Angels Invest Where Banks Dither

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Image Credit: falseprecision.typepad.comBy Ramesh Jaura

BERLIN - For innovative young folks, angels are by no means mythical beings or messengers of God as depicted in the Hebrew and Christian Bibles and the Quran. They are flesh-and-blood source of equity capital at the seed and early stage of company formation, particularly when banks are reluctant to lend.

These so-called "angel investors" usually invest between USD 25,000 and 500,000 in start-ups – and larger amounts through "angel groups" – and also leverage their expertise to provide mentoring to the entrepreneurial teams in which they invest.

Explaining their significance, a new report says: "While angel investment has existed in practice for centuries, the concept of angel investors as a powerful source of financing for high-growth companies has emerged over the past couple of decades in the United States and Europe and is rapidly growing in other regions around the world."

The report, titled 'Financing High-Growth Firms: The Role of Angel Investors', is authored by Karen Wilson who works in the Structural Policy Division of the OECD Science and Technology Directorate.

"OECD (Organisation for Economic Co-operation and Development) member countries were interested in learning more about the growing phenomenon of angel investing," Wilson tells IDN. "In particular, they wanted to understand how it works, how it is evolving and what types of policies might help facilitate further growth of this important source of financing start-ups," she adds.

Wilson has responded to OECD member countries' interest and offered an in-depth report providing insight into angel investment, including definitions, data and processes. The report reviews developments around the world and identifies some of the key success factors, challenges and recent trends. It also discusses policy measures for promoting angel investment, with examples from countries which have been active in this area.

The findings show that angel investments are increasing and, while precise data is hard to collect, the report points out that estimates of the total angel investment market in a number of countries are greater than traditional venture capital (VC) investment, particularly for seed and early stage financing.

In 2009, the total estimated angel market in the U.S. was USD 17,700 million compared to USD 18,725 million for the venture capital market. And in Europe the total estimated angel market, at USD 5,557 million exceeded the VC market which stood at USD 5,309 million.

While policy makers tend to focus on the venture capital market, which is more visible than the angel market, the data from the U.S. and Europe indicate that angel investors will continue to be critical in overcoming the financial and growth challenges facing entrepreneurs, in turn, contributing to innovation and job creation, says the report.

As part of the background research for this project, Wilson interviewed over 100 people from a mix of 32 OECD and non-OECD countries: Argentina, Australia, Austria, Belgium, Brazil, Canada, Chile, China, Denmark, Finland, France, Germany, India, Ireland, Italy, Israel, Japan, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Singapore, Slovakia, Slovenia, Spain, Sweden, Switzerland, Turkey, UK and the United States.

"We chose a mix of developed and developing countries which provided a perspective on how angel investing develops over time and in different contexts," says Wilson replying email queries, and adds: "Within each country, we sought perspectives from a mix of angel investors, entrepreneurs, academics and policy makers."

Many of the countries covered and interviewees were recommended by OECD members or practitioners. However, Wilson does not expect the report to lead new guidelines for OECD members.

Without exaggerating the significance of the report, she says, "it seems that this project was the first time angel investment has been examined on a global basis – previous work has mostly looked within a country or regional area and mostly focused on the U.S. and Europe."

She adds: "The OECD will continue to do work on angel and other forms of seed and early stage investing to help provide further evidence and information for policy makers about possible actions that can be taken in these areas. This is particularly important in today's economic environment given the difficulties many start-ups have in accessing funding."

According to the report, "the angel investment sector is not only growing, but also becoming more formalised and organised through the creation of angel groups and networks. In addition to the money provided, angel investors play a key role in providing strategic and operational expertise for new ventures as well as social capital (that is. their personal networks)."

The report finds that angel investors tend to be less sensitive to market cycles than venture capitalists, although a "wealth effect" could impact how much they are willing to invest when markets fluctuate. "However, in the current market environment, the lack of exits – whether through an IPO (initial public offering) or M&A (mergers and acquisitions) – has put a strain on both angel and venture investment."

At the same time, the internet has created opportunities for the creation of firms with smaller amounts of initial capital than more traditional technology and science sectors, says the report. These companies have been termed "lean start-ups” as they allow greater capital efficiency and more rapid testing and adjustment of products and/or business models.

Angel investors have been able to invest in this space and support companies through an "early exit" (usually M&A) without needing VCs to come in for later rounds. Besides, angel investors support a much wider range of innovation than VC firms as they traditionally invest locally and in a wider range of sectors than venture capitalists.

This means there is broader investment coverage both in terms of industry sectors and geography. In fact angels live everywhere, not only in areas where VCs have offices, which tend to be concentrated in a few technology or science hubs, finds the report.

However, it also means that angel investors can also be involved in companies that are not necessarily technology intensive or high growth as well as companies in later stages of development. Like VCs, angel investors tend to invest in a portfolio of companies, not just in one or two.

According to the report, universities are often highlighted as an important potential source of start-ups. But often these companies are more research rather than commercially focused and therefore do not succeed as often in securing angel or venture capital as often as assumed.

"This example points to a potential disconnect between innovation policies, which tend to focus on R&D rather than commercialisation, and entrepreneurship policies which focus on the translation of innovation into firms," notes the report.

It points out that given the local nature of angel investing, there is no homogeneous national angel market. The level, sophistication and dynamics of angel investment can vary greatly across regions within countries and therefore policy makers must take this into account. In fact, in a number of countries such as Canada and the United States, angel policies are implemented at the regional rather than the national level.

Further, angel investment can vary greatly across countries, both in terms of volume and approach. Policies that have worked in one country may not necessarily work the same way, or be as successful, in another country. Also, while policies targeting angel investment are being put in place in a growing number of countries, there have been few formal evaluations of these programmes to date.

Wilson is of the view that there are several reasons for the lack of knowledge about angel investment. Traditionally individual angel investors have preferred to keep information about their investments private. Even as the industry has professionalised with the formation of groups and networks, accurate data collection has remained a major challenge.

Another key issue, says the author, is the one of definitions. Often the words business angels or angel investors, informal investor and informal venture capital are used interchangeably. However, most definitions clearly differentiate investment from founders, family and friends from angel investors, who do not have a personal connection to the entrepreneur prior to making an investment.♦

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