August 23, 2011
Editor’s Note: This guest post is a three-part series on angel investing. Part I introduces angels and angel groups, Part II focuses on the due diligence process and the post-investment relationship, and Part III breaks down angel investing for entrepreneurs.
Angel investors, or angels, are usually wealthy individuals and “accredited investors” who provide capital for startup companies in exchange for convertible debt or, usually, an equity stake in the company. Angels are investing “mad money” that doesn’t change their lifestyle if spent and tend to make their own investment decisions, unlike professionally managed firms. The average net worth of angel investors tends to be greater than $1 million; there are approximately 250,000 angels in the United States.
Motivations for Angel Investing
Angels sometimes tend to be former entrepreneurs who are interested in getting involved either actively or in a passive mode in the startup community. Early stage investments are high risk, and angels undertake the process because they typically look for more than just making money. Their motivations are a blend of:
- Return on Investment
- Staying involved
- Giving back to the community and/or a personal connection
- Affection for entrepreneurs (usually having been one before)
Type of Angel Investments
Angel investors usually invest their money to get an equity stake but will also do convertible debt, which is becoming more popular these days. Convertible debt is a bond that has both equity and debt features, and, at the simplest, it is a debt that converts into equity in the subsequent financing round.
Comparing Angels and VCs (Venture Capitalists)
Venture capitalists (VCs) definitely outpace angels in deal size when looking at individual deal comparison. Angel investors look at true early stage deals and focus on investing in the earliest stage companies. As companies grow, the capital needs tend to be too large for angels to satisfy.
Angels provide about 90% of the seed and early stage outside equity capital for startup entrepreneurs. VCs tend to do fewer early stage deals not because of poor ROI but rather because they have too much money to invest. Venture capital funds have 10 year life, and the fund needs to be exited in 10+2 years.
According to data from the National Venture Capital Association (NVCA), returns from seed investments grow exponentially after 15 years, and thus the timing of these outcomes prevents a lot of seed stage investments by VCs.
There are more angel groups than small VCs who do tend to focus on seed and early stage investing. Angels or angel groups tend to put smaller dollars in larger number of companies and are more local compared to VCs who tend to have a regional focus.
Here’s a comparison of the angel and VC activity in 2010:
|Angel Investors||Venture Capitalists|
|Amount invested||US $20.10 billion||US $21.97 billion|
|Number of deals||61,900 deals (apprx.)||2,750 deals (apprx.)|
|Number of investors||~ 265,400 people||462 active firms|
Angel investors help fill the funding gap from company inception to growth capital, and, as the chart indicates, VCs are critical to the landscape. “Angels can be great participants in venture rounds, but it’s generally better to have a VC lead those deals, as they have more financial and other resources required to build the company,” says Ben Horowitz, partner at Andreessen Horowitz. However, emerging “super angels,” or micro-VCs, tend to function almost like VCs and have the ability to get investment rounds together quickly.
Angels join groups mainly to ease the pain of solo investing, i.e. for factors like convenience, variety, education and community. Dividing the due diligence work among multiple angels eases the pain while also providing a variety of vertical experiences. The deal flow is definitely larger in volume and of higher quality when sourced as a group.
Joining an angel group can also be motivated by a desire to learn about new trends and sectors in the marketplace and thus diversify the angel portfolio. There is also great camaraderie and networking opportunities for like-minded angels interested in expanding their local startup ecosystem.
Some common models for angel organizations are:
- Angel Funds: Member money is pooled and deals are invested in based on the vote of the membership. They are led by a paid manager and formed as an LLC.
- Manager-led Angel Networks: A Manager tees up deals for the members to then make individual investment decisions. The managers carry a substantial management load and get compensated through a variety of means including carried interest.
- Member-led Angel Networks: Members take the lead on administering and managing deal flow, but they make individual investment decisions.
To prevent potential moral hazard, some angel groups have strict codes of conduct that state if a member yanks a deal out of the angel group pipeline due to personal interest then it will be the last time that the member invests with the group or is allowed to participate.
The number of angel investors who are women tends to be low – in 2010 only 13% of angel investors were women. This is an issue that the Pipeline Fellowship attempts to address. The perception is that women have been more comfortable with certain verticals like fashion, retail and education. Their investment structures have tended to involve developing companies from their background and passion, like social entrepreneurship or impact investing.
“One of the major values of women in the investment arena is that we’re consumers,” says Natalia Oberti Noguera, founder of Pipeline Fellowship. “So with more women in the decision making process, the products and services that are going to be coming through the pipeline are simply going to be better.”
Ways to Become an Angel Investor
Angel organizations have grown to become an important source of seed and startup capital to entrepreneurs all over the U.S. Investing is a learnable and discoverable process, so anyone with the disposable income to spare can become an angel investor. Angels can start investing at an individual capacity first, and if you are moving forward with multiple angel deals, you can then create a legal entity (LLC preferably) to allow for:
- Additional layer of protection
- Other co-investors provide return flow flexibility
- Different voting and governance structures
Alternatively you can get involved in a local angel organization. Here is a listing of all the angel groups in the U.S. and Canada compiled by the Angel Capital Education Foundation. If you would like to start an angel group, the Kauffman Foundation also has a seminal guide titled ‘A Guidebook to Developing the Right Angel Organization for Your Community.’
All angel investors should definitely look into AngelList, a great online service that acts as a matchmaker between promising startups and early stage investors. It also provides a great community for both investors and startups categorized by location, markets of interest and social proof.
More Information: The majority of content for these articles was gathered from a conference on angel investing hosted by Pipeline Fellowship, an organization that trains women to be angel investors and is committed to investing in women-led for-profit social ventures. Pipeline Fund is now accepting applications in NYC and Boston. Women: apply or nominate your female friends and colleagues. The deadline is Monday, August 29th.
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