What is a Business Angel? (Part One)
By John K. Romano
Business angels are individuals who have the ability and willingness to provide your company with enough capital to move your startup businesses to the next phase. Angels are primarily local people who are, relatively speaking, financially independent, but who are by no means super rich. These investors are usually first generation money-entrepreneurs, retired corporate executives, or professionals who have a net worth of more than $1 million and an annual income of more than $100,000. In the United States there are over 2 million households with a net worth of $1 million, and 90 percent of them made their fortunes by starting their own businesses. Angels are self-starters who are trying to help perpetuate a system that made them successful in first place and, at the same time, make a considerable return on their money. A lot of angels don't advance money; in many cases, they will co-sign loans with the entrepreneur.
Angels are all around us. On average, there are approximately one million investors in the U.S. who invest equity capital into business opportunities each year. They are doctors, dentists, lawyers, accountants, managers, business associates, friends, and relatives. Business angels are ordinary people who know how to investigate a company and want to invest a little money into its long-term development and growth. They are willing to assume more risks in financing a company than most banks because they have a personal interest in the company itself. Angels typically take a more active role in the company than do Direct Public Offering investors, who might find you through the Internet or by other means. They may want a recognized input into the decision-making and management of your company, particularly if they have made a substantial investment in your company.
Angels look for a business that shows promise to grow. Angels are closer to venture capitalists than they are to passive investors. They are not totally concerned with the profitability at this point in the game. They prefer to invest in a company that has some proprietary lock on the market, some competitive edge related to location, technology, distribution method, market access, or personal and business relationships-a company that has 100% of a emerging market, a market that has yet to be tapped.
Angels base their investment decisions on a different set of criteria than most investors. The geographic proximity of the firm may be important influence, since most Angels prefer to invest within 50-100 miles of their homes. Angels often invest in fields they may have specialized in or have personal knowledge about, so they can contribute their expertise as well as their money. They may invest in a company because they are personally familiar with the entrepreneur, or because they are were recommended by a respected third party.
What's the difference between angels and venture capital?
The primary difference between angles and venture capital is that Venture Capitalists use someone elses' money and Angels risk their own. The venture capital industry consists of firms staffed by professional money managers that are funded by insurance companies, major corporations, pension funds, foundations and the government. These money managers have a responsibility to their funding sources, due to this responsibility; they take only the most cautious of risks. The venture community includes firms, subsidiaries of banks, subsidiaries of major corporations, small business investment companies (SBICs), and the Minority Enterprise Small Business Investment Companies (MSBIC).
In the mid-1980s, the venture capital industry hit its climax. Then, because of heavy competition in lost profits due to imprudent investment practices, many of the smaller venture capital firms went under, shaking market confidence. Venture capital funds raised dropped from $4.2 billion in 1987 to $1.2 billion in 1991. The total number of venture capital firms in the U.S. has dropped to fewer than 1000, and these firms fund only about 2000 businesses each year. Most of those businesses have been later stage deals; two-thirds of investments are made in bigger companies, where the return is high and the risk is low. Few investment bankers deal in early stage or developmental companies. Usually less than 250 start-up companies nationwide receive venture capital funding each year. The obvious reason is that it takes a venture capitalist just as much time, if not more time, to evaluate a small company as it does a larger one. These statistics prove that angels are often the only source of seed capital for many startups. Angels invest over $27 billion each year, with nearly 50 percent going to early stage businesses.
Not only do angels invest earlier than venture capitalists, but they also invest in smaller deals. They are the primary source of funding when the size is under $1 million. Only 31 percent of traditional venture capital goes into offerings under $1 million; only 13 percent of venture capital money goes to offerings under $500,000. Angels, on the other hand, invest quite frequently in these types of deals. About 90 percent of angel money is invested in offerings under $1,000,000, and 82 percent of that money is invested in offerings that are under $500,000.
The pool of today's angel capital is five times the amount of institutional venture capital, providing money to 20 to 30 times as many companies. Angels invest nearly $30 billion of the $3-6 billion venture capitalists invest each year. Angels fund 100,000 companies each year, while venture capitalist fund only about 2000.
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