7.1.2 Business angels
Modalities
375. Business angels (BAs) are high net worth individuals who invest their own money directly in
seed or start-up companies, with no family relationships, in return for stock in the companies (Mason and
Harrison, 2008). Thus, BAs capitalise their returns by disposing of the start-up shares, through an IPO, a
merger or an acquisition, and often re-invest the gains into new ventures. This is the case also because a
BA is typically financially independent, i.e. a possible total loss of the angel investments will not
significantly change the economic situation of his/her assets.
376. BAs are often former successful entrepreneurs who are interested in supporting other
entrepreneurs by providing both funding and expertise.
As it is the case for VCs, BAs generally take an
active involvement in the start-up company, providing strategic and operational expertise, as well as
connections to other key players in the system. Typically, BAs make investment decisions based on their
experience in a particular sector and invest in companies within their local area (OECD, 2011a). Indeed,
with respect to venture capitalists, BAs are usually less deterred by gaps in the start-up management team,
because they can contribute missing expertise through their own involvement (Mason and Stark, 2004).
377. In spite of their direct engagement in the management of the start-up, often BAs wish to remain
minority shareholders, as they are aware of additional funding needs of the entrepreneur at later stages, to
which other investors may respond, and prefer that the entrepreneur remains in control of the business with
significant stake in the result and incentives to succeed (OECD, 2011a).
378. Angel investing of this sort has existed for centuries, but, over the past couple of decades, the
angel investment sector has gained increasing recognition, as a powerful source of financing for highgrowth companies, and has become more formalised and organised, including through syndicates,
associations and networks (Ibrahim, 2008; OECD, 2011a).
379. Recognition has come with more regulation, although the angel investing market is largely
informal, i.e. BAs act privately and generally prefer to maintain anonymity (CSES, 2012). In the US, angel
investors need approval as “accredited investors” under securities laws, whereas in other countries
certification is necessary but can take the form of a self-certification. These requirements are intended to
ensure that the investors have the necessary financial resources as well as an understanding of the
implications of investing in start-up companies (OECD, 2011a).
380. The typical angel investment size is in the range of USD 25 000 – 500 000, that is, BAs operate
in a seed / early stage investment segment which falls in between informal founders, friends and family
and formal venture capital investments (see Table 7). Since VC is increasingly focused on later stage
investments, to some degree BAs are filling the financing gaps in the early stages (OECD, 2011a). Angels
may therefore be seen as providing a vital kick-start to innovating businesses both in terms of investment
and business-building skills (Wiltbank, 2009).
381. BAs tend to invest in a portfolio of companies, diversifying risk, and can operate alone or invest
jointly with other institutional investors, for example in a seed fund, or join forces with other BAs. This is
the case of formal or informal syndicates (or groups), in which experienced angels pool their capital and
expertise to achieve a critical mass and offer a broad range of managerial skills. Furthermore, investing
through a syndicate allows BAs to assess a wider range of deal opportunities and to identify potential coinvestment partners. Usually the investor pays for the syndicate, and the syndicate will assess the potential
investment for the BA to make the final decision. Syndicates may be member-led, i.e. managed by a lead
angel or a committee, or may be run by professional managers. In any case, members are generally allowed
to make their own investment decisions, although minimum annual investment requirements may be set by
the syndicate (OECD, 2011a; CSES, 2012). The recent growth in BA syndicates may be related to the
increased awareness about angel investment opportunities and a greater demand for pooled angel capital, to
fill the market gap between individual angel investment and venture capital (OECD, 2011a).
382. In recent years, Business Angel Networks (BANs) have diffused at the local and national level,
particularly in Europe. BANs do not invest themselves in start-ups, but rather play a match-making
function between angel investors and entrepreneurs. They help increase the visibility of the angel activity
in a region, without necessarily making the individual BA more visible, as they act as a “front door” for
entrepreneurs looking for financing (OECD, 2011a). BAs that are associated to the network make their
own individual investment decisions, and the BAN does not decide which investors will invest in a deal.
BANs also often provide a number of added value services to both angels and entrepreneurs, such as
investment readiness or syndication opportunities (CSES, 2012). BAN operating model, membership
criteria and sectoral orientation greatly differ across countries and regions.
They may focus on particular
sectors, gather groups of people with similar backgrounds, experiences, cultures or nationalities (e.g.
university alumni, diaspora groups) or include also service providers and other non-angel financial
investors (OECD 2011a; OECD, 2013e).
383. Increasingly, BA syndicates and networks are using online tools to favour the matching process.
In addition online matching platforms have developed, which provide matching services to registered
investors and entrepreneurs. Although these platforms can reduce information search costs for both the
investors and entrepreneurs, they do not replace personal contact and face-to-face interaction, which are
mostly needed in a financing model largely based on confidence and trust (OECD, 2011a).
Business angels vs venture capital
384. Business angels and venture capitalists act and interact in a common space of opportunities, that
of innovative, high growth potential start-ups, but are characterised by different motivations, targets, scale
and operating models
385. First of all, although capital gains represent a common and primary objective, the non-financial
motivations of BAs, and their entrepreneurial background, often imply they are willing to consider a wider
range of sectors than VC funds, including non high-tech fields, and geographical areas that are different
from VC hotbeds. Whereas venture capitalists must produce returns for VC investors, the use of personal
funds gives BAs the flexibility to invest for non-financial reasons and target sectors and local areas in
which they may give back to the entrepreneurial community through “for-profit philanthropy” (Ibrahim,
2008).
386. The non-financial value that BAs can bring to a project is an important factor in their decision to
invest. This also implies that, although in both cases financiers have an active role in the management of
the investee business, BAs tend to take a more hands-on role in the company than VCs and place greater
importance on their relationship with the entrepreneur. These differences in the investment motivations are
also reflected in the emphasis that they give to growth potential, with greater emphasis by VCs on
businesses that may become significant global players (Mason and Stark, 2004). Also, the non-financial
motivations for angel investment help to explain the greater use of informal contracts, whereby the investor
does not apply highly protective terms in order not to signal a lack of trust in the entrepreneur (Ibrahim,
2008).
387. The stage of investment and scale of funding are other important differences between the two
financing models. BAs target seed and early stage ventures, investing relatively small amounts per venture,
whereas VC funds (increasingly) focus on later stage investments and need sufficient scale to be able to
provide multiple financing rounds46. Hence, angel investors have much lower cost structures than VC
funds. The early stage of investment by BAs, and the little historic performance data on which judgements
about investments can be based also explain their greater weight on the attributes of the founders of
businesses, when screening deal opportunities (Stuart et al., 2007). However, the growth of BA syndicates
or “super angels”, wealthy individuals – often serial entrepreneurs – that attract also capital from other
investors, has created a segment in-between the angel and VC market, in which operating models and
contractual relationships are close to those of the VC industry, with full time managers getting a share of
the investment profits (OECD, 2011a).
388. There are also important complementarities between angel and venture capital investors, which
Harrison and Mason (2000) synthetize in: sequential investing in businesses at different stages of business
development; co-investing in deals; provision of finance to venture capital funds; and deal referring.
389. Firstly, BAs provide start-ups with small scale early-stage capital, which is often followed by
larger-scale second and subsequent stage capital by VCs. In fact, investment by BAs often serves as a
signalling effect for other investors, demonstrating that the firm has passed a first screening of due
diligence by investors with experience in the field. Furthermore, the interest by VCs may provide an
interesting exit route for BAs to realize their investment (Harrison and Mason, 2000). At the same time, it
is more frequently observed that BAs themselves support the investee company through exit, instead of
relying on VCs to step in. This is especially the case for firms in the internet and social networking sectors,
which require smaller amounts of initial capital that traditional high tech fields, and are characterised by
more rapid testing and adjustment of products or business models (OECD, 2011a).
390. BAs may also invest jointly with VC funds. VC funds are increasingly recognising the
contribution of angels and, in some cases, are collaborating on early-stage investment with them (OECD,
2011a). The BA typically benefits from reduced risk and better quality investment opportunities, given the
screening on a higher number of potential deals by VCs. On their hand, VCs can benefit from the BA’s
experience in the sector and direct engagement in the management of the start-up. This is especially
relevant for relatively small deals, in which the opportunity cost of management time may be considered
too high by VCs. Also, the presence of angel investors among the funders usually implies that the capital is
more “patient” than in the case of institutional investors, reducing the pressure on VC fund managers to
generate rapid returns (Gifford, 1997; Harrison and Mason, 2000).
391.
High net worth individuals, including BAs, are among the financiers of VCs. The investment in
VC funds represents for the BA an option for diversifying the portfolio risk and may be attractive if the
angel investor has difficulties in evaluating investment opportunities and structuring deals, as it may be the
case for individuals with time constraints, poor referral networks or lack of experience in the industry
(Harrison and Mason, 2000).
392. Deal referring is another area of complementarities between BAs and VCs. The network of a BAs
can represent an important source of investment opportunities for VCs. At the same time, VCs can provide
BAs with access to funding deals that are outside their resources or expertise. According to Harrison and
Mason (2000), which analyse the UK venture capital market, cross-referring of investment opportunities is the most commonly cited form of complementarity by VCs, while BAs tend to highlight the importance of
co-investing to a greater degree.
Profile of firms
393. Angel investment concerns mainly seed and early stage companies, including young firms that
are beyond the start-up phase but need capital to develop their product or business strategy. BAs invest
largely, though not exclusively, in knowledge-based sectors. In fact, compared to VCs, BAs invest in a
wider range of sectors, including traditional ones, and geographies, which are not limited to VC hotbeds
and are typically related to the BA’s entrepreneurial experience and personal networks. However, a
common trait of the target companies is a high-growth potential and likelihood to generate substantial
revenues over the mid- to long-term (3-8 years). In other terms, BAs and VCs look for scalable
investments, that is, companies that can substantially grow their revenues within a few years (Villalobos
and Payne, 2007).
394. As is the case for VCs, angel investors bridge the financing gap for new ventures that is largely
due to information asymmetry. Since they tend to invest in an earlier stage of the business development
than VCs, for BAs the asymmetry may be even more relevant. This also explains the greater emphasis
placed by BAs on the personal relationship and trust with the entrepreneur, who should be willing to
relinquish some control on the firm and accept an active role of the BA in the development of the business
strategy.
395. Generally, the most appropriate time for companies to seek angel investment is when a product or
service is developed or near completion and there exists a base of customers or potential customers that
confirmed their interest in buying it. BAs are usually under little pressure to make an investment in order to
generate income or capital growth. They can afford to wait until they identify the right opportunity and the
right person. This means that entrepreneurs that seek angel investments need to be able to present not only
an appealing idea and business plan but also themselves effectively (Stuart et al., 2007).