How angel investors put funding, expertise, and connections to work to help early-stage companies grow.
by Karin O’Connor
Which group invests more—venture capitalists (professional investors managing large pools of capital, mainly for pension funds and other large institutions) or angel investors (individuals investing their own money)? It might surprise you to learn that, while the VC’s come out on top—it’s not by much—investing $29.1 B vs. the angels’ $22.5 B in 2011. And, unlike VC’s, who prefer to invest larger dollar amounts in more established enterprises, nearly half of angel deals went to the youngest companies of all—in seed and startup rounds.
Angel investing has taken off over the last decade, in large part because it takes far less capital to get a company off the ground these days than it used to. A recent Forbes article calculated the early capital needs of a software startup at only $50 K these days, compared to $600 K or more to get to the same place just eight years ago. Cloud-based technology resources, open source software, and new communications options like Skype have enabled entrepreneurs to build a solution they can take to market quickly and on their own. But that’s only the beginning. Gaining a foothold and building customer traction takes marketing, and marketing takes money. Not millions of dollars right off the bat, but enough that the entrepreneur can test the waters with different ways of finding customers—web advertising, PR, social media, partnerships, direct sales—and figure out what works best. And that’s often where angels come in.
Perimeter Advisors founder Karin O’Connor has been a member of Chicago-based Hyde Park Angels (HPA) for nearly four years. HPA investors—over 100 strong at this point—have put more than $10 MM to work backing 22 promising companies thus far. The group looks at about 200 deals per year—last year, it invested in 7 of these. Company applications are reviewed by teams of members, assisted by MBA candidates from the University of Chicago Booth School of Business, and opportunities that are recommended by the team are presented to the entire group. Each angel then decides for himself/herself whether or not to invest, and, if so, how much. A typical first-round investment would be a group of 20-25 angels investing a total of $400 K in a round of between $1 MM and $2 MM (other investor groups are almost always involved).
The goal is to give the company enough “runway” to build value and get to the next “financeable” event. This is a key concept, because the company must be able to prove that its model is “working” and has continued potential in order to attract another round of funding before it runs out of money. If it fails at this, the business will either be sold at a loss or shut down. Ideally, the company will be able to find a next-round investor and that investment will be at a higher price than the first round—meaning that value has been created (at least on paper) for the founders and early angels. The plan is that the company will eventually be acquired at an even higher price. What kind of return do the angels seek? A typical rule of thumb is 10 times their original investment over the course of about 5 years. That may sound extreme, but remember, these are high-risk bets on unproven ventures—many of them will fall by the wayside along the way.
But the best angels (and angels groups) provide more than cold hard cash. Often comprising serial entrepreneurs, seasoned executives, and mature investors and advisors, they bring wisdom, experience, and connections that count. Helping the entrepreneur work through challenges such as margin pressures, loss of a key customer, product development delays, etc. can be critical to a young company’s success. So can introductions to potential partners, customers, and new financing sources.
A big contributor to angels’ willingness to help comes from the fact that they tend to take a very personal interest in the companies they back. One example is Retrofit, a data-driven weight loss company that attracted investment from an enthusiastic group of HPA members last fall. Several of them had already been clients and could speak first-hand to the effectiveness of the company’s solution—and to its potential for changing health outcomes and even lives. And Retrofit continues to benefit from this passion. Jeff Hyman, the company’s founder and CEO, recently commented, “I’ve been most impressed with HPA’s responsiveness and value-add. Throughout the process, the members have proactively made introductions to prospective clients and media outlets that have accelerated our growth.”
Angel investing is not for every investor, nor for every young company. But, when the right match is made, it can be, well, heavenly! Want to know more? Just give us a call.