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By William H. Payne
Entrepreneurs are critical to the economic well-being of our country and our region, creating over half the new jobs in the United States. Yet entrepreneurs constantly struggle to obtain the critical capital needed for their businesses to thrive.
One vital source of funding comes from “angel investors,” people who invest in companies that will grow rapidly and create substantial value for entrepreneurs and investors alike. Angel investors provide the first outside equity funding for
as many as 50,000 companies per year
in the United States—eight to 10 percent of all new companies formed. In turn, these rapidly growing companies create both employment for the community and wealth for the entrepreneurs and investors—which is likely to be reinvested locally.
 William H. Payne is an entrepreneur, angel investor and entrepreneur-in-residence at the Kauffman Foundation of Kansas City. |
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Who are these so-called angels? Generally, they tend to be retired businesspersons and successful entrepreneurs who have exited their businesses. Because angels are experienced in commerce, they can bring these skills and experiences to
the entrepreneurs and companies in which they invest. Thus, angels invest both their time and money in seed and startup companies—often before the companies are generating revenues.
The average angel invests about $40,000, according to Jeffery Sohl, a professor at the University of New Hampshire. Most diversify their investments in numerous companies in an attempt to mitigate their risk, averaging between six to 12 startups each.
Angels are normally quite active in the companies in which they invest. Using their business acumen, they serve as mentors and coaches to entrepreneurs and often sit on the boards of directors of their portfolio companies. After careers in which business travel may have been both time-consuming and mandatory, angels tend to invest in businesses within 50 miles of their residences, Sohl says.
While most angels invest in companies operating in business segments familiar to them, others invest in a wide range of industries. High technology ventures are popular angel investments, but so are low technology (or no technology) companies.
Angels differ substantially from their later-stage cousins, the venture capitalists (VC). Angels invest their own money, while VCs invest pooled funds raised from wealth institutions and individuals. Since VCs are investing “other people’s money” their motivation is straightforward and clear: return on investment. Angels, on the other hand, have a variety of motivations: working with entrepreneurs, giving back to the community, staying engaged with business into their retirement years, and so on.
Because many VCs are managing funds exceeding $1 billion, the average VC round of investment has grown to $7 million (with two or three VCs participating), while the average angel round is $600,000 (with between six and 12 angels). Another difference is that angels consider their investing a part-time activity, while VCs are usually full-time general partners of their respective funds.
Typically, a rapidly growing company will need smaller sums of money in the early years, escalating to substantially larger rounds of investment in later stages of growth. For that reason, most angel investments are focused on the seed/startup stage of development, while VCs invest primarily in later-stage companies.
In short, several angels band together to invest smaller amounts of their own money in seed and startup rounds in very early-stage companies. A few VCs will study a company together and invest pooled funds in much larger rounds of investment in later-stage companies.
Angel Organizations—A New Trend
Angel investors operated under the radar for decades. Rather than soliciting entrepreneurs (and becoming inundated with business plans), angels preferred vetting deals presented to them by trusted sources, such as other angels, service providers, entrepreneurship centers, etc. Even then, angel investing was still difficult work.
To make things easier, angels began organizing groups in the mid-1990s, and the number of these organizations has grown to some 200 in 2003. While these angel groups vary in makeup and mission, all offer specific advantages over solo investing: a wide variety of deals to vet; a reproducible process for deal flow; a breadth of experience in the group for studying specific deals; a standard term sheet with consistent terms; and regular educational events, along with the camaraderie that arises from like-minded investors working together.
Most importantly, angel groups finally give entrepreneurs easy access to significant numbers of angel investors. And because angel organizations encourage deal flow, it is easier for entrepreneurs to apply for funding.
There are many models for an angel organization, but broadly speaking they are either “angel funds” or “angel networks.” In an angel fund, the members pool their money, vet opportunities together and then vote on whether to invest. Normally, only deals that achieve a super majority of member votes receive investment funds. Angel networks, on the other hand, put deals together and then let members decide individually if they wish to invest or not.
Both funds and networks may be led by paid managers, while others are led by elected members. Paid managers run the administrative services of the organization, manage the deal flow process and work with members in conducting due diligence and designing term sheets for each investment opportunity. Member-led organizations elect members to a variety of operational roles and rotate jobs among the members.
The Ewing Marion Kauffman Foundation of Kansas City is fostering the formation of a new organization of angel groups, called the Angel Capital Association (www.angelcapitalassociation.com.) ACA’s mission is to help start new angel groups, bring best practices to angels and angel group leaders and to increase the knowledge of angel investing through research. After only a few months of operations, ACA has over 50 members from all over North America.
PRINCIPAL SOURCES OF CAPITAL FOR ENTREPRENEURS |
Grants: Contract funds often designated by sources to commercialize specific
technology. These funds can total as much as $500,000 or more and are focused on technology development and innovation, not on the nuts and bolts or starting companies. Grant money is neither debt (which must be repaid) nor equity (cash exchanged for ownership in the company) and is therefore very “cheap” financing.
Friends, Family and Fools (FFF): Cash invested in a friend or family-member, often with no strings attached. FFF investors have faith that their friend or family members will use the money to build value in their enterprise. While FFF provide vast sums of money in new ventures, most of the 500,000 or so companies that are started each year in the United States receive less than $25,000 in total funding from FFF. Friends and family members are passive investors in startup ventures, and their funds may be gifts, debt or equity.
Angel Investors: Provide as much as $30 billion in 35,000 to 50,000 seed and startup companies per year. Angels are usually the first “outside” equity, that is, capital not sourced from the entrepreneur or those close to the entrepreneur. Investment is made after a thorough study of the business plan and reference checks on the management team, a process called “due diligence.” Angels are investing monies as part of their personal asset allocation (not investing “other people’s money”) and are known to be very patient investors. Typical investments are $40,000 per individual angel and with other angels in a round of investment totaling $250,000 to $1,000,000.
Venture Capital (VC) Funds: Limited partnerships that invest in rapidly growing companies, usually beyond the startup phase. Funds are raised from pension plans, corporations, wealthy individuals and others. While VCs invested over $100 billion in 2000, current investment rates are in line with historical trends, about $20 billion in 2003. The general partners select the companies in which funds are invested and assist those companies through board service and linkages with substantial customers and partners. Compared to angels, VCs tend to invest larger amounts of money (average currently $7 million per round) in later stage companies (2500 per year) with the expectation of exiting in three to six years.
Public Markets: Companies “go public” through an initial public offering (IPO)—a laborious, time-consuming and risky process. Large amounts of capital (tens to hundreds of millions of dollars) can be raised through IPOs, but less than 300 companies are successful in completing an IPO in any given year. |
Angels Help Accelerate Global Velocity |
ne local startup which has success-
fully navigated the tricky waters of angel investing is Global Velocity. Co-founded by Matthew Kulig and David Reddick,
the hi-tech company recently closed on a $1.5 million Angel round.
Situated in the downtown St. Louis Technology Entrepreneur Center, an IT incubator, Global Velocity produces high-speed network devices that read data going through Internet gateways. The idea is to sort the good from the bad before it gets to your computer.
Because their products are literally being invented as they go, Kulig and Reddick say it never occurred to them to seek a conventional bank loan. “Typically, banks are risk-averse. They don’t really look at startups,” says Kulig, president and chief executive of the company. “What we were trying to do was...very innovative technology that required significant engineering work.”
Kulig says the company opened its Angel round in 2002, but it wasn’t until 2003 when the process gained serious traction. Their first commitment for funds came from a local investment club made up of angel investors.
“From there we went out and talked to individual investors and started networking,” Kulig says.
Although the process of angel investing can be tricky, Kulig and Reddick say hiring a financial consultant right off the bat may not be the best choice. The key, they say, is surrounding yourself with experienced professionals.
“I think probably the most important thing you need to hire is a good (startup) attorney,” Kulig says. “If they’re a good attorney with a good reputation in the community, they’re going to know the accountants and the financial consultants and the other people who have the experience you’re going to need.”
So far, both executives say they have been impressed with the depth of local angel investing. They note that 92 percent of their investments so far have been from St. Louis investors.
“We’ve heard people say that it’s challenging to raise money in this town, (but) I would say we’ve had success,” Kulig says. “It’s hard work, and you’ve got to get in front of a lot of people. You’re going to get a lot of noes as opposed to the yeses. But the funny thing is, you’re going to learn from the noes...because they’re going to ask tough questions, and that helps you better understand your company and what you need to tell the story correctly.” |
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