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The Angel Investment Environment

By H. Randall Goldsmith

I came across a quote recently from Tim Draper, a legendary investor and a founder of Draper Fischer Jurvetson, a venture capital firm that has backed successes such as e-bay, Hotmail, and Skype. He said, "We are looking for uniqueness. I like companies that are taking long odds at an extraordinary outcome…companies that set out to change the way we live."

Not every opportunity meets that criteria, but it is the quest of every investor. Along the way, angel investors discover companies with a compelling business proposition based upon a significant market opportunity that could generate an attractive return on investment, and they are seeking an initial investment. In considering these opportunities, it is important to note that angels are critical to the U.S. capital structure. Angel investors invest virtually the same amount of capital per year as do venture capital firms. The primary difference is they invest in 10 times as many deals. Angel investment opportunities provide much of the pipeline for venture capital firms. One in ten of these angel investments will qualify for venture capital funding. With proper guidance, assistance and access to critical funding at the right time under the right terms, the success rate can be much higher within a state or region.

To put it in perspective it is much a factor of numbers. Each year in the U.S. as many as 700,000 new business establishments are created with funding coming primarily from friends and family. In fact 67% of all new establishments do not launch with outside investment capital. Of this number of new establishments, it is estimated that approximately 5% will evolve into high-performance entrepreneurial growth companies. These companies are the one’s most likely to be in need of outside investment. It’s at this point where angel investments become so important to driving the new economy in a community or state.

In an attempt to stay abreast of the investment environment, I have distilled some key facts from a variety of surveys, reports, and research papers over the past few weeks. I would like to share them with you here to provide insight into how important entrepreneurship and capital are to our economic future.

Economic Development Impact

  1. The single greatest contributor to economic progress today is the creation of "innovation intensive" companies.*
  2. "Innovation intensive" companies have the potential to define a future local, state, national, or global economy.
  3. Angel investments in 2006 resulted in more than 200,000 new jobs (roughly 4 jobs per investment).

Angel Investor Activity

  1. More than 234,000 private individuals (angels) with high net worth (in excess of $1 million in net assets and $200,000 in annual income) provided $25.6 billion to approximately 51,000 "innovation intensive" deals in 2006.
  2. First round investments to companies represents 63% of angel investor activity, while 45% to 55% represent later-stage investments (the combined percentage is greater than 100% since some angels invest in first rounds as well as later rounds).
  3. Angels, on average, invest in 20% of qualified deals they review.
  4. In 2006 women angels represented 13.8% of the angel market and invested in 21.5% of the women-owned ventures reviewed (women-owned ventures represent 13% of total new venture opportunities).
  5. An Angel Capital Association survey reported a 23% increase in average total investment per group in 2006 and a 34% increase in average number of deals funded.
  6. The ACA survey reports that angel groups expect to:
    • See an increase in the quantity and quality of investment opportunities.
      • 96.5% expect to invest in a new company.
      • 77% will invest in 8 to 9 companies.
      • Average number of investments per group is 7.4 deals
      • Average amount of investment in all deals per group is $1.78 million.
      • Average size investment per deal is $241,528.
    • Continue with seed and early-stage investments (80% and 85% respectively; only 22% reported expansion round investments and 5% late-stage investments).
    • See a strengthening of opportunities for positive exits (30% reported distributions to members in 2006).
    • See more co-investments with other angel groups and with other investment capital firms (72% of groups reported co-investment with Venture Capital Firms in the same or follow-on deals).
    • The dominant investment areas for angels in 2006 was :
      • Medical devices (89%)
      • Software (85%)
      • Bio-technology (67%)
      • Remaining areas in alphabetical order include: business products and services, electronics and instrumentation, healthcare services, industrial/energy, IT services, networking and equipment, and telecommunications.

Investor Expectations

  1. Investors invest on the expectation that the venture will be merged, acquired or "go public (IPO)."
  2. In 2006, there were 335 venture-backed mergers and acquisitions (M&A) at an average value of $113.8 million per deal (the average amount of investor capital in the M&A deals was $22 million).
  3. In 2006, there were 58 venture-backed IPO’s at an average offer amount of $91.7 million with a pre-offer venture value of $200 million (the average amount of investor capital in the IPO venture was $50 million).
  4. The average time to an M&A or an IPO was 6 years.
  5. Acquisitions that returned more than 10 times the amount of the original investment comprised 30% of the transactions while 30% returned less than the original investment.

Throughout history the U.S. competitive advantage has been a combination of research and technology development, entrepreneurs and risk capital. What has been the "secret sauce" in the past is being discovered throughout the world. China, India, Korea, Singapore, and Scandinavia are gaining or have passed us in global competitiveness. Tim Draper says, "Investors today are more focused on China and India today than the U.S." This poses a situation where local angel investments are more critical than ever. If we are to maintain our competitiveness or intend to increase our local regional competitiveness, it comes down to local appetite for risk. If there are no local investment opportunities, opportunities go where they can find the investors. In today’s world, deals and capital are mobile. Regions that fail to present access to a pool of high-risk, patient, investment capital cannot support nor attract the emerging "innovation intensive" companies that will shape their future.

* Sources: Angel Capital Association, National Venture Capital Association, Center for Venture Research