Bring me an angel

As the economy improves, there are tentative signs that angel investors are starting to re-enter the market, keen to support young companies set to ride the recovery.

In July, Computershare founder Chris Morris took a $1 million stake in web services company Webfirm. In June, former realestate.com.au chief Simon Baker bought a stake in DVD distribution company Quickflix. The wealthy Smorgon and Gandel families have also recently taken stakes in small and medium-sized listed companies.

With bank finance still relatively tight and a sharemarket float not a viable option for many small companies, angel investors remain a key source of funds for SMEs. But what does an angel investor look like? And more importantly, why do they invest?

What are angel investors and when do they invest?

Angel investors, often simply referred to as “business angels”, are high net-worth, non-institutional, private equity investors who have the desire and the money to enable them to invest part of their assets in high-risk, high-return entrepreneurial ventures in return for a share of voting, income and, ultimately, capital gain.

Angel investment is normally the first round of external independent investment. Angels normally invest in early stage high growth potential ventures where the founding team has exhausted their personal savings and sources of funding from family and friends.

These ventures are not sufficiently developed to stand on their own, or sufficiently attractive to gain venture capital funding. These ventures exist in a halfway state, often between possible failure and take-off. Typically, the management team lacks experience in a growth venture and the business needs not only the additional funding, but also mentoring to take it to the next stage of development.

Investing in early stage private companies has many drawbacks, which is why this form of investment is typically undertaken by individuals who can afford to lose the money and/or are willing to wait some years before they see a return on their money.

A defining characteristic of angel investing is that it is a ‘transformational, value-added, active investment strategy’, in which the investor expects to have a hands-on approach to their investments, not possible in public company investments.

What do angels bring to the table?

Entrepreneurs often seek out angel investors to help them develop their business. Apart from the funding they bring, an angel would be expected to contribute in one or more of the following ways:

• Industry experience.
• Experience in start-up or business building.
• Networks.
• Experience in raising venture capital.
• Access to VC firms (only a very small percentage of angel ventures go on to VC – in fact, recent publications have discouraged this – see Basil Peters’ book, Early Exit).
• Access to strategic partners.

There are different types of angels. An angel with direct experience in the firm’s industry and with entrepreneurial experience can help with business development, recruitment, sales, strategy, contacts and so on. Their expertise and experience can be an invaluable help in developing the business. Often cashed-up entrepreneurs with start-up experience will invest back into new ventures. They can bring the experience of a successful venture through its growth stages. However, they may not have experience in the industry in which the firm operates.

Wealthy and/or retired corporate executives often make investments in new ventures within their industry. They can assist with customer introductions, recruitment and risk assessment. However, many angels are simply wealthy individuals with a desire to invest in the private sector and their only real contribution is finance.

The new venture entrepreneur may find angel investment very useful as a bridge to VC finance. The angel can provide much needed finance, as well as assist in developing the business further to prove the business model.

How do you spot an angel?

So what does the typical angel look like? There have been a number of studies of angels across several countries; however, because angels typically stay out of the public eye and are often reticent to speak of their investing experience, data has been difficult to collect and therefore the samples have been relatively small. Even so, the findings are relatively consistent across several studies.

The Center for Venture Research at the University of New Hampshire has created a profile of the “typical (USA) angel investor”. The predominant characteristics are:

Angels tend to invest close to their home base, usually no further than a half-day’s drive.

• Individual angels rarely invest more than a few hundred thousand dollars in total.
• Angel investors tend to be older, wealthier and better educated than the average citizen, yet a large number are not millionaires.
• Angels anticipate an average annual return of 26% on their investments.
• Angels expect that up to one third of their investments will fail, resulting in significant capital losses.
• Angel investors reject seven out of every 10 deals that cross their desks.
• Deals are rejected for a variety of reasons, including poor growth potential, overpriced equity and inexperienced management team.

By contrast, a study by Professor Kevin Hindle and Robert Wenban of Australian Angels found that: there were two dominant groups – those with university education and those without, they were slightly younger than their American equivalents, invested less per transaction and were mostly ‘general managers’ or ‘people managers’ by background, although most had been involved in several start-up ventures.

They typically invested 10-14% of their net worth in new ventures, although one quarter invested over 25% of their net worth. They were investing in about one third of proposals considered.

Why do angels invest?

Motivation for investing varies slightly among the countries for which survey data is available. Benjamin and Margulis, in their book Angel Capital, provide the following reasons:

• Improve self-image, self-esteem and recognition, ‘you never know how much you know until a small company turns to you’.
• Alleviate concerns – help others.
• Obligation to give back, the ‘joy of giving’.
• Get ‘first crack’ at next high-rise stock prior to IPO.
• Habit, addicted to high-risk ‘rush’.
• Fun and exciting.
• Return on investment of 30% minimum.
• Desire to take charge of the stock selection process more directly.

It may be that their sample has more hi-tech Silicon Valley entrepreneurs and thus is not representative of angels in other countries. In contrast, Australian angels appear to have a greater focus on the investment returns.

What do angels expect from their investment?

When they do invest, angels will stipulate similar conditions to their investments as VCs. Typically they will require:

• A position on the Board of Directors.
• Remuneration for their time spent on the business.
• Veto power over the issue of new shares.
• Adjustment of the number of shares issued to the investor if milestones are missed and/or a lower valuation is set in a subsequent round of investment.
• Veto power over further long-term debt.
• Approval rights over executive remuneration.
• Approval rights over issue of options.
• The right to put the business up for sale if certain milestones are not achieved.
• The right to replace the CEO if certain milestones are not achieved.

Angels are normally active ‘hands-on’ investors. They expect and often enjoy being directly involved in the management of the venture. In fact, this is often one of their primary reasons for investing. They typically spend time with each of their investments on a regular basis.

Where can I find an angel?

In Australia, Angel Networks are listed on the website of the Australian Venture Capital Association (see www.avcal.com.au). Australia has an association of angel groups called the Australian Association of Angel Investors (www.aaai.net.au) where you can find details of Angel Groups.

A recent report on Australian Angels entitled ‘Study of Business Angel Market in Australia’ by Professor Michael Vitale, Belinda Everingham and Richard Butler (November 2006) is available here.

Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the former Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia. Dr McKaskill is a member of the Gold Coast Angels.

His latest eBook, ‘Raising Angel & Venture Capital Finance’ can be downloaded for free here.

Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the former Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia. Dr McKaskill is a member of the Gold Coast Angels.

His latest eBook, Raising Angel & Venture Capital Finance can be downloaded for free here.