Angel Investing – Some Data

angel_investingLet’s say you read my earlier post on angel investing and decided – despite my helpful warnings – that you would still like to pursue angel investing in your area. You don’t listen, do you?

Well anyway, your next step as a smart money person would involve collecting data about angel investing to, you know, educate yourself before throwing your money at a few startups.

Aha! Now that’s a real problem. You will find angel investing a frustrating place to gather anything more than anecdotal data.

But then again you have me. I’m here to sift through available studies on angel investing to let you know what is knowable, before you jump in.

In contrast to angel investing, we typically know extraordinarily detailed things about publicly traded companies we might invest in. You could find with a quick online search which CEOs of public companies like to dress up like the Pope or which ones resort to spreadsheets to make perfect cupcakes. But finding angel investing facts and data can prove elusive. Because angel investing is done at a small scale – tens of thousand of dollars to a few million – when compared to its big brother venture capital – at a few million to tens of millions – we sometimes have to turn to venture capital data for information.

Key pieces of data you might want to know before investing include:

  1. How scarce is money for entrepreneurs who need angel investments?
  2. What percent of funded companies succeed in making money for angels?
  3. How long will your capital be tied up?
  4. What kind of returns can you expect from angel investing?

After presenting each piece of data I’ll do a little interpretation of the numbers. Let’s take these one at a time.

About scarcity, according to a report on venture and angel investments by the Ewing Marion Kauffman Foundation 30 percent of venture capital and angel investments occur in just four metropolitan areas: Boston, San Francisco, Los Angeles, and New York. Even in those areas, only an average of 1 percent of startup firms receive the full amount of money the entrepreneur seeks, while the national average is 0.6 percent. Firms in Austin, according to the Kauffman report, successfully raise venture and angel investments at twice that rate, while entrepreneurs in other Texas cities like San Antonio, Dallas, and Houston firms report success rates of 0.9, 0.9, and 0.6 percent respectively.

I interpret this data to mean that providers of angel and venture capital in areas of capital scarcity – meaning outside of the big four metropolitan areas – could, conceivably, be an advantage. When you provide a thing that other people can’t otherwise find, that might tilt odds and negotiating terms in your favor.

To answer the second big question – what percentage of firms actually make money for investors – we turn to the Angel Resource Institute an industry group which publishes semi-regular data. Their 2016 report shows that 70 percent of angel-backed firms lose money for investors, meaning 7 out of 10 angel-backed startups return less than 1X of an investor’s original investment. That’s a lot of failure.

On the other hand, we could interpret this data in baseball terms, and say that regularly batting .300 could conceivably still win the game. The Angel Resource Institute further reports that 10 percent of angel-backed firms tend to make up 85 percent of the cash generated and returned for investors. To continue the baseball analogy, we see that investors depend on a homerun from one in every ten at-bats in order to make money.

The Angel Resource Institute also helps set our expectations for the third question, which is about how long an angel investment will tie up our capital. They report an average holding period – the time between investment and “liquidity event” – of 4.5 years. The first thing I think is that that’s a long time to have money tied up in a speculative, illiquid investment. The next thing I think it that 4.5 years represents the average, so many commitments will stretch far longer than that. My friend Tom Dickerson, a venture capital firm founder, laments that many venture capital investments seem to stretch on and on, seemingly without end. Patience is both a virtue and a necessity here.

Fourth and finally, what kind of returns can you expect from angel investing? Given the difficulty of tracking angel investments, I apply the largest grains of salt to this answer. The Angel Resource Institute reports an internal rate of return from their latest survey-driven report of 22 percent. That sounds great, but please remain skeptical.

rat_holeMy friend Tom reminds me “the majority of positive returns are concentrated in a handful of venture capital firms. The majority of venture capital funds actually lose money.“ And yet the phenomenon known as “survivorship bias” keeps the successful venture capital firms in front of investors, while the losers disappear quietly.

In addition, the Angel Resource Institute study – while one of the better sources of data we have – has a bias toward angel-backed firms which later receive venture capital. That in turn will skew outcomes toward larger and more successful firms than normal. In addition, if only 1 in 10 angel-backed firms provide nearly all of the positive returns to investors, it’s easy to see how angel investing could provide a below-average result for many.

So, that’s the aggregate data you should have in advance of angel investing. I don’t know, maybe you like opaque, illiquid, speculative areas of investing? It raises the possibility of market inefficiency, which many believe works to their advantage. Still, you will want to get comfortable investing with scant data if you plunge into angel investing.


A version of this post ran in the San Antonio Express News and Houston Chronicle.

Please see related posts:

Angel Investing – An introduction

Seeking Mr. Rathole

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Rat Holes and Small Biz Crowd Funding

This comes up when you google ‘rat hole’

When I started my business twelve years ago I needed to raise what was for me a substantial amount of money. A good friend introduced me to his wealthy boss, who agreed to meet about my business pitch.

He listened carefully, nodding sagely at the appropriate times.

Mr. Rat Hole

“Well Michael, it sounds plausible,” he replied, “But I’m not going to invest any of my own money. I’ll tell you what, though. I know a few guys who like to throw money down a rat hole. I’ll give you their names.”

“Um. Okay! Thanks!”

Of course I was happy to be referred to other potential investors. I tried not to think too deeply about his jaundiced assessment of my business’ prospects.

Forever after, my friend and I referred to a prospective investor gained through his boss as ‘Mr. Rat Hole”

[note: This video is only tangentially related to the theme of rat-holes, but it’s just one of my favorite Onion videos of all time]


Raising money is hard

I wrote recently about the various difficult ways of raising money for your startup business that you could try.

The other primary startup-funding source is not a loan, but rather a direct equity investment in your company. You sell part ownership in your business to an investor who hopes to earn a return on their money, if and when your business proves profitable.

With Equities: Lawyer up

If you happen to have wealthy acquaintances who enjoy throwing money down a rat hole, I recommend approaching them with your business startup plan. Generally speaking, however, the sophisticated ones will understand that direct equity investments in startups are extremely risky endeavors. This is why securities regulations have traditionally imposed barriers to prevent ‘regular’ non-accredited (meaning: non-wealthy) people[1] from investing in startups.[2]

The more money you seek to raise, and the more investors you seek to raise it from, the more quickly you will approach legal thresholds that require you to either register with state or federal entities for selling ‘securities’ or seek exemptions from that registration.

I guess what I’m saying is two things. First, obviously, you should never take legal advice from a newspaper columnist.

Second, get thee to a lawyer’s office now! I can’t overstate this second point. Never – EVER – sell a piece of your business without getting a good business lawyer involved. She will protect your business, your investors, and most of all, you.

Newfangled crowd-sourcing

But what if you don’t have wealthy acquaintances with an abiding interest in rat holes? The good news (I guess) is that a combination of federal securities law changes following the 2012 JOBS Act as well as ‘fin-tech’ solutions, are attempting to open up the wallets of ‘regular’ people to the capital needs of startups.

As of a week ago, in fact, crowd-funding ‘portals’ can now apply to the SEC – with a target date of May 2016 – to go live for the first time, allowing regular investors access to private investments.  Federal investment limits range from $2,000 to $10,000 per investment, with annual limits of $100,000, in any given year, per individual.

In Texas

Meanwhile, a relatively new state crowd funding law allows Texas-based regular investors to invest in Texas-based startups, with a $5,000 limit per deal, and no limit on the number of deals one can do.

lone star beer

This Texan-to-Texan funding makes sense because allowing non-Texans to invest in startups in this state would be tantamount to treason. No, obviously this doesn’t make any sense at all, but it is the kind of Texas-y thing you could imagine a Texas legislator would like to vote for.[3]

I remain skeptical

I mention the crowd-sourcing route for funding your small business partly because it’s hip and topical. As of now I don’t see it, however, as very practical. In my opinion and experience a non-insane entrepreneur would always prefer the fewest number of relatively wealthy investors over a larger number of people who cannot afford to lose their money.
If your business plan is good enough to attract hundreds of ‘regular’ people, it should be good enough to attract a handful of wealthy people, is one way of thinking about it.

Maybe for marketing?

Another way of thinking about crowd sourcing, however, is that this is a way to cement a relationship with your most fervent customers. You raise the bulk of your money through a few wealthy folks, and then use crowd sourcing as a marketing tool. I can live with that method.

Howard Orloff, Chief Marketing Officer for ZachsInvest, a Chicago-based firm that expects to be involved as a crowd funding portal in 2016, agrees.

“As a pure fundraising mechanism, the equity crowd funding rules may be a bit clunky as is, but we view this from another perspective. As a marketing tool, and possibly used in conjunction with social media among your best customers – we think this is phenomenal.”

Finally, be wary

I understand that as a startup entrepreneur seeking money right now your primary focus remains: How do I get my hands on that sweet, sweet, money?

But I hope I don’t have to belabor the point that this ‘opening up’ of equity investments to regular folks via crowd sourcing is a mixed blessing, at best.

I mean, we like to think it’s a free country and non-wealthy people should be allowed to throw their money down a rat hole too, right?

At some point, and in many cases of course, ‘regular’ people will be hurt.


A version of this ran in the San Antonio Express-News.


Please see related posts

Small business startup money is hard to get

Entrepreneurs are a touch funny in the head

Small business startups – a few sources of debt capital

Entrepreneurship – The Air, The Taxes, The Retirement


[1] Traditionally, ‘non-accredited’ in this context has really meant non-wealthy. The theory generally being that a) wealthy people can afford to lose their money and b) wealthy people may themselves be unsophisticated but they have the wherewithal to hire sophisticated advice from lawyers and accountants to sufficiently protect them from their own mistakes, as well as from greedy and unscrupulous stock-sellers.

[2] The SEC’s definition of ‘wealthy’ may be debatable. An ‘accredited investor’ is one with a $1 million net worth or $200,000 in annual income for the past two years, with a reasonable expectation of maintaining that income level.

[3] Actually 30 different states have passed new versions of ‘intra-state’ crowd funding laws, so its not just a result of only-in-Texas chauvinism. But Texas did pass a more restrictive rule mandating that Texas deals only be listed by Texas-based portals. This, in fact, makes no sense.



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