Business Opportunities: On-Line Articles - Angel Investors Can Provide More Than Just Pennies from Heaven

Angel Investors Can Provide More Than Just Pennies from Heaven
by Michael J. McDermott

As anyone who's ever tried to start a business knows all too well, among the toughest challenges entrepreneurs face is lining up capital to support their ventures. For many, it is an ongoing challenge until the business reaches a point where it is self-sustaining, able to raise money in public markets, or sold.

One potential source of financing entrepreneurs should not overlook, especially in the early stages, is angel investors. According to an expansive study conducted by researchers at the Massachusetts Institute of Technology (MIT), angel investors are an important and growing source of financing for the start-up and initial growth phases of new ventures.

This is especially true in industries such as technology, but angel investors play an important role for start-up businesses in many other sectors as well.

According to the Center for Venture Research (CVR), angel investments in 2004 by industry sector broke down as follows: software, 22%; healthcare services and medical devices, 16%; biotechnology, 10%; financial services and computer services, 8% each; retail, 7%; telecommunications, 6%; and "other," 23%.

Traditionally, angel investors have concentrated on start-ups and early-stage ventures where the founders have used up their own money, tapped out all other sources of available cash (such as family and friends), and cannot yet qualify for bank loans or financing from conventional venture capital firms.

Angels' willingness to invest in such ventures is one of the characteristics that make them attractive to start-up companies, especially those with concepts that are a bit off the beaten path. Another plus is the small sums in which angels are willing to deal, typically between $150,000 and $3 million-too little to capture the attention of mainstream financiers.

Angels are an important source of financing in the start-up and initial growth phases.

As legions of entrepreneurs who have gone through the process will attest, angels are often idiosyncratic and can be whimsical, even quirky.

According to Gerald Benjamin, managing partner of International Capital Resources (ICR) and author of three books on angel investing, there is no "typical" angel. However, most active angel investors are wealthy, well-educated individuals with extensive business and/or management experience and often have owned their own companies. In contrast to banks and venture capital firms, angels invest their own money. As such, they look for start-ups with a business concept they understand. Many favor start-ups in industries where they have had previous experience, and they are often passionate about their chosen field. According to CVR, 90% of angel investors live within a day's drive of their investments.

Those characteristics present another set of potential advantages to entrepreneurs who work with angels, but it is one that must be approached with some caution. Angels can provide access to their own network of contacts as well as technical, marketing and management expertise and guidance to start-up companies. They can help new ventures recruit valuable employees and make introductions to customers and vendors.

SET BOUNDARIES

The caveat for entrepreneurs is to make sure the nature and extent of the angel's involvement in your business is clearly delineated from the outside. Because many angels are successful, self-made businesspeople, they tend to be aggressive, take-charge types who may have to be kept in check from time to time.

Entrepreneurs who have been through the process say start-ups often get a lot more than money from the deal. Since angels tend to invest in ventures in industry sectors where they have significant experience, they can be a valuable source of guidance, wisdom and expertise.

"It's like having an extremely skilled consultant on retainer at all times, but without having to pay the retainer fee," is how one business owner describes her experience with an angel investor. "Not only does he understand everything about my business, he's done it all himself in the past, including starting up several successful companies in this field."

Like all investors, angels expect to reap a return on their investment, but their expectations are not always limited to monetary returns. Many are motivated by other desires, such as a strong interest in job creation, a commitment to urban revitalization, a chance to help improve the environment and similar causes.

Experienced angels may be motivated by a desire to give back to their communities.

In dollars-and-cents terms, ICR's research suggests that between 60% and 65% of angel investments do no better than break even. About 20% provide a return of two to five times the original investment, 8%-9% hit a multiple between five and 10 times the investment, and about seven in every 100 see a return of 10 times or more the investment made.

Although angel investors' time frames for return on investment can range from five to 10 years, the holding time to liquidation for successful angel investments averages eight years.

In return for the substantial risk they assume, angel investors typically negotiate steep discounts to the valuation markers suggested by the entrepreneur. They may also seek additional hedges, such as a seat on the company's board or increased direct involvement in the venture if it fails to meet certain benchmarks or performance milestones by within an agreed upon timeframe.

As mentioned earlier, besides looking to earn a strong return on their investment, experienced angels often are also motivated by a desire to "give back" something to the industries or communities that helped make them successful, and the study conducted by the MIT researchers confirmed that finding.

The motivations and operations of experienced angel investors are typically different than those of early-stage venture capital firms. First-time entrepreneurs often can benefit from starting their search for early-stage funding by approaching experienced angel investors first-even before meeting with early-stage venture capitalists.

NETWORK NIRVANA

An angel's personal network of contacts is a key element in screening deals, conducting due diligence, negotiating terms, adding value after the investment, securing additional rounds of financing and executing the exit strategy, according to the MIT study.

In recent years, experienced angels have become increasingly systematic in their operations. They have standardized procedures for evaluating and analyzing a venture's level of risk, which has helped to improve their returns. Systemization is also helping angels increase the number of deals they can consider.

Some angel investors have organized into loosely knit networks, most often with other angels interested in the same industry sectors. They may get together for breakfast or lunch a few times a year, and they sometimes pool their funds for larger investments.

While angels generally have their own network of contacts that steer promising start-ups their way, business owners interested in working with angel investors have many resources available to help them.

A good place to start is the Angel Capital Association (www.angelcapitalassociation.org), which includes a comprehensive directory of links to dozens of angel networks organized by region and state, along with a listing of links to capital source databases.

Angel Investor News (www. angel-investor-news.com) offers links to useful self-assessment and evaluation tools. FundingUniverse (www.fundinguniverse .com) offers free business plan evaluation and a matchmaking service that helps business owners find angel investors in their area.

Those interested in working with angel investors have many resources available for help.

Another source, Active Capital (www.activecapital.org, formerly the SBA's Angel Capital Electronic Network), avoids brokers and consultants and facilitates direct contact between entrepreneurs and accredited investors.

Active Capital's online registration system eliminates the need to register the equity offering with separate state regulators, making it easier for entrepreneurs to promote their opportunities to and raise money from investors in almost any state.

However, while Active Capital allows any entrepreneur seeking equity partners to use its matching service, the actual operations "must take place in a university or nonprofit setting."