younger angels to balance their more experienced and more gray brethren.
One of the largest trends in angel investing has been the growth in angel groups. There were approximately 100 in 1999 and with this number reaching 300 by 2009.# Groups typically invest $100K-$500K in a deal, and with recent surveys showcasing that the average investment is in the mid-$200K, and that there are multiple groups syndicating investment. Groups for the most part invest locally, but with some groups have chapters either across a state or even across the country, the ability to invest nationally or internationally has become more comfortable. There is a membership fee typically associated with participating in an angel group. A brief summary of benefits to angels of belonging to a group include:
- Strong deal flow
- Established procedures for screening and due diligence
- Experienced set of individuals involved in early stage investments
- Diverse set of experiences and domain knowledge
- Ability to have multiple people conduct due diligence
- Greater financial capability allows for better investment terms
Next Installment: Learnings from an Angel