If your primary reason for investing in private securities is return on investment, then you should invest in startups and early-stage companies that have strong growth potential. Not all investors, and not all investments, are motivated primarily by ROI, though. Most angels, in fact, invest in startups for strategic or social reasons foremost, according to academic research published in 1991 and 2005.
Certainly investors would not buy into a deal if they fully expect the issuer to fail. But this is the point: They invest because they want the issuer to succeed, for various reasons aside from a financial return on investment. Here are eight non-financial reasons for investing in angel deals (seven of which are valid):
- Strategic investors work in (or have retired from) the same industry as the startup, and perhaps have interacted with the founding team as suppliers, advisers or strategic partners. Retired strategic investors often buy shares of growing companies because it allows them to make use of expertise they have developed in that particular industry or technology during their careers. These investments are usually relationship-driven, rather than ROI-driven.
- Locavestors are members of a community—at the neighborhood or local level—who have a shared connection to a business that they depend on and want to “own a piece of.” The businesses tend to be gathering spots like restaurants, cafes, delicatessens, bodegas, groceries, microbreweries, bowling alleys, fitness centers and hair salons; or a business whose owner who has been the victim of a tragedy or perceived injustice. They may be motivated also by broad community development goals, such as job creation and neighborhood renewal. The term locavestor was coined by Amy Cortese, author of “Locavesting” (Wiley, 2011).
- Demography-driven investors want to show support for businesses owned by war veterans, college alumni, women, diaspora members, coreligionists or (on a more local level) inner-city minorities, for example. In fact, some equity crowdfunding funding platforms will develop around niches like these.
- Social impact investors are passionate about supporting a cause- or ideology-oriented company. Examples include green (eco-friendly) products, renewable energy development, low-income housing, elder care, for-profit drug rehab clinics, pet rescue missions and organic lawn care. Issuers may form benefit corporations (B corps), which is possible in California, Illinois, Massachusetts, New York, and several other states. Investors in this category are concerned about the social benefits and the sense of belonging to a committed group of people who think alike. Investors who previously contributed funds on donation- or rewards-based crowdfunding platforms will follow the same issuers to new equity-based platforms.
- The Leading Edge. Angels invest in high-tech startups to help drive innovation because it is truly exciting to be “ahead of the curve,” help brilliant entrepreneurs succeed, and possibly own a share of the next big thing. This category crosses over into financial motivation too, because it is where returns on investment can be spectacular.
- Creatives. Investors who want to join creative, hip, or glamorous projects such as music, film and publishing. These deals have been among the first to use rewards-based crowdfunding as an early financing method. In equity financing rounds, investors are more concerned about fun and prestige than profit. They may have an opportunity to offer creative input into the project, in the development and/or promotional phase. In evaluating deal terms, they are concerned with access to meetings, rehearsals, movie sets and premieres.
- Brand evangelists. This category will grow with the launch of equity crowdfunding under Title III of the Jumpstart Our Business Startups Act of 2012, as low minimum investment amounts (possibly well under $1,000) will attract new, non-accredited angel investors. Brand evangelists are enthusiastic users of a product or line of products—loyal fans—who want to help ensure the future availability of the product or brand. At an early stage of product development, they want to help get a new product to market so they can be among the first people to use it. Examples in this category include gadgets, games, hobbies, 3D printers, Apple electronic devices, fitness, cooking, recreational supplies and equipment, sports teams, clothing and fashion accessories.
- Big shots. Have you ever been to a “demo days” event, where startups pitch their offerings to a small group of accredited investors? You’ll see some young, hip, superbly clothed angel investors who mainly want to feel wealthy and fabulous. They must make an investment sooner or later, lest they be perceived as wannabes.
— David M. Freedman, based in Chicago, has worked as a financial and legal journalist since 1978.
Matthew R. Nutting practices corporate law with the firm Coleman & Horowitt in Fresno, CA.
Freedman and Nutting are coauthors of Equity Crowdfunding for Investors, published by Wiley & Sons in June 2015.