Angel Investors

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ANGEL INVESTORS

Angel investors are a vital component of the venture capital industry. Known for making a splash in the e-commerce world of the late 1990s and early 2000s, they have emerged as a hugely successful economic force, attracting droves of well-leveraged individuals and groups looking for the early investment that can spawn an industry powerhouse. The decade-long U.S. economic expansion produced ever more wealthy individuals willing and able to invest in risky new business ventures. As the dot-com mania picked up speed, more of these new ventures turned angel investing into one of the most glamorous sectors of finance.

In a sense, angel investing has been around as long as business itself. Traditionally, before an entrepreneur even created a sound or semi-promising business plan or prototype to attract seed money from institutional investors, he or she would seek initial start-up funds from a wealthy patron. Angels provide entrepreneurs with the early-stage seed money needed to get on their feet, while venture capital (VC) funds tend to steer their money toward firms that are in the later stages of early development, closer to an initial public offering (IPO). In addition, angels put their own money into companies, unlike venture capitalist firms, which pool funds and invest them in a manner similar to mutual funds.

Risk is an inherent component for angels. Besides backing entrepreneurs that are not yet attractive enough even for VC funds, angels also eschew other investment safeguards, such as Federal Deposit Insurance Corp. (FDIC)-insured accounts. With excess money at their disposal, angels more or less take a chance when handing checks over to entrepreneurs, albeit not without an often-heavy hand in guiding the development process. And even in the fairy-tale dotcom boom of the late 1990s and early 2000s, the risk was very real; roughly nine out of ten angel investments proved to be washouts. However, the high yield of winners makes the field what it is. Thus, angels tend to approach their investments as though they were buying lottery tickets; it takes only one success to hit it big, and that one easily pays for all the others.

Different angels have different styles. While some bring in lawyers to negotiate deals and demand a great deal of say in company development, others are more relaxed and hands-off. Some specialize in greasing the wheels between entrepreneurs, banks, and investors, while other angels concentrate almost exclusively on seeking out new entrepreneurs, giving little attention to how things progress. Hands-off angels work on the idea that one big winner will pay for the less-sound investments. There also are those phil-anthropic angels who, with money to spare, throw it behind valuable and socially redeemable projects out of altruistic motives.

According to Fortune, an angel or small group of angels provides between $100,000 and $1 million in exchange for up to 30 percent of a company. While such deals tend to be private, Fortune reported that angels poured at least $40 billion into roughly 50,000 start-ups a year in the late 1990s. According to some estimates, this amounted to 30 or 40 times the level of investment provided by institutional venture capitalists. According to the Center for Venture Research at the University of New Hampshire, about 400,000 active (at least one deal a year) angels were in operation in 2000, representing 60-percent growth since 1997, while the entire field of angels numbered about 3 million.

With the millionaire population of the United States doubling between 1994 and 1999, a whole new league of players was eligible to play the angel investing game. The tremendous boom in angel investing in the late 1990s was primarily attributable to the avalanche of dot-com initial public offerings (IPOs) that seemed to flout all traditional market logic. In other words, earnings, fundamentals, and other typical variables of valuation, took a back seat to the fact that the words "dot-com" were appended to a company's name. Additionally, a symbiotic relationship existed between the strong economy and the proliferation of angels. Edward G. Boehne, former president of the Philadelphia Federal Reserve Bank, said that angels are "a big part of the extensive infrastructure that's developed to finance and support entrepreneurs." According to Boehne, Angels helped to spur a wave of entrepreneurship that was largely responsible for sustaining a long period of economic growth and expansion, which exceeded the expectations of many.

Among analysts, however, there was widespread consensus that the tech boom and the lure of fantastic returns created a glut of angel investors. For this reason, they felt the field was unlikely to sustain the astronomical growth rate of the late 1990s. With tech and dot-com stocks finally returning to financial reality in 2000 and 2001, high-stakes angel investing appeared less fashionable and less feasible. But no one expected the practice to completely go away. In fact, angel investing was taking even firmer root in U.S. culture. Some 150 formal angel clubs were established throughout the country by 2001, mostly in the late 1990s and early 2000s, at which local and regional elites could share information and turn angel investing into a potent and coherent economic force. Such investors typically pay between $25,000 and $100,000 to join these exclusive pools.