Angel investors are changing. Here's what they're looking for, how they operate, and (because the devil is in the exit strategy) what they expect for their money
The phrase "angel investor" conjures up a vision of some kind of saintly benefactor willing to take a flier on some whimsical notion of a business that has little chance of success. Nothing could be further from the truth. Angels invest for the same reason other people do: to make money. They hope that some of their investments will reap them high rewards in return for the high risks they are taking. They are well-off people -- often former company builders -- who are willing to put anywhere from $10,000 to half a million or more into promising start-up companies.
According to the University of New Hampshire's Center for Venture Research, there were 225,000 active angel investors in the U.S. last year. But until recently, angels have been difficult to identify. That's because individual angels generally like it that way, if only because they aren't terribly interested in having thousands of entrepreneurs flooding their e-mail boxes with business plans or getting buttonholed every time they attend a cocktail party. "Staying under the radar allows them to pick and choose their sources for their quality deal flow," says Jeffrey Sohl, director of the Center for Venture Research. "People find them anyway, but the harder to find them, the better."
Now, however, angels are forming groups, at least in some measure to become more visible to people with ideas. 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 U.S.; now there are more than 200. The reasons for this growth seem clear. Investors benefit from a group's organizational structure, which can sift through hundreds of business plans and select a few entrepreneurs to present their opportunities to the group as a whole at regular meetings, which are generally monthly. And entrepreneurs are able to identify local entities that can evaluate their plans. Even if they don't make it to a presentation, they can usually get some feedback on what they need to do to improve their plans and businesses to increase the odds of getting funding down the road.
The groups themselves are getting increasingly organized. Just last year 46 investor groups formed the Angel Capital Association. The association, which now has 89 member groups, wants to establish best practices for angel groups, collect data, establish benchmarks, and encourage individual angels to join groups.
The operational details of angel groups vary greatly. Most take executive summaries or business plans by e-mail; sometimes the groups' websites have a template for entrepreneurs to fill out. Usually a staff or screening committee will select a group of businesses for further investigation, and out of that bunch a few will be invited to present before the entire angel group. (See "Mr. Cashman, You're On," page 100.) In some groups, individual members make their own investment decisions after the presentation. Other groups operate with a fund that is the primary investment vehicle or that supplements the individual investments.
Angels like companies that appear likely to grow at 30% to 40% annually and then be bought or go public. Don't show them a plan that doesn't feature a way for them to make a profitable exit.
What are angels looking for? Simple, says Jeffrey Sohl: high-growth companies, meaning companies that appear likely to grow at 30% to 40% annually and then either be bought or go public. By his estimate, 10% to 15% of private companies fit that description. The problem, he says, is that "about 80% of the entrepreneurs think they're in that 10% to 15%." Many angels and angel groups are flooded with business plans that don't even feature a way for angels to make a profitable exit. These won't pass the first screen.
Last year, according to the Center for Venture Research, 18.5% of deals that got through early screens and were presented to investors attracted funding, up significantly from 10% in 2003, which is about the historical average, and getting dangerously close to the 25% that were funded during what Sohl calls "the crazies of 2000." Sohl fears that if the rate continues to rise, it could represent a flood of inexperienced angels getting into bad deals. On average, each firm that received angel money in 2004 got $469,000. The lion's share went to high-tech companies, and the single biggest category within high tech was software. Technology is where the growth is, and it's where most angels made their money, so they're investing in what they know. Another reason angel money tends to go to technology companies: Businesses with assets, such as manufacturing companies, can get collateral-based loans from banks.
The best time for an entrepreneur to seek angel funding, says James Geshwiler, managing director of the Boston-area CommonAngels and chairman of the Angel Capital Association, is when a business is at what he calls the go-to-market stage. "They have a working prototype, they can show it to us, we can see how it could actually work in several different places, and they have some initial discussions and initial partnerships going on," Geshwiler says. "Still, the world is their oyster." This go-to-market moment is also, he observes, a good time for angels to caution entrepreneurs on what not to do. Two common pitfalls, he says, are wanting to sell directly to consumers -- as opposed to selling through channels the angels are familiar with but the entrepreneur may not be -- and entering a burdensome partnership with a big corporation. (For more on how to present a business to angels, see "Do Not Say, 'I Just Want the Money," on page 96.)
Although angel groups are now the most visible sources of angel funding, Sohl estimates that they are doing just 15% to 20% of all angel deals. Individuals quietly investing still represent the bulk of activity. In addition, there are investment firms that do angel investing, including VC firms that specialize in early-stage deals.
On the following pages are profiles of well-respected, expert angel investors in all these categories. In sum they represent the broad universe of angel investing today -- and more specifically, that part of it where an entrepreneur's inquiry is welcome. We've aimed for a variety in structure, geographical distribution (most angels invest in firms close to home), and operating and investing style. Six of the funding sources are angel groups, two are firms that do angel investing, and one is an individual who's been an angel for a long time.
Negotiating the terms of a deal will always be tricky, and disagreements about operations can be difficult to hash out. More than one business owner has suggested that angels work on finding a more accurate name. But all parties want to see the business succeed. If it does, the business owner may well be interested in completing the circle -- hearing pitches, looking to fund the next generation.