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Monday, May 19, 2008

Introduction to Angel Investors (Angel Investors 101)

An angel investor or angel is an affluent individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity. A small but increasing number of angel investors organize themselves into angel groups or angel networks to share research and pool their investment capital.

Source and extent of funding
Angels typically invest their own funds, unlike venture capatalist, who manage the pooled money of others in a professionally-managed fund. Although typically reflecting the investment judgment of an individual, the actual entity that provides the funding may be a trust, business, limited liability company, investment fund, etc.
Angel capital fills the gap in start-up financing between "friends and family" (sometimes humorously called "friends, family, and fools") who provide seed funding, and venture capital. Although it is usually difficult to raise more than a few hundred thousand dollars from friends and family, most traditional venture capital funds are usually not able to consider investments under US$1–2 million. Thus, angel investment is a common second round of financing for high-growth start-ups, and accounts in total for almost as much money invested annually as all venture capital funds combined, but into more than ten times as many companies (US$25.6 billion vs. $26.1 billion in the US in 2006, into 51,000 companies vs. 3,522 companies)Of the 51,000 US companies that received angel funding in 2006, the average raise was about US$500,000. Healthcare services, and medical devices and equipment accounted for the largest share of angel investments, with 21 percent of total angel investments in 2006, followed by software (18 percent) and biotech (18 percent). The remaining investments were approximately equally weighted across high-tech sectors.

Investment profile
Angel investments bear extremely high risk, and thus require a very high return on investment. Because a large percentage of angel investments are lost completely when early stage companies fail, professional angel investors seek investments that have the potential to return at least 10 or more times their original investment within 5 years, through a defined exit strategy, such as plans for an IPO or a trade sale. Current 'best practices' suggest that angels might do better setting their sights even higher, looking for companies that will have at least the potential to provide a 20x-30x return over a five- to seven-year holding period. After taking into account the need to cover failed investments and the multi-year holding time for even the successful ones, however, the actual effective IRR for a typical successful portfolio of angel investments might, in reality, be as 'low' as 20-30%. While the investor's need for high rates of return on any given investment can thus make angel financing an expensive source of funds, cheaper sources of capital, such as bank financing, are usually not available for most early-stage ventures, which may be too small or young to qualify for traditional loans.

Profile of investor community
The term "angel" originally comes from England where it was used to describe wealthy individuals who provided money for theatrical productions. In 1978, William Wetzel completed a pioneering study on how entrepreneurs raised seed capital in the USA, and he began using the term "angel" to describe the investors that supported them.
Angel investors are often retired entrepreneurs or executives, who may be interested in angel investing for reasons that go beyond pure monetary return. These include wanting to keep abreast of current developments in a particular business arena, mentoring another generation of entrepreneurs, and making use of their experience and networks on a less-than-full-time basis. Thus, in addition to funds, angel investors can often provide valuable management advice and important contacts.

According to the Center for Venture Research, there were 234,000 active angel investors in the U.S. in 2006. Beginning in the late 1980s, angels started to coalesce into informal groups with the goal of sharing deal flow and due diligence work, and pooling their funds to make larger investments. Angel groups are generally local organizations made up of 10 to 150 accreditted investors interested in early-stage investing. In 1996 there were about 10 angel groups in the U.S.; as of 2008 there are over 300, with a roughly equal number in all other countries combined; these groups accounted for approximately 10,000 individual angel investors in 2008. The more advanced of these groups have full time, professional staffs; associated investment funds; sophisticated web-based platforms for processing funding applications; and annual operating budgets of well over US$250,000. A recent development, particularly in North America, has been the emergence of networks of angel groups, through which companies that apply for funding to one group are then brought before other groups to raise additional capital.

Have a look at these groups for further information:

Archangel Informal Investment Limited UK
Braveheart Investments UK
New Vantage Group US
LINC Scotland




Bill - Angels Den said...

A fantastic summary of angel investment Gordon. The data was pretty-much US-centric. Would you like any information regarding UK angel investment for your blog?

We run Angels Den which connects entrepreneurs with angels and would appreciate your feedback.

Amy Jenson said...

Interesting article. I want to run my own business, but I'm a little shy of having enough capital. An angel investor would be great and very beneficial. I'd like to buy a business instead of starting one from scratch, but I haven't had any luck looking for the right one. Do you have any suggestions? Thanks.

Gordon said...


Get in touch with my email..it's in my profile..


Monica Kermani said...

@Amy -- Are you looking for a huge company? If not, and you're just looking for a relatively small business, you might be better off finding a regular lender. I know you can find a lender through BizTrader.com. You can also find a broker and a business to buy. Check it out and good luck.