Updated: Mar 28
Congratulations, you’ve “made it”!
As a potential Angel investor, you are a high-net-worth individual who is qualified to be an Accredited Investor. Kudos – you have made it to the stage in your life when you are permitted by the government of your country to invest in opportunities outside of the public equity markets without the required use of a broker. These investments are typically higher risk with higher potential for reward.
The good news is that you are now allowed to make private Angel investments outside of the normal public stock markets. You don’t need to spend money on management expense ratios or brokerage fees. The bad news is that the government permits this because it thinks you are smart enough to do all the work yourself and wealthy enough to afford losing all your money in these investments!
This series of articles made possible thanks to NACO, will help you manage this risk and improve your potential for a good return on investment (ROI). It will help you find good opportunities, structure good deals, grow good companies, determine good exit strategies, and manage an investment portfolio, to maximize your chances of gaining high investment returns.
If you do it right (and maybe get a bit lucky), your Angel investment portfolio can achieve significant returns. The average US Angel participating with an Angel group achieves 27% annual return on their portfolio of Angel investments. However, in order to achieve this return, the average Angel will have to wait four to eight years to get their money through an exit event, such as the company being acquired or going public (Wiltbank & Boeker).
Got What It Takes?
An Accredited Investor is an individual who, either alone or with a spouse, owns financial assets (not including principal residence) having an aggregate realizable value that before taxes, but net of any related liabilities, exceeds $1 million; or whose net income before taxes exceeded $200,000 in each of the two most recent calendar years; or whose net income before taxes combined with that of their spouse exceeded $300,000 in each of the two most recent calendar years; and who, in either case, reasonably expects to exceed that net income level in the current calendar year.
An Angel investor, also referred to as a "Business Angel", is an Accredited Investor who privately invests their own money in a business, usually in exchange for ownership equity, debt or other terms. (An “angel” is a spiritual being sent by the celestial powers to give money to entrepreneurs who need it. This imaginary creature has never been found in reality.)
This series of articles will help distil the wisdom of hundreds of Angel investors who came before you. They will share their tips about things that worked and things that didn’t. I hope you’ll learn from their mistakes before going out there and making your own.
The Good, the Bad, and the Reality
Good news – you are wealthy enough to make private investments! Bad news – most of your investments will be complete losses! The reality – you should invest in a portfolio of 20-plus companies in order to gain average investment returns of 27% per year.
1. Who Are Angels and Why?
Most mortals are restricted from Angel investing and must invest exclusively in highly regulated financial asset classes, such as public stocks, bonds, GICs, T-Bills, money markets, mutual funds and insurance. Most countries’ securities regulations allow exemptions for certain high net worth individuals to be accredited investors and make private Angel investments.
Angels are expected to sign a formal document declaring their eligibility to make Angel investments. For example, Canadian securities regulation National Instrument 45-106 requires an Angel to earn over $200,000 per year ($300,000 as a couple) or have over $1 million in assets, not including their principal residence. Most recently, Angels with less than $5 million are also required to sign a Risk Acknowledgement Form #45-106F12 (RAF) (Volker).
Most Angels enjoyed a successful business career and want to share their expertise and experience with younger entrepreneurs. Of course, they want and expect to gain above-market rates of return on their investments, but often they also want to “pay it forward,” help others, and give back to their communities.
Angels are often retired executives or other professionals, or, in many cases, they are “cashed-out” former entrepreneurs who ran and then sold their own companies. Most of their money goes into stable investments in real estate, public stock markets, and bonds and other investment asset categories managed by professional financial advisors. Some gets spent on their bucket lists – sports cars, cottages, dream homes, yachts, or nice long vacations to a tropical paradise. But then what?
What Will You Do with the Next 20-Plus Years of Your Life?
For most Angels, the answer is “I want to continue to do what I love but without the daily stress of running a company. I want to be involved in strategy, important deals and major decisions. I want to lend my expertise but I don’t want a job,” or, “I want to help other entrepreneurs learn from my mistakes but I want a share in the upside for my time.”
If you are looking for the stories of individual Angels, Josh Maher’s book, Startup Wealth, provides interviews with 23 US Angels who give their personal reasons for becoming an Angel, and what they have learned about Angel investing over the years.
The term “angel” was initially coined for wealthy people who donated, loaned or invested in Broadway theatre productions. They were often thought of as patrons of the arts who invested because of their love of the theatre. Similarly, business Angels invest because of their love of business.
Angels invest for many reasons, including:
• Potential for significant financial returns
• Excitement of being involved in an interesting company or industry
• Mentorship with the entrepreneur
• “Paying it forward” by sharing their expertise with those who need it
• Contributing to the economic growth of their region or country
• Giving back to the community
• Enjoying the social aspects of networking with other Angels
Hopes and Dreams
Being an Angel is like being a grandparent. You get all the joys of being a parent/entrepreneur but you don’t have the stress of changing diapers, paying for university, firing employees or meeting payroll.
Aside from personal reasons for investing, we know, for example, that the median US Angel is 57 years old and has 14.5 years of entrepreneurial experience founding 2.7 ventures. He (86% are male) invests no more than 10% of his net worth and has made 10 investments over nine years with two exits or closures. 99% have college degrees and over half have graduate degrees (Wiltbank & Boeker).
As an investment asset class, we know that Angel returns can average 2.6X the investment in 3.5 years – an internal rate of return (IRR) of about 27%. This compares very well with other asset classes (Wiltbank). However, looking only at averages can be very misleading!
The distribution of returns shows that over half of all investments never return their original capital or fail completely (less than 1X, or the first bar in the graph above). Only 7% of exits return more than 10X the capital – thus creating over 75% of total portfolio investment returns. 10% of exits produce 90% of total returns. Since only one in ten investments will account for almost all returns, successful Angels must use a portfolio approach. (This need for a portfolio to reduce risk is the same as the reasoning behind mutual funds or index funds.)
2. How Do Angels Invest?
Visible Angels are Angels who participate in an Angel group or syndicate and/or who want to be found by entrepreneurs who are looking for investment. Because we know who they are, they are counted in annual reports, and governments can track the important role they play in stimulating the economy. It is estimated that there are 10 times more invisible Angels who do not want to be found. We know this from company tax returns and because of our data comparisons with the number of US Angels for example, who tend to be far more visible than those based in other countries.
YarakSeed Ventures provides an array of statistics about Angel investing, and it is well worth the time to review its contents. You can benefit from knowing which sectors are popular, which Angel groups are performing well, and what deal structures they are using.
Most Angels calculate their ROI in terms of their multiple returned:
if a $10,000 investment pays back $15,000 that’s a 1.5X multiple. However, this simple reporting metric fails to account for the time value of money. A 1.5X multiple over a short time is far better than the same 1.5X paid out over a long time.
An alternative way to state your ROI is using internal rate of return (IRR). The IRR is the interest rate you would have required over the same period to achieve the same final lump sum payment (i.e., exit event). You can convert the multiple to IRR using the following:
Money received upon exit / Money invested = (1+R)t
where R is the IRR and t is the number of years to exit. Unless you happen to have an old HP15C kicking around, it is easier to use an online calculator. Below is a table to illustrate how IRR compares to multiples over different time periods.
According to the Angel Resource Institute (ARI), for most Angels in Angel groups, it appears that a general guideline for an individual is to invest around $25,000 in a first round of investment. This will vary from group to group. For example, the average for the Golden Triangle Angel Network (GTAN) is closer to $42,000 per deal. In addition to this first round of investment, most Angels also reserve some money to invest in the next (usually larger) round, if the company needs and deserves it.
If we look in more detail, we find that the average Angel investment is $384,000, but the median investment was only $160,000. This means there are a few big investments and lots of smaller ones. These stats thus tend to be heavily skewed by a small number of Super Angels who may invest large amounts of money that resemble those invested by venture capitalists. Only 35% of investments were made by an individual (known as a Lone Wolf).
Most Angels (65%) co-invest with others, for an average deal size of about $1.2 million. Most deals involve three or four investors.
Average Angel investment deal size has grown over the last few years to $1.7 million in
2016. However, since the median deal was less than $400,000, there are a large number
of much smaller deals. Overall, Angels do a large number of smaller investments and
then, as these companies grow, provide an ongoing source of fewer, but much larger
funding rounds. In many cases, successful companies achieve significant exits without
any venture capital (VC) or other investors
The average pre-money (before investment) company valuation is $5.6 million with a median valuation of only $4 million. As shown in the figure, this average is also heavily skewed by a small number of very large deals.
Pop Quiz: With a pre-money valuation of $5 million, how much of the company does a $1 million investment buy?
How many companies do you need in your portfolio? The general suggestion among Angels is 20 companies. Dr. Wade Brooks estimated that you need 40 companies to have a 95% chance of getting the average IRR of 27%. A portfolio of 20 companies would give you a 60–70% chance of hitting the average (NACO National Angel Summit, 2015).
Of course, success takes more than just luck and a large portfolio. Angel experience, length of due diligence, and post-investment participation in company coaching and governance also significantly increase the rate of return and the chances of successful exits (Wiltbank & Boeker).
Again, these numbers can be misleading. Angel investment practices across countries vary tremendously, and we will explore this diversity in more detail as we go through these series of angel investing articles.
To start, you must know yourself and Set Good Targets, so that’s explored in Chapter 1. How much time and money do you want to put into each investment? How many investments will be in your portfolio? How active do you want to be in the management of your investees? Do you want to be a Lone Wolf or a member of an Angel group? Do you want to just dabble or devote significant time to this over many years? The answers to these questions may vary over the years or from deal to deal.
Answer: 1/6 of the company or 16.67%. If you thought the answer is 20%, you should read Chapter 4.3 – Valuation.
The better your deal flow – finding lots of high-quality companies that ask you for funding – the better your chances of picking good ones to invest in. The best entrepreneurs have many choices, so there is plenty of competition to invest in the best deals. Chapter 2 will help you Find Good Companies through good sources of deal flow, screening techniques and managing deal flow. Various examples of different practices across different countries by several Angel groups are described.
The process to Pick Good Companies is referred to as due diligence, always a popular topic among Angels. Chapter 3 guides you through assessing the character of the entrepreneur, looking for skeletons, identifying the crown jewels, validating key assumptions and risks, and building trust with the company executives before you give them your cash.
Chapter 4 covers the nuts and bolts of how to Make Good Deals. This is the longest section of the book and includes big topics to which the book Age of the Angel devoted five chapters, namely: negotiations, term sheets, valuation, trust and deal syndication. Dozens of Angels generously provided sample documents that are available on our website.
Once the entrepreneur has your cash, how do you Grow Good Companies? Chapter 5 discusses being on a board of directors, corporate governance, coaching entrepreneurs, sourcing talent and managing follow-on investments.
Anyone can give their money to a company – the hard part is getting it back again! Chapter 6 discusses different exits that Angels achieve across Canada and gives advice on how to Create Good Exits. This includes knowing when to sell and how to maximize exit values. We also dig more deeply into the issues of the time value of money, dilution, multiples and rate of return.
The Role of Angel Investing in the Economy
“No money – no company. It’s as simple as that. Without investment capital, there would be no new companies and no new jobs – our economy would be in the dumps!” (Carl Furtado, Golden Triangle Angel Network)
Small to Medium-sized Enterprises (SMEs – companies with fewer than 500 employees) represent over 98% of companies in North America and Europe and employ over two-thirds of all workers (Lukács). A small fraction (around 4%) of these SMEs, however, are high-growth companies (called Gazelles) that create virtually all new jobs (estimates range from 50–100%) in the entire economy (Littunen & Tohmo; Acs, et al.; Henrekson & Johansson).
Virtually 100% of all new jobs in the last 30 years have come from new company startups. This is true of all developed countries, and the US job data shows this particularly well.
Two major forces are affecting the Angel asset class. First, entrepreneurs need less cash than ever to prove their business models and achieve an exit using agile lean techniques. This has created the rise of the “one-and-done” investment and has meant that VCs are becoming less important in the early-stage investment ecosystem. Second is the ability for Angels to co-invest and syndicate deals. This allows larger deals, which again pushes VCs into later-stage and even-larger-sized investments.
Some of the most attractive Angel investment opportunities use technology-based barriers to entry to achieve competitive differentiation and high exit valuations. While some countries like the US invests heavily in scientific research and development, it is difficult to commercialize these technologies and bring them to market with solid business models.
Angels provide a vital bridge across this commercialization funding gap, filling the gap in the funding continuum between initial seed capital from “friends and family”, and the larger-scale investments made by venture capital. If funding is not available through this often-lengthy interim development phase, many startups fall into the “valley of death”, reducing the pipeline of businesses for later-stage growth and development. As summarized by Bryan Watson: “It was not that long ago that the majority of policy and support programs were designed primarily for supporting VC-backed companies only. Angels, a collective of individuals, were a difficult entity to develop policy for. The economic crisis of 2008 and crowding out of Angel investors in the Canadian market (Cumming & MacIntosh), coupled with increased sophistication of Angel groups, allowed Angels to communicate with all levels of government. This led to programs that Angel-backed companies could leverage to cross the funding gap while also helping offset the risk Angels faced.”
The Innovation Funding Continuum – Angels Fund Companies to Scale Up
Source: Adapted from First Ed. NACO Angel Investing.
You can continue reading Chapter 1. Don't hesitate to contact us at email@example.com if you have any questions.