An Introduction to Angel Investing
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An Introduction to Angel Investing

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  • This talk is designed to provide a rather extensive introduction to angel investing. The target audience is accredited investors considering becoming angel investors, especially for use by angel organizations in recruiting new members. This presentation is also appropriate for emerging market communities who are seeking a better understanding of the capital food chain for entrepreneurs and the importance of angel investors to the funding of entrepreneurs. For some audiences, it may be appropriate to shorten the talk by eliminating some of the slides. To shorten the presentation, the following procedure is recommended: (1) copy the entire presentation first and then (2) deleting those slides which may not be important for the intended audience. Presenters may also consider adding a few slides to the end of this presentation, to provide an introduction to your region’s angel group(s).
  • With 52 slides in this presentation, about an hour should be allocated for this talk (plus time for Q&A).
  • This slide addresses some confusion about angel investing, specifically: In most deals, angel do not compete with VCs to fund entrepreneurs. Most VCs are later stage investors and are not looking to make investments in the range of $250,000 to $1,000,000. Angels dominate this early stage market. Investors who provide equity capital in the range of $250,000 to $1,000,000 to early stage companies are not angel investors unless they have also made a substantial commitment of time to spend mentoring and coaching entrepreneurs and serving on Board of portfolio companies. It is not necessary for angels to be engaged with all portfolio companies, but some substantial commitment of time working with entrepreneurs is required. Those who do not commit time to entrepreneurs and choose to remain passive are private investors. Private investors provide important capital to starting companies but do not fall within the definition of angels.
  • While successful entrepreneurs and businesspersons who still hold full time positions in their ventures can bring substantial money and important experiences to angel investing, the heavy lifting of angels in angel groups is done by retired businesspersons and exited entrepreneurs. The differentiating element is the amount of time that can be dedicated to running the organization and working with portfolio companies. It is difficult to operate a member-led angel organization when all members have full time jobs, which often leads to choosing a manager-led organizational model. Unlike VCs (who are money managers), angel investors are investing their own money in early stage companies. Because they are investing their own money, angels have a variety of motivations for angel investing.
  • Each angel investors seems to be motivated by a different set of these factors. There is no single model for describing the motivation of angel investors.
  • An active group of angel investors is not sufficient to support a thriving community of entrepreneurs. There are many pieces to this puzzle, as are described in the next slide.
  • An entrepreneur-friendly community has many components. Sources of product ideas, high tech or no tech. Knowledgeable service providers. Experienced businesspersons and exited entrepreneurs are needed for mentoring and coaching start-up entrepreneurs. An Entrepreneurship center to provide educational and networking opportunities and to help with the development of business plans. A pool of talented people with both technical and management skills. And, as these critical ingredients are established, it is also necessary to foster a variety of funding sources for entrepreneurs. Angel investors are a critical source of seed/startup and early stage venture capital.
  • The next eight slides discuss the formation of companies in the US and the primary sources of equity capital that support the growth of those companies. All references to dollars and companies are annualized.
  • The next slide details the characteristics of the top three categories, which dominate the capital food chain for entrepreneurs. The Other category, while important in some regions, is dwarfed by the other sources. Debt financing from conventional sources is generally unavailable to seed/startup and early stage companies. We will not discuss common sources of debt financing involved in pre-seed financing, namely: Loans from FFF: This debt financing often does not accrue interest and has no fixed schedule for repayment. Credit card debt: This is not really corporate debt. This is personal debt by founders who use the cash to start companies. The obligation to repay is solely that of the personal owner of the credit card.
  • There are several important distinctions among these investor groups which are covered in this slide. FFF are investing small amounts of cash in a friend or family members. Most FFF investors are not experienced in business and they bring little expertise to the business (passive). Angels invest both time (business acumen) and larger sums of money (their own) in entrepreneurs (not usually a friend). They generally are professional investors and maintain a portfolio of investments to mitigate risk. VCs are professional investment managers who invested large amounts of “other people’s money” in a larger portfolio of companies. While the management team is important, they are investing in companies.
  • In most years, more than ½-million companies are started in the US. The Global Entrepreneurship Monitor (GEM report), sponsored in part by the Kauffman Foundation, reported in 2003 that about 5% of Americans invested in FFF rounds in companies, that is, over 12,000,000 Americans invested in pre-seed and later stage companies. Other GEM studies have estimated that nearly $100 million is invested annually by FFF in the startup of these 500,000 or more companies. According to Prof. Jeff Sohl (Center for Venture Research, Univ. of NH), 35,000 to 50,000 angels invest $15 to 30 billion annually in seed/startup and early stage ventures. In 2003, VCs invested in only 166 seed and startup ventures (PWC MoneyTree)
  • FFF are critical sources of capital for entrepreneurs starting companies. While very important, these investments are made based on the relationship with the entrepreneurs. Excluding this “personal relationship” capital, angels are the dominate source of seed/startup funding for entrepreneurs. Estimates of the funding for seed/startup entrepreneurs from grants and other Federal, state and local programs are substantially less than $1 billion annually. (W. H. Payne – personal interviews)
  • The next eight slides describe hypothetical asset allocation, portfolio strategies and exit options for angel investors.
  • These are conservative portfolio considerations, based on the personal bias of the author (W. H. Payne). For example in a paper published by the Center for Venture Research (citation below), based on a survey of only 146 angels, 50% of these angels had 15% of their net worth invested in angel deals and a surprising 10% of angels had as much as 50% of their net worth in angel investments. Discussions with a large number of angels has shown that most feel 8-10 deals is sufficient diversification and that 1-2 deals in ten yield most of their return on investment, with the remainder providing little or no return. The statistics available on high tech vs. low/no tech are interesting. Less than 1/3 of INC 500 companies are typically high tech companies. And, only about 20% of the members of the Young Entrepreneur’s Organization (3500 members in North America) are high tech companies. And, according to Fortune Magazine, less than 0.5% of new companies are considered high tech companies. “ Angels and Non-Angels: Are There Differences?” J Freear, J. E. Sohl and W. E. Wetzel, Jr., Journal of Business Venturing, 9 , 1090-123 (1994)
  • The next few slides will describe the implications of the conservative portfolio strategy described in the previous slide.
  • These is the SEC definition of an accredited investor. The assumption is that accredited investors know what they are investing in and can afford to lose their invested capital. Few if any angel organizations or portfolio companies require potential angels to prove they qualify as accredited investors. It is important for new angels to understand that, by attesting that they are accredited investors, they are giving up the rights of regulated disclosure defined by the SEC.
  • This slide continues the conservative posture assumed in slide 16. It concludes that this very conservative posture would suggest that the minimum net worth necessary to invest in a diversified portfolio of 10 companies would be $5 million. It is important for accredited investors who are considering becoming angel investors to understand the implications shown here. However , each angel investor needs to make their own decisions regarding level of investment and diversification. Very few, if any, angel organizations have imposed standards higher than the SEC for membership in their organizations.
  • This data was gathered during 2001, so the 20-year returns for the S&P and NASDAQ are actually somewhat above broader historical measures. This slide shows that Seed Funds have returned 22.4% over the past twenty years. Since angels tend, on average, to invest a bit earlier than Seed Funds, angels should expect returns on investment of 25% per year. To our knowledge, there is no statistically significant data on ROI for angel investing. Anecdotal data from many sources suggest that 25% is an appropriate objective.
  • Size of Opportunity is a very important consideration that is not well understood by accredited investors and new angels. We have no data that suggests that chance of success is a function of the size of the opportunity. That is, it does not appear that a business plan that shows proforma revenues of $5 million in five years has a greater chance of survival than does a plan with proforma revenues of $100 million. Since only 1 or 2 of ten angel investments will provide the bulk of the ROI for angels and since angels are not good at picking winners (since only 1 or 2 in ten are winners), it is necessary that all angel investments must scale, that is, show the opportunity to grow sufficiently to return 20-30 times the capital to angels. Regarding the calculation above: A 25% return per year for five years results in tripling one’s capital (3X). If only one investment (1/10 th of capital) provide all the ROI for the portfolio, it must yield a 30X return (1/10 x 30 = 3X). Since we cannot pick winners, all must be capable of 20-30X.
  • Angels should plan on a seven year turnover for their portfolios. (Some investments are gone in 18 months, while others may take over ten years to exit.) If angels invest in ten companies in a single year: This is a tremendous amount of work in year 1 All companies are generally at the same stage. After a few years, engagement with the companies diminishes. Angels who make all investments at the outset, don’t have a chance to learn from their mistakes. The balance the workload and to maintain a portfolio of companies at all stages of development, most angels choose to build a portfolio 2-3 companies per year over several years.
  • This slides shows all the M&A activity and all the public offerings in this country in the past four years. This data is not limited to venture-backed companies and includes some data for the spin-off of divisions of larger companies. Nonetheless, the data is clear. Even during the hottest years for IPOs of venture-backed companies, the ratio of M&A exits to IPOs was 20x. Now the ratio is at least 100:1. Some have suggested posting only data for venture backed companies, because it would show a much higher proportion of IPO exits. Frankly, this would tilt the data in the other direction, because empirical data suggests that VCs experience IPOs in portfolios much more frequently than do angels.
  • We have found little or no robust data on the impact of angel investing on the economy. However, let’s look at what we do know.
  • David Birch is a MIT scientist who formed his company, Cognetics, to better understand job creation in America. He has been recognized as an expert in this field since the ‘70s.
  • More anecdotal data….
  • In the next two slides, we will briefly cover the important subject of the post-investment relationship. While it takes3-4 months on average to make an angel investment in a seed/startup or early stage company, the involvement of angels often continues for 5 to 10 years.
  • From the outset, we have emphasized that angels bring more than funding to portfolio companies. Invested entrepreneurs often state that the business acumen angels brought to their companies was worth at least as much as their invested capital. Very seldom are angels enlisted as employees of invested companies. The most important reason is angels do not want to be saddled with full time jobs. However, infrequently, angels are called upon to jump in to help portfolio companies in crisis – temporarily replacing the CEO, advising the sales and marketing departments, working thru legal and financial issues which threaten the company. In these cases, it is not unusual for angel to be compensated for this time, over and above their commitments as angels. If the company has achieved positive cash flow, this compensation might be in cash. More likely, this compensation will be in additional equity, usually through warrants.
  • Portfolio strategy dictates that angels develop a diversified portfolio of 8-10 investments to mitigate risk. But, serving on the Board of ten companies exceeds the commitment of time most angels are willing to reserve for their angel portfolios. It is important that angels “pick and choose” the appropriate roles to serve within each portfolio company. When investing with other angels, it is often the case that other angels investing with you in a given round have more direct experience in the business of the investee than do you. In some of these cases, therefore, it might be appropriate for you to remain a passive investors. So, within an angel’s portfolio of companies, each angel has a range of engagements, from very active in some to passive in others. As a company matures, angels continually measure their contribution on the Board of Directors, and exit the Board at the appropriate time. There are always new portfolio companies which will benefit greatly from the angel’s service.
  • The next three slides compare investing as a solo angel to investing as part of an angel organization.
  • Angel organizations are a new phenomenon. To our knowledge, virtually all angel organizations have been started in the past decade. Professor Sohl at the University of New Hampshire and Marianne Hudson at the Kauffman Foundation have created databases to track the explosive growth of the organizations. The formation activity around the country suggests this growth will continue indefinitely into the future. Investing through angel organizations has changed the landscape of angel investing substantially, as can be seen in the next two slides.
  • Investing as a solo angel investor is very difficult. Deals are hard to find. And, finding enough other angels to fill a round of investment was difficult, for both lead angel investors and entrepreneurs, alike. Due diligence was difficult, because the vertical experience of any one angel is limited. In general, a decade ago VCs did not like to invest with angels, because the angel investing process was not particularly rigorous and inconsistently applied across the spectrum of angel funded companies.
  • Angels investing through organizations can apply the resources of the organization to finding and scrubbing deals. Furthermore, angel organizations have fostered robust process and term sheets, which has standardized the investing process and attracted VCs as syndication partners. And, working with like-minded people is likely to create many new friendships within the organization.
  • The following eight slides describe the process employed by angel organizations in making investment decisions. While few organizations utilize the process exactly as it is described here, all organizations tend to utilize the same steps, involving combinations of members and managers to performs these duties.
  • This is an outline of the steps described in the following slides.
  • This chart describes hypothetical deal flow statistics. Since angel organizations utilize somewhat different processes, these statistics can only be suggested as representative. For example, some angel organizations have very rigorous pre-screening teams who spend more time than others in reviewing the plan and pre-screening the entrepreneurs. For these organizations, many more entrepreneurs would be declined at the pre-screening stage and fewer later in the process. The importance of this chart is to show that angel organizations tend to invest in 1-2% of the companies who apply for funding.
  • This says it all!

An Introduction to Angel Investing An Introduction to Angel Investing Presentation Transcript

  • ANGEL INVESTING An Introduction to
  • OUTLINE
    • Who are these Angels?
    • Entrepreneur-friendly Communities
    • Company Formation and Startup Funding
    • Portfolio Strategy for Angel Investors
    • Post-investment Relationship between
    • Entrepreneurs and Angel Investors
    • Why Angels are Joining Groups
    • The Angel Investing Process
    • The Power of Angel Investing Seminar
  • Angel Investors (vs. private investors)
    • Invest money in seed, startup
    • and early stage companies
    • Invest time in entrepreneurs
    • and their companies
          • Business acumen
          • Mentoring and coaching
          • Serve on boards
          • Make business introductions
  • Who are these Angel Investors
    • Often successful, exited entrepreneurs or retired business persons – active investors
      • Invest both time and money in companies
    • Accredited Investors - SEC definition
    • Angels invest their own money (not money managers)
    • Investing in local companies
  • Motivation: Why Become an Angel Investor?
    • Helping entrepreneurs
    • Stay engaged – using skills and
    • experiences to help build a business
    • Giving back to community or university
    • An active form of investing –
    • not just watching markets
    • Return on Investment is the metric
  • How do Angels fit into Entrepreneur-friendly Communities
  • Entrepreneur-friendly Communities Service Providers Mentors Coaches Role models ENTREPRENEURS Talented People Entrepreneurship Center
    • Bus Plans
    • Education
    • Networking
    Funding Sources VCs Angels
    • Grants
    • Banks
    • SBIRs
    • Sources of
    • Technology
    • Innovations
    • Product Ideas
    Colleges & Universities Companies Labs
  • New Company Formation and Funding Sources for Startup Companies
  • Who are Funding Startup Companies
    • Friends, Family (and Fools) – FFF
    • Angel Investors
    • Venture Capitalists
    • Other
      • Government grants (SBIRs, etc.)
      • State and local programs
    • Friends, family & fools
    • Angels
    • Venture Capital
    • Not accredited
    • Unsophisticated
    • Investing in a friend
    • Passive
    • 1-2 lifetime investments
    • ($100 to $5,000 each)
    • Accredited
    • Expertise and personal money
    • Active
    • Investing in entrepreneur
    • Portfolio of angel deals
    • Limited partnership
    • Institutional money
    • General Partners active
    • Invest in company
    • Large portfolio
    Typical round: $10,000 Each investor: $ 2,000 Source: estimate Typical round: $600,000 Each investor: $ 40,000 Source: Center for Venture Research Typical round: $7,000,000 Each investor: $3,000,000 Source: PWC MoneyTree
  • Funding Seed and Startup Entrepreneurs (typical year)
    • Startup companies
    • Funded by FF&F
    • Funded by Angels
    • Funded by VCs
    • 500,000
    • 200,000 (est.)
    • 35 - 50,000
    • < 500
  • Estimated that 90% of Outside Equity Capital in Seed/Startup Stage Companies is Sourced from Angels
  • An Angel Portfolio Strategy
  • An Angel Investing Strategy: Portfolio Considerations
    • 5-10% of net worth (asset allocation)
    • 8-10 investments (risk diversification)
    • High tech, low tech, no tech (your choice)
    • Variety of involvements
      • Lead investor
      • Board, advisor
      • Passive
    • Most of ROI from 1 - 2 of 10 companies
  • Implications of this Strategy
    • Net Worth Requirements
    • (testing the SEC definition
    • of an accredited investor)
    • Return on Investment implications
  • Definition: Accredited Investor
    • Financial position of investor:
        • Net worth: $1 million, or
        • Annual personal income: $200K, or
        • Family income: $300K
    • Assumption:
        • Knowledgeable – capable of due diligence
        • Can afford to lose invested funds
    • Implications:
        • Giving up regulated disclosure
  • Implications: Angel Investor Net Worth
    • Typical angel investment ~$25K
    • 10 investments = $250,000 invested
    • 100% reserves, another $250,000
    • 10% of Net Worth ($500K/10% = $5 million)
    • Therefore:
      • Minimum net worth for angels = $5 million
      • SEC definition is 70 years old
  • Angel Expectations: 25%/yr Source: Venture Economics, HFRI Equity Hedge Index 22.4 18.7 18.7 16.5 14.9 13.2 0 5 10 15 20 25 Returns Seed Funds All Venture Hedge Funds Buyouts S & P 500 NASDAQ Historical 20 Year Returns for Alternative Assets
  • Implications: Size of Each Opportunity
    • 1-2 in 10 investments will produce almost all of the ROI for the portfolio
    • These successes must yield 20-30X ROI
    • ( Nonbelievers: Do the calculations!)
    • And…we cannot pick the winners
    • Therefore, all portfolio companies must demonstrate the opportunity for a 20-30X return on investment.
  • Integrating Exits into Portfolio Strategy
    • VCs exit in 3-5 years (assume 5)
    • Angels invest earlier and expect to exit in 5-7 years (assume 7)
    • A balanced angel portfolio contains ten companies.
    • Consequently, angels should invest in 2-3 companies per year
      • Build to ten company portfolio gradually
      • A portfolio of companies in all stages of development
      • Good balance for investors time
  • Exit Strategies 0 2000 4000 6000 8000 10000 12000 1999 2000 2001 2002 IPO M&A 2002 Software Industry Equity Update 20X 100X
  • Economic Benefit from Angel Invested Entrepreneurs and their Companies
  • We have absolutely no data but Consider the following:
    • Angels invest in 7-10% of all startup companies
    • Angels only invest in companies that will scale
      • 20 to 30 times growth in valuation in 5-7 years
      • Employment created by these companies is high
    • David Birch (MIT) and others have demonstrated that high growth companies create all net new jobs in America.
    • Angel-funded companies create lots of jobs
  • We have absolutely no data but Consider the following:
    • Anecdotal data suggests Angel Investors and the Entrepreneurs in whom they invest enjoy some very successful exits.
    • Exited entrepreneurs often become angels
    • Angels often reinvest portfolio returns
    • The wealth creation from angel investing is spawning an even greater number of companies.
  • Post-Investment Relationship
  • Angels invest time in portfolio companies
    • Angels bring expertise to portfolio
      • Business acumen
      • Vertical expertise
      • Financial experience
      • Director service
    • Common roles
      • Advisor, Mentor, Coach, Director
      • Except in emergency, not paid consultant
  • Portfolio Considerations
    • With many portfolio companies
      • Not active in all, pick roles suited to your skills
      • Let other angels serve remainder of companies
    • As contribution fades, exit in favor of
    • new directors, advisors
    • Limit number of Boards to 3-5
  • Why Angels Join Groups
  • Growth in Angel Organizations Data provided by Professor J. Sohl, University of New Hampshire
  • Solo Angels
    • Process is time-consuming
      • Deal sourcing
      • Reading plans
      • Due diligence
    • Due diligence is difficult
      • Finding vertical experience
      • May require using outside experts
    • Legal support is expensive
  • Investing through Angel Orgs
    • Dividing the work eases the pain
    • Variety of vertical experience available
    • Standardized processes and term sheets
    • Deal flow encouraged, entrepreneur-friendly
    • Pick and choose the deals you like
    • Great camaraderie among the like-minded
  • The Angel Investing Process
  • Summary: Angel Investing Process
    • Pre-screening
    • Screening
    • Due diligence
    • Investment presentation
    • Follow-up discussions and meetings
    • Closing
  • Deal Flow Statistics
    • Prescreening
    • Screening
    • Due Diligence
    • Investment
    • OVERALL
    • 1 in 4 to Screening
    • 1 in 3 to DD
    • 1 in 3 to Inv. Meeting
    • 1 in 2 raise money
    • 1 in 72 who apply receive investment
  •  
  • Power of Angel Investing
    • Developed by Kauffman
    • Delivered more than 30 times in the US
    • Trained over 500 angel investors
    • High ratings by participants
      • Knowledgeable speakers 4.64/5.00
      • Important topics & content 4.60/5.00
      • Relevant & beneficial information 4.60/5.00
      • Well presented information 4.54/5.00
  • Seminar Content
    • Is angel investing right for you
    • Where to find good deals
    • Due diligence
    • Structuring the deal
    • Valuation
    • The post-investment relationship
  • Seminar Format & Delivery
    • All day experience
    • Networking opportunities
    • Designed for 20-25 accredited investors
    • Mix of learning methods
      • Lectures
      • Panel discussions
      • Case study exercise (valuation)
  • SUMMARY
    • Angels are making a difference
      • In job creation
      • In wealth creation
      • by providing equity capital and mentoring to entrepreneurs
    • Plan a portfolio strategy as you begin investing
    • Join an angel organization
      • Good deal flow
      • Robust processes
      • Great camaraderie
    • This introduction to angel investing was developed by the Kauffman Foundation for the Angel Capital Association. It is designed as a recruiting tool for angel organizations and to introduce interested groups to the subject.
    • For more information on Kauffman’s Angel Initiative, the Angel Capital Association, or the Power of Angel Investing seminar for new angel investors, contact:
    • Marianne Hudson
    • (800) 489-1447
    • [email_address]