Angel Investing has become an increasingly popular source of capital for businesses — and an important first step on the way to more formal sources of capital, such as venture funding or an IPO. Here are some of the reasons:
• Most angels expect a lower rate of return on their investments than venture capital and other professional firms do. (A desire to double their investment in three years is not out of the ordinary for many angels, whereas VCs and other firms might expect returns that compound at more than 30 percent.
• Angel funding can often be obtained much more quickly than venture capital.
• Angel investors are often less aggressive in their demands for ownership and control of the business than venture capital firms are.
• The process of due diligence (where the investor checks out a potential investment) is less rigorous than in more formal funding situations.
For these reasons and others, finding an angel investor is often the strategy of choice for young and high-growth businesses that are looking for cash infusions in the range of $100,000 to $1 million — too small to land on the radar screens of venture capital firms and investment banks — but that do not yet have the track record to get this kind of money in the form of a bank loan or line of credit.
As much press as angel investors get these days, you’d think that they’re falling all over themselves looking for places to park their money. That is not quite the case. First of all, the universe of people with enough extra money to invest in fairly risky ventures is relatively small. Second, the recent dot-com meltdown has made many potential angels wary of investing in relatively risky start-ups and high-growth companies. That being the case, it pays to understand where you’re most likely to find angel investors and what kinds of investments they look for.
A rise in income and a robust stock market have created enormous wealth, at least for the top tier of U.S. taxpayers. That wealth has enabled individuals to set aside a portion of their capital for what are called alternative investments — investments other than securities and rated debt, including early-stage companies.
Angels have played an increasingly significant role in this sector because there are more of them, and they have more money than in prior periods — the wealth factor academics frequently cite. Personal wealth has a good deal to do with entrepreneurship. Data show that rising residential real estate prices stimulate the venture economy, as entrepreneurs and angels put their newfound wealth to work by borrowing against the value of their residences and putting the capital in emerging-growth opportunities.
Also, the celebrated wins in venture capital have drawn more players to the game. Reading about the sensational good fortune experienced by the early shareholders in Microsoft, Cisco, Intel, and the like has encouraged others to play. During the past 10 to 20 years, many major business successes have become angels — they are still fairly young, they aren’t ready to retire yet, and they want to keep their fingers in the entrepreneurial pie. Of course, this happy picture has been spoiled somewhat by the dot-com meltdown, but as the economy begins perking back up, angels will be back in force.
Finally, early-stage opportunities have pulled in angel capital because professionally managed venture capital has largely deserted the early-stage sector, preferring to go after bigger fish.
The dearth of venture capital for brand-new ventures opens up an opportunity for angel capital — nature abhors a vacuum. Angels, by and large, are not competing with professionally managed funds. That doesn’t necessarily mean that angels get good deals, but they do have the advantage of avoiding competitive auctions with prices spiking upward because of bidding from venture capitalists with more money than they know what to do with.
Just as the number of angel investors has been increasing during the past several years, so too has the average size of angel investments. A decade ago, the average investment size was in the range of $48,000 to $60,000. Today, that range has grown to an average investment size of $145,000. And even when angels pool their money and invest in syndicates, the size of the average startup deal is only about $600,000, raised from six to eight angel investors. The size of the investment often depends on the type of angel involved. First-timers like to put their toes in the water slowly; serial angels are semi-professionals — and they’re much more willing to invest larger sums of money in their chosen companies.