Angels

Business angels are high net worth individuals who invest their own money in startup and emerging companies. They represent the primary source of seed and startup capital for entrepreneurial ventures in most advanced economies.

Introduction

Business angels are high net worth individuals who invest their own money in start-up and emerging companies. They represent the primary source of seed and start-up capital for entrepreneurial ventures in most advanced economies. In the field of angel financing, the ABC's (Attitudes, Behavior, and Characteristics) of angels are well understood based on numerous research studies (Mason 2006). Also well-known is the organization of the current angel market and the various portals to entry that individuals use. These portals span the spectrum from informal collections of individual angels to the more structured hybrid angel funds that in some ways resemble a classic venture capital fund (Sohl 2007)

While topics such as the size and scale of the angel market, the importance of angels in the equity financing of high-growth ventures, and the important role of angels in economic development and job creation have been studied, additional research efforts are needed. In addition, there are many facets of the angel market that still remain under researched, and aspects of the market where entrepreneurs, investors, and policy makers need more reliable research in in order to make informed decisions. Some of these facets include the development of a theoretical foundation for angel financing, the changing nature of angel portals, the impact of recent crowdfunding legislation on the angel market, the potential migration of angels away from seed and start-up financing, the investment criteria of angels, and the exit market for angel-backed ventures.

Discussion

Following the seminal study of business angels initiated by William Wetzel, early research on angels conducted by Freear, Sohl, and Wetzel (1994b) expanded on this research area through the establishment of the distinct roles of business angels and venture capitalists, the unique characteristics and attributes of business angels, the critical role of business angels in high-tech start-ups, and the study of the latent angel population. Following this early work in the United States, angel research expanded across the Atlantic with the work conducted by Mason and Harrison on the angel market in the United Kingdom (Mason and Harrison 1994) (Mason and Harrison 1995) (Mason and Harrison 1996). Encouraged by these early researchers, the research activity progressed in the last two decades to an extensive body of literature that follows the underlying tenant of applying academic rigor to an applied area of study (Kelly 2007) (Mason and Harrison 2000).

The research on angels as an academic field has progressed to a point where attention is directed towards refinements of the research agenda with respect to more meaningful market statistics and the compilation and estimation of key market indicators to determine the pulse of the angel market on a national basis. These market indicators include data on the sectors that garnered investment activity, return rates for angel investments, exit strategies with respect to initial public offerings, and mergers/acquisitions and yield rates.

Yield rates (the yield or acceptance rate is defined as the percentage of investment opportunities that are brought to the attention of investors that result in an investment) are an important indicator of angel activity. When research is limited to those entrepreneurs that receive angel funding, there is danger of spurious results and misleading conclusions. The yield rate provides a more accurate measure of both the intention of entrepreneurs and angels in addition to their investment activity, since the yield rate includes not just those entrepreneurs that received angel funding, but those that are seeking funding (FA 2007) (IBAN 2010) (Mason and Harrison 2010) (Sohl 2010) (Stedler and Peters 2003).

Sector investing by angels is also an important indication of market trends since these early stage ventures are poised to grow into tomorrow's corporations of the future. As such, angel investments represent an indication of where the job growth and economic development opportunities exist. Sector investments tend to be clustered around high-tech ventures, especially software, and these clusters are similar in both the U.S. and Europe (Kjærgaard, Napier, and Nordstrøm 2002) (Mason and Harrison 2010) (Munck 2010) (Reitan and Sörheim 2000) (Stedler and Peters 2003).

An important area of study is related to the spread of angel groups in the U.S. and the need to understand these portals, how they function, and the distinguishing characteristics of different types of angel portals. The initial research sought to classify the types of portals, and is progressing to matching the economic geography of a region with the optimal type of portal for angel investing given these economic characteristics (Sohl 2007). In addition to this identification of portal structure, as women increased their economic impact and women angels became more active, many women-focused angel portals started to appear. This focus resulted in an increased interest on research about women angels and their role in angel investing (Becker-Blease and Sohl 2007).

Future Research

There are many facets of the angel market where opportunities exist to advance our knowledge of the market, uncover and understand emerging trends, and to provide foundation for better decision making by entrepreneurs in their search for capital, investors in their search for quality deals, and policymakers as they work to facilitate angel investing as a vehicle for regional economic development and job creation.

As policymakers and private sector entities have encouraged the growth in angel portals, there is a potential downside. While the justifications are many and the results promising, one often-cited justification is a misconception, namely that a more organized angel market leads to a more sophisticated angel market, and a more sophisticated angel market in turn leads to more capital for entrepreneurs and better returns for angels; however, there is a danger of attributing causality where it may not be justified. In this case, a better organized market does not necessarily lead to a more sophisticated market; however, on the downside, as angels are becoming more organized they are to some degree transforming into a nascent venture capital industry and are losing some of the penchant for seed and start-up stage investing, much like the retreat experienced by the venture capital industry more than a decade ago. As a result, there is a redistribution of investment dollars from the seed/startup to more established ventures, albeit still at the early stage of development. What is needed is research to determine the scale and momentum of this potential capital shift and the underlining reasons for any shifts in the stage profile for angel investors.

One of the ancillary effects of the applied nature of angel research is the misperception between common practices and best practices. Common practices are essentially what someone or some group does that appears to be effective for their micro market, but this effectiveness is a relative term and one that is not verified. Best practices take the research to the stage where the regional market is tied directly to the identification of the best practices and the mapping provides the best practices given the particular infrastructure facing the market (Sohl 2012). This conundrum is most notable in angel portal structure. The basic research question is to develop a method to determine the best angel portal structure given the economic geography in which they operate. Angel markets are regional, and regional differences abound with respect to the entrepreneurial infrastructure, the labor force, the availability of capital, and other relevant factors. A model-based approach that produces a map to connect the regional economic geography with the angel portal structure, based on both data and theory, would add much to the development of a vibrant and sustainable angel portal (Sohl 2012).

An evolving policy initiative that could have substantial impact on angel investing is the passage of the Jumpstart Our Business Start-ups (JOBS) Act. Prior to the JOBS Act, crowdfunding was essentially donation-based funding, where funders donate via a collaborative goal based process in return for products, perks or rewards. The JOBS Act authorized general solicitation of start-up equity where businesses seeking capital can sell ownership stakes online in the form of equity or debt. In this model, individuals who provide funding become owners or shareholders and have a potential for financial return, unlike in the donation model. This general solicitation of equity capital to both accredited and unaccredited investors has the potential to create a pre-seed capital market, and its impact on angel investing could be substantial. Certainly, as an evolving market in the angel space, equity crowdfunding deserves the attention of entrepreneurship researchers.

Another emerging area of research interest is the notion of legitimacy. With external equity from angels as the primary source of seed and start-up funds, information asymmetries often impede entrepreneurs' access to this market. To date, there is very limited research on the impact of legitimacy on the acquisition of very early stage or start-up financing and whether legitimacy influences these investors. The research focus should be on the relation between legitimacy and angel investing. Measures of legitimacy suggested by the literature need to be developed and used to examine whether firms with higher legitimacy are viewed more favorably by angel investors, have better access to these investors, and are more likely to receive investments from these investors. This research would provide important new insights into the determinants of early firm survival and growth.

To fulfill their growth aspirations, entrepreneurial ventures depend on equity capital from angels and venture capitalists. While venture capitalists invest in later-stage ventures and thus have data available on revenues and costs, angels have the twin problems of information asymmetry and limited diversification opportunities. The field of angel financing needs to develop theoretical arguments grounded in venture financing literature and signaling theory to develop new concepts, such as the venture's emergent volatility (fluctuations in either revenues or employees over time) and deliberate diversity (external financing from more than one source), to test the signaling impact of these and other attributes on venture financing by angels.

Various forms of tax incentives are being introduced in the U.S., Europe, and many other parts of the world. These range from tax credits for angel investments, matching funds for angel investors, and programs to facilitate the deal flow for angels and access to capital for entrepreneurs. To date, comprehensive research on the effectiveness of these programs does not exist, though the financial commitments from the public sector are substantial. Research is needed to evaluate the effectiveness of various public policy initiatives and to identify which programs are the most effective within the framework of the public policy goals and the economic geography of the targeted programs.

These and many other trends in the angel market offer interesting and timely research opportunities. While the field of angel research has grown in recent years, much of the market remains to be understood. The applied nature of the field continues to bring opportunities for future research that will help to develop public policy and private sector initiatives.  

Data Sources

One of the major difficulties in conducting angel market research is the scarcity of quality data available for analysis. Primary data collection, though costly and time consuming, still remains the main source of data for most of the current and past research on angels; however, there have been several major efforts at quality data collection, some remaining proprietary (and unavailable to the research field) data, and others emerging as publically available sources, which are outlined below.

  • Center for Venture Research: This is the oldest and most-reliable source of data in angel research. The data are proprietary due to the confidential nature of the information collected from individuals and angel groups. The annual survey data has been systematically collected since 2000 and additional data sets have been added to this data stream.
  • Global Entrepreneurship Monitor: Collected by a consortium of researchers from around the world this data is collected yearly and is available only to consortium members for the first three years after collection, then it is open to the public. The focus is on entrepreneurship but there is some limited data on angel investing.
  • SEC Initial Public Offering: IPO data is available from the Security and Exchange Commission new issues database. These are electronic prospectus data for IPOs filed in the Edgar database of the SEC. In the offering prospectus is information on the stock ownership by managers, venture capitalists and other investors listed in the "Management" and "Principal and Selling Shareholders" sections of the IPO prospectus. This provides the basis for the identification of angel investors who are shareholders at the time of the IPO. Assembling this data is labor intensive since the data are not in searchable files, but rather in narrative form. This data was assembled by the Center for Venture Research and may be available to the public in the future.
  • NETS and Pitchbook data: National Establishment Time-Series (NETS) contains data on private firms from 1990 to 2010 and includes, at the firm level and annually: employment, sales, year business started, primary SIC, job growth relative to peers, D&B credit ratings, and Paydex Scores. Pitchbook database (POF) contains selected information on private-equity portfolio companies, including source of funding, for 16,500 companies. The value of these two databases is when they are merged and possibly used with additional databases on angel investing and private equity. This database is commercially available.
  • CB Insights: Data on angel groups who are members of the Angel Capital Association, published quarterly. It is unclear what level of detail on angel group investing is commercially available and the response rate for the survey is unknown. The cost is quite high but it may be available free to researchers through the Angel Capital Association.

References

Becker-Blease, John R., and Jeffrey E. Sohl. 2007. "Do women-owned businesses have equal access to angel capital?" Journal of Business Venturing 22(4): 503-521. doi:10.1016/j.jbusvent.2006.06.003

FA, France Angels. 2007. "Les Réseaux investisseurs membres de France Angels en quelques chiffres."

Freear, John, Jeffrey E. Sohl, and William E. Wetzel Jr. 1994a. "Angels and Non-Angels: Are There Differences?" Journal of Business Venturing 9(2): 109-123. doi:10.1016/0883-9026(94)90004-3

Freear, John, Jeffrey E. Sohl, and William E. Wetzel Jr. 1994b. "The Private Investor Market for Venture Capital." The Financier 1(2): 7-15.

IBAN, Italian Business Angel Network. 2010. "Italy angel investment industry."

Kelly, Peter. 2007 "Business angel research: The road traveled and the journey ahead." Handbook of Research on Venture Capital. Ed. Hans Landström. Cheltenham: Edward Elgar, 315-331. doi:10.4337/9781847208781.00021

Kjærgaard, R., G. Napier, and Borup J. Nordstrøm. 2002. "Business angels in Denmark." Copenhagen: Danish Growth Fund.

Mason , Collin M. 2006. "Informal sources of venture finance." The Life Cycle of Entrepreneurial Ventures. Ed. Simon C. Parker. New York: Springer, 259-299. doi:10.1007/978-0-387-32313-8_10

Mason, Colin M., and Richard T. Harrison. 2010. "Annual report on the business angel market in the United Kingdom: 2008/09." London: Department of Business Innovation and Skills.

Mason, Colin M., and Richard T. Harrison. 1995. "Closing the regional equity capital gap: The role of informal venture capital." Small Business Economics 7(2): 153-172. doi:10.1007/bf01108688

Mason, Colin M., and Richard T. Harrison. 1996. "Informal venture capital: a study of the investment process and post-investment experience." Entrepreneurship & Regional Development 8(2): 105-126. doi:10.1080/08985629600000007

Mason, Collin M., and Richard T. Harrison. 2000. "Informal venture capital and the financing of emerging growth businesses." Blackwell Handbook of Entrepreneurship. Ed. Donald L. Sexton and Hans Landström. Oxford: Blackwell, 221–239. doi:10.1111/b.9780631215738.1999.00015.x

Mason, Colin M., and Richard T. Harrison. 1994. "The informal venture capital market in the UK." Financing Small Firms. Ed. A. Hughes and D.J. Store. London, UK: Routledge, 64-111.

Munck, C. 2010. "An overview of the current European business angel market."

Reitan, Bjornar, and Roger Sörheim. 2000. "The informal venture capital market in Norway – investor characteristics, behavior and investment preferences." Venture Capital: An International Journal of Entrepreneurial Finance 2(2): 129–141. doi:10.1080/136910600295747

Sohl, Jeffrey E. 2010. "The angel investor market in 2009: holding steady but changes in seed and startup investments." Center for Venture Research.

Sohl, Jeffrey E. 2007. "The Organization of the Informal Venture Capital Market." Handbook of Research on Venture Capital. Ed. Hans Landström. UK: Edward Elgar Publishers, 347-368. doi:10.4337/9781847208781.00023

Stedler, Heinrich, and Hans Heinrich Peters. 2003. "Business angels in Germany: an empirical study." Venture Capital: An International Journal of Entrepreneurial Finance 5(3): 269–276. doi:10.1080/1369106032000126596

Page last updated 8 December 2016