Angel investor

The application of the term "angel" originally comes from Broadway theater, where it was used to describe wealthy individuals who provided money for theatrical productions that would otherwise have had to shut down. In 1978, William Wetzel, a then-professor at the University of New Hampshire and founder of its Center for Venture Research, completed a pioneering study on how entrepreneurs raised seed capital in the US. He began using the term "angel" to describe the investors who supported them. A similar term, "patron", is commonly used in arts.

Angel investors are often retired entrepreneurs or executives, who may be interested in angel investing for reasons that go beyond pure monetary return. These include wanting to keep abreast of current developments in a particular business arena, mentoring another generation of entrepreneurs, and making use of their experience and networks on a less than full-time basis. Because innovations tend to be produced by outsiders and founders in startups, rather than existing organizations, angel investors provide (in addition to funds) feedback, advice and contacts. Because there are no public exchanges listing their securities, private companies meet angel investors in several ways, including referrals from the investors' trusted sources and other business contacts; at investor conferences and symposia; and at meetings organized by groups of angels where companies pitch directly to investor in face-to-face meetings.

According to the Center for Venture Research, there were 258,000 active angel investors in the U.S. in 2007.[3] According to literature reviewed by the US Small Business Administration, the number of individuals in the US who made an angel investment between 2001 and 2003 is between 300,000 and 600,000.[4] In the late 1980s, angels started to coalesce into informal groups with the goal of sharing deal flow and due diligence work, and pooling their funds to make larger investments. 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 United States. There were over 200 as of 2006.[5]

Angels typically invest their own funds, unlike venture capitalists, who manage the pooled money of others in a professionally managed fund.[6][7] Although typically reflecting the investment judgment of an individual, the actual entity that provides the funding may be a trust, business, limited liability company, investment fund, or other vehicle. A Harvard report[8] by William R. Kerr, Josh Lerner, and Antoinette Schoar provides evidence that angel-funded startups are more likely to succeed than companies that rely on other forms of initial financing. The paper by Kerr et al., found "that angel funding is positively correlated with higher survival, additional fundraising outside the angel group, and faster growth measured through growth in web site traffic".

Angel capital fills the gap in seed funding between "friends and family"[9] and more robust start-up financing through formal venture capital. Although it is usually difficult to raise more than a few hundred thousand dollars from friends and family, most traditional venture capital funds are usually not able to make or evaluate small investments under US$1–2 million.[10] On an annual basis, the combined value of all angel investments in the US almost reaches the combined value of all US venture capital funds, while angel investors invest in more than 60 times as many companies as venture capital firms (US$20.1 billion vs. $23.26 billion in the US in 2010, into 61,900 companies vs. 1,012 companies).[11][12]

There is no "set amount" for angel investors; investments can range from a few thousand to a few million dollars. In a large shift from 2009, in 2010 healthcare/medical accounted for the largest share of angel investments, with 30% of total angel investments (vs. 17% in 2009), followed by software (16% vs. 19% in 2007), biotech (15% vs. 8% in 2009), industrial/energy (8% vs. 17% in 2009), retail (5% vs. 8% in 2009) and IT services (5%).[11][13] While more readily available than venture financing, angel investment is still extremely difficult to raise.[14] However some new models are developing that are trying to make this easier.[15]

Much like other forms of private equity, the angel investment decision-making has been shown to suffer from cognitive biases such as illusion of control and overconfidence.[16]

Angel investments bear extremely high risks[17] and are usually subject to dilution from future investment rounds. As such, they require a very high return on investment. Additionally, angel investors often mitigate the risk of an angel investment by allocating less than 10% of their portfolio to these types of investments.[18] Because a large percentage of angel investments are lost completely when early stage companies fail, professional angel investors seek investments that have the potential to return at least ten or more times their original investment within 5 years, through a defined exit strategy, such as plans for an initial public offering or an acquisition. Current 'best practices' suggest that angels might do better setting their sights even higher, looking for companies that will have at least the potential to provide a 20x-30x return over a five- to seven-year holding period. After taking into account the need to cover failed investments and the multi-year holding time for even the successful ones, however, the actual effective internal rate of return for a typical successful portfolio of angel investments is typically as 'low' as 20–30%. While the investor's need for high rates of return on any given investment can thus make angel financing an expensive source of funds, cheaper sources of capital, such as bank financing, are usually not available for most early-stage ventures.

The last years showed the emergence of founding angels as angel investors involved even before the foundation of a start-up.[19] Founding angels co-found start-ups together with scientists who bring in the technology on which the start-up is based. After foundation, they are actively engaged in the management of the start-ups, typically in a non-executive position. This type was firstly described by Festel and De Cleyn who found that founding angels are individuals playing a key role in providing day-to-day operational support to the start-up together with early-stage financing.[20]