In my time working in the financial sector in London, the financial capital of the U.K., I have come to learn first-hand how the mainstream financial services are generally not designed to cater to the needs and realities of budding startups. More often than not, young entrepreneurs often meet a “funding gap”. There are a multitude of reasons for this (which I shall examine in a subsequent article), nevertheless, it has been fascinating to see how startups have sought to overcome this “funding gap” and one of the prominent ways has been through angel investments.
Recent estimates have revealed that angel investments stood at $24 billion in the U.S. and $ 11 billion in Europe. These figures signify that the angel investment market is actually quite substantial, perhaps much more than many would come to initially assume. Interestingly, the term ‘angel investor’ was first coined in the early 20th century to describe wealthy individuals who invested in Broadway productions. It was not until the 1970s that the term began to refer to the emergence of private individual investors who were interested in investing in new ventures. Unlike the venture capital counterparts that predated them, these investors are drawn to new and developing ventures because of their belief that such investments, though risky, offered a higher rate of return compared to other mainstream investment options such as ordinary equities or bonds. Their belief is somewhat grounded as studies have found that investing early in developing ventures could reap great returns if growth and commercial potential is met. For example, a recent study found that 20% of angel investments examined actually yielded over %100 IRR at exit.
Today, angel investors typically invest in the range of $ 500,000 to $ 1 million per venture, generally in exchange for ownership or convertible debt. In addition, post investment, they generally become involved with the venture via active monitoring, mentoring and/or active participation such as having involvement at the board. In fact it is held that a total of 60% angel investors participate in the board. Unlike venture capital firms, angel investors invest with their personal funds for personal profits. This has resulted in such investors having a more personal investment sourcing and selection criteria which is believed to result in comparatively faster and more flexible(negotiable) decision making process.viii
Angel Investments & Funding Gap
From this perspective, angel investments can potentially be a very viable source of financing for young ventures that have issues raising initial capital. Particularly, with an investment focus and risk profile that tolerates growing ventures; many founders can attempt to access angel investors to effectively fill their funding gap raised by other traditional debt and equity financing methods. Their distinct characteristics as defined above also mean that the chance of securing funding from such sources early-on for growing ventures is comparatively higher. A recent study from the Centre for Venture Research also seems to confirm this as it traced that more than two-thirds of profiled startups were actually financed by angel investments.
Angel Investment Benefits for Growing Ventures
However, angel investors also provide additional benefits that aid the growth of young ventures that may also translate to subsequent funding.
i. Mentorship & Involvement
Active involvement and interaction are often associated with angel investments;; this can provide powerful outcomes for several reasons. Firstly, most angel investors tend to be seasoned ex-entrepreneurs or experienced industry-executives allowing them to contribute their own skills, knowledge and experiences to the venture. This may be particularly beneficial to many young ventures that lack the acumen as previously identified for accelerators. Angel investors can thus provide the crucial guidance that may help grow ventures. Secondly, in their involvement angel investors can play a significant role in the strategic decision-making process of ventures, especially when they often take active involvement in the management and monitoring of invested ventures. Coupled with their experience, their involvement allows them to become an invaluable “sounding board” for such ventures in allowing the effective supervision over the development and growth of such ventures. Thirdly, angel investors also often possess a great network of industry contacts that they share with their investees. These contacts may come to fill existing personnel deficiencies or they may even extend to opportunities for further investments either from other angel investors or other equity-financing sources.
Being able to raise investments from business angels may also provide the requisite validation for other financing sources that may raise the possibility of securing subsequent investments. This may be particularly the case if these ventures are able to secure investments from notable angel investors.
As mentioned earlier, as angel investors exercise their own investment decisions without accountability to others, there is a potential room in personal negotiations with the nature of the investment. This flexibility can become very important as certain traditional investment or risk mitigation conditions can be a hindrance to the potential growth of early ventures. At the same time, they could also come to prevent subsequent funding due to antiilution clauses. As such the flexibility of angel investors provide the potential opportunity to cater an investment to the needs of a venture without overbearing investment risk mitigation.
Drawbacks of Angel Investments for Growing Ventures
Nevertheless, there are certain drawbacks to angel investments that have to be brought into mind:
i. Lack of Consistency
The dynamics and nature of angel investments may vary greatly from one angel to another. This is because angel investors are usually private individuals, they may possess very different investment capacity, risk profiles, outlooks, expectations and skills. Ultimately, what this means is that not all angels will be able to homogenously offer value or funds that may appeal to all ventures. This means that the identification and selection of the appropriate angel investor is an important process of the equation if a venture aims to achieve the most value out of this.
ii. Lack of Visibility
For very much the same reasons above, angel investors are comparatively harder to research and identify. Whereas venture capital firms are required to register themselves in many jurisdictions, angel investors being private individuals are generally exempt from such requirements. This may mean sourcing angel investors is often more difficult compared to other funding sources. This difficulty is heightened especially when young ventures lack vast networks as well. Nevertheless, recent developments in the angel investment market have mitigated this to an extent. The emergence of “super angels”, angel investors that have come together to form a collective group or network in offering their collective funding services, has led to stronger presence in the marketplace. The formation of many angel networks and associations also provide repositories that young ventures can easily access in attempting to overcome the visibility issue.
iii. Follow-on Angel Investments
Angel investors rarely provide additional investments even when it is necessary. This is mostly due to the fact that to do so would create further investment risks that angel investors tend to avert. This could prove to be problematic for ventures that expect further investments from angels.
The active involvement of angel investors in young ventures can also be a strong drawback for two major reasons. Firstly, many ventures may face change management issues when the involvement of an outsider is introduced. Some may perceive the involvement as an interference and depending on the extent of the control exerted by the angel investors, it may result in great frustration and resistance in many team members. Secondly, many angel investors may actually lack the requisite or appropriate experience and expertise to actually offer valuable involvement. It may quickly become very disastrous if they assume active involvement of their investees despite being inexperienced or inadequate. As such, ventures should carefully review their term sheets when accepting angel investments and ensure that the degree of participation is appropriate for the nature and dynamics of their venture.