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Cascade: No. 62, Summer 2006

Under the Wings of Angel Investors

Across the country, angel investors are spurring economic growth through investments in industries as varied as software, manufacturing, and health care.* Angel investors are wealthy individuals or groups that provide capital to businesses, usually at an early stage – for instance, in the concept (pre-seed) or the start-up (seed) stage.

The capital provided by angels, often referred to as patient money, frequently serves as a bridge to more formal sources of capital. Compared with venture capital or other sources of capital, however, relatively little is known about the behavior and investing habits of angels.

The Federal Reserve System, which is committed to fostering economic growth, is interested in the activities of these early-stage investors, whose efforts often make it possible to bring a concept to fruition or create a product. To learn more about this important activity, the Federal Reserve Banks of Cleveland, Philadelphia, Atlanta, and Denver hosted focus groups of eight to 12 angel investors from their respective Districts. Scott Shane, professor of economics at the Weatherhead School of Management at Case Western Reserve University in Cleveland, conducted the focus groups and compiled the results in a report published October 1, 2005. This article highlights some of the report’s findings.

A Diverse Group

According to the report, three common factors appear to be true of angel investors: they invest amounts of less than $2 million, they invest in private companies, and they invest from their own funds.

Beyond these common factors, angels differ in their approaches to investment. Some like to invest as individuals, while others prefer to invest as a member of an angel group or network. Angel investors may invest individually simply because they are financially able to do so or because they would like to remain anonymous, become involved in the business, or avoid the administrative costs of participating in a group. In some places, individual investing became the model simply because of a lack of angels in the area.

Network angels invest as a group in order to realize benefits such as pooled capital and knowledge, diversification, deal flow, division of labor, and social relationships. Angel networks can harness the capital contributions and the technology or industry knowledge of its members. Thus, networks create economies of scale by providing members access to a large number of deals and a diversified set of skills and technical competence with which to evaluate and conduct due diligence on those deals.

Other characteristics differentiating angel investors include their net worth, knowledge of start-up companies, extent of company involvement, preferred stage of investment, degree of formality, and degree of risk. 


What motivates these investors? The report says that “by spurring economic development through investments in start-up companies, the angels believe that they can keep jobs, technology, and talented people in the community.” Some investors describe this sense of giving back to the community as a “psychological return” on their investment. Angels also add value by helping others create and grow companies and by making their expertise available to companies. Some angels invest with a view to becoming the CEO of a company, while others look for a financial return or personal enjoyment.

Evaluating a Deal

In general, angels are attracted to businesses that generate products that satisfy demand and can grow exponentially given the capital invested. As a result, sectors such as computer software, hardware, medical devices, and semiconductors are favored, while biotechnology, consumer, and commodity products are less favored.

When looking at businesses, angels tend to gravitate toward experienced entrepreneurs and a strong management team. Certain characteristics of the entrepreneur are also important. They include being able to accomplish tasks, knowing their own limits, working well with others, communicating openly and honestly, being charismatic, having a vision, and overcoming obstacles.

In terms of the financial deal, angels prefer to see valuations that are arrived at reasonably, or even undervalued, rather than overvalued.

Social Networks

The report noted that “among the common sources of deal flow are attorneys, accountants, investment bankers, former colleagues, previously funded entrepreneurs, customers and suppliers of companies that they have funded, other angels, and venture capitalists.”

Return on Investment

Many angels point out that “successful companies tend to generate positive returns,” and that the calculation of a rate of return is a less important exercise, especially given inconsistent revenue streams and the difficulty of accurately assessing risks and costs. While a typical expected return is 10 times the initial investment, anticipated returns can range from one to 15 times the initial investment.

According to the report, “The focus group participants believe that successful angel investing in a region depends on the presence of seasoned entrepreneurs and managers, first generation capital, a relevant industrial base, strong universities, the right culture, scale, and successful experience.”

To see the report, go to www.clev.org, select regional research and data, and highlight angel investing. Readers may also be interested in Angel Investment Groups, Networks and Funds: A Guidebook to Developing the Right Angel Organization for Your Community, a publication on the website of the Ewing Marion Kauffman Foundation at www.kauffman.org. Another resource is the Center for Venture Research, which focuses on early stage equity financing for high-growth ventures, at http://wsbe.unh.edu/cvr/.

  • * The Center for Venture Research at the University of New Hampshire’s Whittemore School of Business and Economics estimates that angel investors invested a total of $22.5 billion in 2004, 24 percent higher than the $18.1 billion they invested in 2003.

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