The recent Global Entrepreneurship Congress brought to light new insights for policymakers as to how the world can develop more robust ecosystems for our entrepreneurs and their investors and supporters. Over the next few weeks I plan to dive deeper into some of the learnings and outputs on specific topics. Today, we look at early stage investing.
Entrepreneurs have an earthly connection to angels. Most entrepreneurs initially finance their firms using their own savings but an investment by an angel investor who puts his or her own money directly into a startup, if done at the right time, makes a critical difference to the success of the firm. Policymakers know already how vital access to capital is to business survival rates but do they fully understand the importance of angel investors?
For millennia, wealthy people have provided startup capital to entrepreneurs. Professor Bill Wetzel of the University of New Hampshire (UNH) coined the term “angel” in 1978 to describe early-stage investors. As expert John May reports in his new book, Angels Without Borders, the organized, systematic form of angel investing only began about 20 years ago – and angel groups only began to emerge after 2000. Today, the U.S. has about 300,000 angels and about 400 active angel groups.
Although the total size of the angel investment market in the U.S. cannot be measured precisely (because many investments are made on an individual basis and therefore are not subject to disclosure rules), estimates indicate that angel investments have long surpassed venture capital investments and continue to grow. Surveys by the Center for Venture Research at UNH indicate that the total U.S. angel market grew from $17.6B in 2009 to $24.1B in 2014. Even more dramatic is the rise in angel investing around the world – in Europe the total market doubled during the past five years and in Canada it tripled.
According to a 2011 study by William Kerr and Josh Lerner of Harvard, and Antoinette Schoar of MIT, angels significantly increase startup success rates. Comparing angel deals that just met the cut for getting funding with those that just missed the cut, they found that – apart from whether they got funded – the two sets of companies looked very much alike.
Yet, the difference in outcomes was substantial. Those that received funding were 20 to 25 percent more likely to survive after four years and 16 to 19 percent more likely to have grown to 75 employees. In addition, they had more employees and higher internet rankings.
It turns out that the involvement of angels plays a pivotal role in entrepreneurial success in more ways than one. Because angels come from a variety of backgrounds and many invest in startups because they are passionate about a particular sector, they are able to provide invaluable expertise and feedback about customers and competitors, management plans, sales channels, and, through their personal networks, potential partnerships. By serving as mentors and advisors and taking an “active” role in growing a company, angels are life-savers when startups pass through the aptly named “Valley of Death,” the critical point when success or failure hangs in the balance.
The effect of angel investors in other settings is just as pronounced. In a related study, Lerner and Schoar applied the same methodology to analyze data from a multinational sample of angel groups and found similarly high gains – even across very different funding landscapes within different types of entrepreneurial systems. These studies point to the large gains to be had from encouraging angels, irrespective of the environment.
Seeking answers to under-explored questions about the impact of angel investing, Yoosef Ghahreman and Barton Hamilton of Washington University in St. Louis examined the characteristics of angel investors in the United States. Their findings point to the importance of angel networks, such as the relatively new Global Business Angel Network (GBAN).
Although it is clear that angel investors, no matter how organized, serve society by financing entrepreneurs, the effect of less organized angels is lower. Individual angel investors remain the majority, but the less organized they are, the less beneficial their impact in terms of increasing survival and hiring rates. The implications for policy are also clear: encouraging the development of angel groups and networks significantly increases the impact of their investments – which influences new business development, and job creation.
Another benefit that Ghahreman and Hamilton find is that more organized angels make better-informed and wiser investment decisions in terms of down the road return on capital. While angel investors are better able to assess risk and likely business success than the general population, lone angels (those who invest outside an angel group) have access to fewer deals, are less able to undertake due diligence, and, due to lower and less diversified asset holdings (i.e., they have all their eggs in one or two baskets), are less able to absorb investment failures, all of which may lead them not make future investments.
Therefore, incentives that encourage angels to band and work together will improve entrepreneurial outcomes. Where angels are active, Kerr, Lerner and Schoar point out, the whole financing ecosystem develops because they facilitate, connect and bring expertise to seeking new growth capital. They not only fill the voids in the ecosystem, but also connect and synergize the different entities. Angels increase the number of scale-ups and widen pools of startup financing in entrepreneurship ecosystems of all shapes and sizes.
Often times, as John May points out, money is not the only, or even the primary, factor motivating angels. They seek to follow the example of their mentors in giving back to the community, or desire to spur local economic development, appreciate using their business skills, or simply for the gratification that comes with developing long term personal relationships with entrepreneurs. Incentivizing angel groups helps to ensure that they can continue propelling entrepreneurs.
For all these reasons, policymakers should more actively seek to encourage and support angel investor groups and networks when writing rules or establishing incentives. The Global Business Angels Network (GBAN) gathered twice recently to discuss what we could learn from other countries that have experimented with innovative new policies to boost early stage angel investing. As a Co-Chair, I attended both the World Business Angels Investment Forum presented by GBAN in Istanbul as well as the GBAN Annual Meeting at the Global Entrepreneurship Congress in Medellin on March 16th, 2016. Next week, I will share more of what we have learned from scholars and practitioners as to how policymakers can more effectively boost angel investment and drive global economic growth.
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