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A Chorus of Angels
 

After years of flying solo, angel investors are forming into groups--and changing the rules for cash-hungry entrepreneurs.
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Desert Angels, Band of Angels, Angels With Attitude....It sounds like a collection of motorcycle gangs. But the angels in question aren't bikers--they're investors, and they're interested in making money, not mayhem. Still, they're kicking up a lot of dust these days.

Angel investors, of course, have long been a fixture of the start-up scene. These wealthy individuals, often successful entrepreneurs themselves, make small investments--from a few thousand to several hundred-thousand dollars but rarely more than $1 million--in fledgling companies. They play a vital role in start-up funding because those deals--big investments for individuals--are too small for most venture capital firms, and banks often balk at lending such sums to unproven companies.

In the past, most angels flew solo, meeting with prospective entrepreneurs individually, doing their own due diligence, and investing at their own pace. That could often be a major hassle for cash-strapped business owners, who were forced to haul their dog-and-pony shows from one angel to the next, making the same pitch over and over. The new wave of angel groups is changing that. Such groups, generally composed of 50 to 60 wealthy individuals, are all about reducing risk and increasing the odds of finding a top-quality deal. After all, a group of several dozen experienced investors is far more likely to spot a flawed business plan than a lone individual.

Some 170 such groups have launched in the past several years, compared with just a handful as recently as five years ago, says Jeffrey Sohl, director of the University of New Hampshire's Center for Venture Research. And it's not just in places like Silicon Valley--Boise, Kalamazoo, and Honolulu all have angel groups as well. There is even an annual angel organization summit, whose website (www.angelsummit.org) offers links to some 100 groups. These groups are "reshaping the way angels do business," says David Hsu, a professor at the Wharton School of Business. "There is more organization, more formality. Angel groups are more sophisticated and channeling money more efficiently."

That's changing both the kinds of deals that are being done and the way such deals are being financed. Indeed, angel groups tend to be an odd mixture of traditional angel investing and venture capital financing. Internally, at least, they operate a lot like individual angels of yore.

As a rule, each member decides whether to invest his or her own money in a deal rather than leaving that decision to a general partner, as is the case in venture funds. What's more, while an individual angel might be willing to invest in a business with little more than an intriguing idea, an angel group likely won't. "You've got to have a business that has customers, is scalable, and that we think will give us a big return on our investment," says Barry Moltz, founder of Prairie Angels, a 60-member group in Chicago. "We want the home-run potential, not just the solid base hit that some individual angels think is okay."

Jordan Warshafsky has experienced such changes firsthand. When the veteran pharmaceutical executive took the helm of TyRx Pharma Inc. in mid-2000, the New Brunswick, N.J., biotech start-up had a promising product but was fast running out of cash. "There was only about $700,000 left in the bank," recalls Warshafsky--that was far less than he needed to get his polymer products to the next stage of development. Warshafsky was familiar with angel investors, having pitched to them in the past. He went searching for one.

In years past, Warshafsky would have set up a series of one-to-one meetings. But for the first time, he also pitched groups--and found himself in a new world. Before he could even talk to any of the 45 angels from Boston-based Angel Healthcare Investors LLC, for example, he had to pass muster with two of the group's managers. "We screen all the opportunities and help decide who will be invited to pitch," says managing director Mary McNamara. Following an initial breakfast meeting, Warshafsky found himself in an extensive due-diligence process. In the end, he was offered $300,000--less than he sought, but he has no complaints. For one thing, whenever he needs information or help, one of his 18 angels can refer him to an experienced pro in the industry. That's a big difference compared with his individual angels, one of whom owns a fruit juice processing company. Even better, AHI's members are familiar with regulatory hurdles, and they're patient.

Another difference is that angel groups can be picky about small things that individual angels might overlook. At Boston-based Common Angels, which does five or six deals a year, James Geshwiler immediately rejects applications sent from Yahoo or AOL e-mail accounts, avoids companies named after their founders or whose owners say they find venture investors too bossy--all factors he says imply a lack of sophistication. Individual angels, by contrast, are much less dogmatic about these issues, says Wharton's Hsu. Of course, no two groups are the same. "None of us does it just for the money, even though we wouldn't do it if we didn't feel these were great businesses," says David Berkus, an Arcadia, Calif., entrepreneur turned angel and chairman of Tech Coast Angels. "Angel investing, unlike venture investing, is still more art than science."

Such groups aren't for everyone. Hal Eason recently approached AHI in search of funding to commercialize new stem-cell technologies. AHI's members liked the new company, Plureon Corp., but wanted Eason to find another group to split the up-front investment burden. Then there was the confidentiality issue: With so many well-connected Boston biotech industry players among AHI's members, Eason worried that sensitive information might leak out to potential competitors. So he pulled out from the talks with AHI, and raised the capital he needed from friends and family members.

But Warshafsky says angel groups are well worth the trouble. Group money, he says, is seen as smarter money than that of individuals. "There's a perception that a lot of individual angels are just rich guys with money," he says. With AHI in his corner, Warshafsky says he is now being approached by venture capitalists who three years ago wouldn't return his phone calls. "You can't pin a value on that," he says.

Last updated: Jan 1, 2004




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