Angel investor
Encyclopedia
An angel investor or angel (also known as a business angel or informal investor) 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.
ists, 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. The Harvard report by William R. Kerr, Josh Lerner, and Antoinette Schoar tables evidence that angel-funded startup companies are less likely to fail than companies that rely on other forms of initial financing.
Angel capital fills the gap in start-up financing between "friends and family" (sometimes humorously given the acronym FFF, which stands for "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 60 times as many companies (US$20.1 billion vs. $23.26 billion in the US in 2010, into 61,900 companies vs. 1,012 companies).
Of the US companies that received angel funding in 2007, the average capital raised was about US$450,000. However, there is no “set amount” for angel investors, and the range can go anywhere from a few thousand, to a few million dollars. In a large shift from 2009, in 2010 healthcare/medical accounted for the largest share of angel investments, with 30% of total angel investments (vs. 17% in 2009), followed by software (16% vs. 19% in 2007), biotech (15% vs. 8% in 2009), industrial/energy (8% vs. 17% in 2009), retail (5% vs. 8% in 2009) and IT services (5%). Angel financing, while more readily available than venture financing, is still extremely difficult to raise. However some new models are developing that are trying to make this easier. Many companies who receive angel funding are required to file a Form D
with the Securities and Exchange Commission.
and are usually subject to dilution
from future investment rounds. As such, they 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 initial public offering
or an acquisition
. 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 internal rate of return
for a typical successful portfolio of angel investments is, in reality, typically 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.
and founder of its Center for Venture Research, 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. Because there are no public exchanges listing their securities, private companies meet angel investors in several ways, including referrals from the investors' trusted sources and other business contacts; at investor conferences and symposia; and at meetings organized by groups of angels where companies pitch directly to investor in face-to-face meetings.
According to the Center for Venture Research, there were 258,000 active angel investors in the U.S. in 2007. According to literature reviewed by the US Small Business Administration, the number of individuals in the US who made an angel investment between 2001 and 2003 is between 300,000 and 600,000. 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 accredited investors interested in early-stage investing. In 1996 there were about 10 angel groups in the United States.
The past few years, particularly in North America, have seen 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.
dominates the destination of angel funds, receiving 39% of the $7.5B invested in US-based companies throughout Q2 2011, 3-4 times as much as the total amount invested within New England.
in 2009 estimated that there were between 4,000 and 6,000 angel investors in the UK with an average investment size of £42,000 per investment. Furthermore, each angel investor on average acquired 8 per cent of the venture in the deal with 10 per cent of investments accounting for more than 20 per cent of the venture.
In terms of returns, 35 percent of investments produced returns of between one and five times of the initial investment, whilst 9 per cent produced returns of multiples of ten times or more. The mean return, however, was 2.2 times investment in 3.6 years and an approximate internal rate of return of 22 per cent gross.
Startup company
A startup company or startup is a company with a limited operating history. These companies, generally newly created, are in a phase of development and research for markets...
, usually in exchange for convertible debt or ownership equity
Ownership equity
In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists...
. A small but increasing number of angel investors organize themselves into angel groups or angel networks to share research and pool their investment
Investment
Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
capital.
Source and extent of funding
Angels typically invest their own funds, unlike venture capitalVenture capital
Venture capital is financial capital provided to early-stage, high-potential, high risk, growth startup companies. The venture capital fund makes money by owning equity in the companies it invests in, which usually have a novel technology or business model in high technology industries, such as...
ists, who manage the pooled money of others in a professionally-managed fund
Collective investment scheme
A collective investment scheme is a way of investing money alongside other investors in order to benefit from the inherent advantages of working as part of a group...
. Although typically reflecting the investment judgment of an individual, the actual entity that provides the funding may be a trust
Trust law
In common law legal systems, a trust is a relationship whereby property is held by one party for the benefit of another...
, business, limited liability company
Limited liability company
A limited liability company is a flexible form of enterprise that blends elements of partnership and corporate structures. It is a legal form of company that provides limited liability to its owners in the vast majority of United States jurisdictions...
, investment fund, etc. The Harvard report by William R. Kerr, Josh Lerner, and Antoinette Schoar tables evidence that angel-funded startup companies are less likely to fail than companies that rely on other forms of initial financing.
Angel capital fills the gap in start-up financing between "friends and family" (sometimes humorously given the acronym FFF, which stands for "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 60 times as many companies (US$20.1 billion vs. $23.26 billion in the US in 2010, into 61,900 companies vs. 1,012 companies).
Of the US companies that received angel funding in 2007, the average capital raised was about US$450,000. However, there is no “set amount” for angel investors, and the range can go anywhere from a few thousand, to a few million dollars. In a large shift from 2009, in 2010 healthcare/medical accounted for the largest share of angel investments, with 30% of total angel investments (vs. 17% in 2009), followed by software (16% vs. 19% in 2007), biotech (15% vs. 8% in 2009), industrial/energy (8% vs. 17% in 2009), retail (5% vs. 8% in 2009) and IT services (5%). Angel financing, while more readily available than venture financing, is still extremely difficult to raise. However some new models are developing that are trying to make this easier. Many companies who receive angel funding are required to file a Form D
Form D
Form D is an SEC Filing form to be used to file a notice of an exempt offering of securities under Regulation D. Commission rules require the notice to be filed by companies and funds that have sold securities without registration under the Securities Act of 1933 in an offering based on a claim of...
with the Securities and Exchange Commission.
Investment profile
Angel investments bear extremely high riskRisk
Risk is the potential that a chosen action or activity will lead to a loss . The notion implies that a choice having an influence on the outcome exists . Potential losses themselves may also be called "risks"...
and are usually subject to dilution
Stock dilution
Stock dilution is a general term that results from the issue of additional common shares by a company. This increase in common shares of a stock can result from a secondary market offering, employees exercising stock options, or by conversion of convertible bonds, preferred shares or warrants into...
from future investment rounds. As such, they require a very high return on investment
Return on investment
Return on investment is one way of considering profits in relation to capital invested. Return on assets , return on net assets , return on capital and return on invested capital are similar measures with variations on how “investment” is defined.Marketing not only influences net profits but also...
. 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
Exit strategy
An exit strategy is a means of leaving one's current situation, either after a predetermined objective has been achieved, or as a strategy to mitigate failure. An organisation or individual without an exit strategy may be in a quagmire...
, such as plans for an initial public offering
Initial public offering
An initial public offering or stock market launch, is the first sale of stock by a private company to the public. It can be used by either small or large companies to raise expansion capital and become publicly traded enterprises...
or an acquisition
Mergers and acquisitions
Mergers and acquisitions refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling, dividing and combining of different companies and similar entities that can help an enterprise grow rapidly in its sector or location of origin, or a new field or...
. 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 internal rate of return
Internal rate of return
The internal rate of return is a rate of return used in capital budgeting to measure and compare the profitability of investments. It is also called the discounted cash flow rate of return or the rate of return . In the context of savings and loans the IRR is also called the effective interest rate...
for a typical successful portfolio of angel investments is, in reality, typically 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
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
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 Broadway where it was used to describe wealthy individuals who provided money for theatrical productions. In 1978, William Wetzel, then a professor at the University of New HampshireUniversity of New Hampshire
The University of New Hampshire is a public university in the University System of New Hampshire , United States. The main campus is in Durham, New Hampshire. An additional campus is located in Manchester. With over 15,000 students, UNH is the largest university in New Hampshire. The university is...
and founder of its Center for Venture Research, 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. Because there are no public exchanges listing their securities, private companies meet angel investors in several ways, including referrals from the investors' trusted sources and other business contacts; at investor conferences and symposia; and at meetings organized by groups of angels where companies pitch directly to investor in face-to-face meetings.
According to the Center for Venture Research, there were 258,000 active angel investors in the U.S. in 2007. According to literature reviewed by the US Small Business Administration, the number of individuals in the US who made an angel investment between 2001 and 2003 is between 300,000 and 600,000. Beginning in the late 1980s, angels started to coalesce into informal groups with the goal of sharing deal flow
Deal flow
Deal flow is a term used by finance professionals such as venture capitalists, angel investors, private equity investors and investment bankers to refer to the rate at which they receive business proposals/investment offers. The term is also used not as a measure of rate, but simply to refer to...
and due diligence
Due diligence
"Due diligence" is a term used for a number of concepts involving either an investigation of a business or person prior to signing a contract, or an act with a certain standard of care. It can be a legal obligation, but the term will more commonly apply to voluntary investigations...
work, and pooling their funds to make larger investments. 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 United States.
The past few years, particularly in North America, have seen 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.
Angel investing in the US
Geographically, Silicon ValleySilicon Valley
Silicon Valley is a term which refers to the southern part of the San Francisco Bay Area in Northern California in the United States. The region is home to many of the world's largest technology corporations...
dominates the destination of angel funds, receiving 39% of the $7.5B invested in US-based companies throughout Q2 2011, 3-4 times as much as the total amount invested within New England.
Angel investing in the UK
A study by NESTANESTA
The National Endowment for Science, Technology and the Arts is an independent endowment in the United Kingdom established by an Act of Parliament in 1998....
in 2009 estimated that there were between 4,000 and 6,000 angel investors in the UK with an average investment size of £42,000 per investment. Furthermore, each angel investor on average acquired 8 per cent of the venture in the deal with 10 per cent of investments accounting for more than 20 per cent of the venture.
In terms of returns, 35 percent of investments produced returns of between one and five times of the initial investment, whilst 9 per cent produced returns of multiples of ten times or more. The mean return, however, was 2.2 times investment in 3.6 years and an approximate internal rate of return of 22 per cent gross.
See also
- Crowd fundingCrowd fundingCrowd funding describes the collective cooperation, attention and trust by people who network and pool their money and other resources together, usually via the Internet, to support efforts initiated by other people or organizations...
- EntrepreneurshipEntrepreneurshipEntrepreneurship is the act of being an entrepreneur, which can be defined as "one who undertakes innovations, finance and business acumen in an effort to transform innovations into economic goods". This may result in new organizations or may be part of revitalizing mature organizations in response...
- Pre-money valuationPre-money valuationA pre-money valuation is a term used in private equity or venture capital that refers to the valuation of a company or asset prior to an investment or financing....
- Private equityPrivate equityPrivate equity, in finance, is an asset class consisting of equity securities in operating companies that are not publicly traded on a stock exchange....
- Seed funding
- Venture funding