Angel investors are changing. Here's what they're looking
for, how they operate, and (because the devil is in the exit strategy)
what they expect for their money
The phrase "angel investor" conjures up a vision of some kind of
saintly benefactor willing to take a flier on some whimsical notion of a
business that has little chance of success. Nothing could be further from
the truth. Angels invest for the same reason other people do: to make
money. They hope that some of their investments will reap them high
rewards in return for the high risks they are taking. They are well-off
people -- often former company builders -- who are willing to put anywhere
from $10,000 to half a million or more into promising start-up companies.
According to the University of New Hampshire's Center for Venture
Research, there were 225,000 active angel investors in the U.S. last year.
But until recently, angels have been difficult to identify. That's because
individual angels generally like it that way, if only because they aren't
terribly interested in having thousands of entrepreneurs flooding their
e-mail boxes with business plans or getting buttonholed every time they
attend a cocktail party. "Staying under the radar allows them to pick and
choose their sources for their quality deal flow," says Jeffrey Sohl,
director of the Center for Venture Research. "People find them anyway, but
the harder to find them, the better."
Now, however, angels are forming groups, at least in some measure to
become more visible to people with ideas. Angel groups are generally local
organizations made up of 10 to 150 accredited investors interested in
early-stage investing. In 1996 there were about 10 angel groups in the
U.S.; now there are more than 200. The reasons for this growth seem clear.
Investors benefit from a group's organizational structure, which can sift
through hundreds of business plans and select a few entrepreneurs to
present their opportunities to the group as a whole at regular meetings,
which are generally monthly. And entrepreneurs are able to identify local
entities that can evaluate their plans. Even if they don't make it to a
presentation, they can usually get some feedback on what they need to do
to improve their plans and businesses to increase the odds of getting
funding down the road.
The groups themselves are getting increasingly organized. Just last
year 46 investor groups formed the Angel Capital Association. The
association, which now has 89 member groups, wants to establish best
practices for angel groups, collect data, establish benchmarks, and
encourage individual angels to join groups.
The operational details of angel groups vary greatly. Most take
executive summaries or business plans by e-mail; sometimes the groups'
websites have a template for entrepreneurs to fill out. Usually a staff or
screening committee will select a group of businesses for further
investigation, and out of that bunch a few will be invited to present
before the entire angel group. (See "Mr. Cashman, You're On," page 100.)
In some groups, individual members make their own investment decisions
after the presentation. Other groups operate with a fund that is the
primary investment vehicle or that supplements the individual investments.
Angels like companies that appear likely to grow at 30% to 40%
annually and then be bought or go public. Don't show them a plan that
doesn't feature a way for them to make a profitable exit.
What are angels looking for? Simple, says
Jeffrey Sohl: high-growth companies, meaning companies that appear likely
to grow at 30% to 40% annually and then either be bought or go public. By
his estimate, 10% to 15% of private companies fit that description. The
problem, he says, is that "about 80% of the entrepreneurs think they're in
that 10% to 15%." Many angels and angel groups are flooded with business
plans that don't even feature a way for angels to make a profitable exit.
These won't pass the first screen.
Last year, according to the Center for Venture Research, 18.5% of deals
that got through early screens and were presented to investors attracted
funding, up significantly from 10% in 2003, which is about the historical
average, and getting dangerously close to the 25% that were funded during
what Sohl calls "the crazies of 2000." Sohl fears that if the rate
continues to rise, it could represent a flood of inexperienced angels
getting into bad deals. On average, each firm that received angel money in
2004 got $469,000. The lion's share went to high-tech companies, and the
single biggest category within high tech was software. Technology is where
the growth is, and it's where most angels made their money, so they're
investing in what they know. Another reason angel money tends to go to
technology companies: Businesses with assets, such as manufacturing
companies, can get collateral-based loans from banks.
The best time for an entrepreneur to seek angel funding, says James
Geshwiler, managing director of the Boston-area CommonAngels and chairman
of the Angel Capital Association, is when a business is at what he calls
the go-to-market stage. "They have a working prototype, they can show it
to us, we can see how it could actually work in several different places,
and they have some initial discussions and initial partnerships going on,"
Geshwiler says. "Still, the world is their oyster." This go-to-market
moment is also, he observes, a good time for angels to caution
entrepreneurs on what not to do. Two common pitfalls, he says, are wanting
to sell directly to consumers -- as opposed to selling through channels
the angels are familiar with but the entrepreneur may not be -- and
entering a burdensome partnership with a big corporation. (For more on how
to present a business to angels, see "Do Not Say, 'I Just Want the
Money,'" on page 96.)
Although angel groups are now the most visible sources of angel
funding, Sohl estimates that they are doing just 15% to 20% of all angel
deals. Individuals quietly investing still represent the bulk of activity.
In addition, there are investment firms that do angel investing, including
VC firms that specialize in early-stage deals.
Negotiating the terms of a deal will always be tricky, and
disagreements about operations can be difficult to hash out. More than one
business owner has suggested that angels work on finding a more accurate
name. But all parties want to see the business succeed. If it does, the
business owner may well be interested in completing the circle -- hearing
pitches, looking to fund the next generation.
