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Angel Investing

Installment 8: Venture Capital and Angel Investing

What’s the Difference?

This installment starts the discussion of venture capital investing by introducing its relative or subcategory angel investing.

[Editor’s Note: This is the eighth installment in a series of articles dedicated to the 95% of people in the U.S. who have never invested in a startup, a venture capital fund, a private equity fund, or a hedge fund even though they are permitted to do so and even though doing so may make sense to achieve property diversification. Read Installments #1, #2 , #3. #4, #5, #6 & #7.]

Distinctions between Private Equity and Venture Capital

We touched on the differences between venture capital (VC) and private equity (PE) in Section 4.2.  This chart explores them a bit more:

Characteristic Venture Capital Private Equity
Target companies Startups, early-stage companies, often pre-revenue Mature companies, often under-performing or under-valued, but always with real revenue
Target industries High-growth industries like high-tech, biomedical, alternative energy All industries, usually with established marketplace for the product or service
ROI expectation Many failures, some solid returns, a few spectacular successes. Expectations must reflect the risks Similar to VC but less dramatic failures and successes
Investment size ($) Smaller Larger
Liquidity horizon Five to ten year but generally slightly shorter than PE Five to ten years but generally slightly longer than VC
Desired ownership percentage of targets Usually minority stake in company Control (often 100%) of company
Funding structure Often equity only, but highly flexible Equity and debt
Investor active? Investors provide advice, connections, distribution; monitor cash burn; etc. Similar to VC

More about Angel Investing

For the purpose of this series, we combine VC and angel investing because there is significant overlap. First, VC investors and angel investors compete with each other to some extent. While it is generally true that angels tend to invest in earlier stage companies than do VC investors, this line of demarcation is anything but a solid one. Second, the terminology is all the same. That said, these two groups do operate differently. As an accredited investor thinking about allocating some of your investment funds into the VC and/or angel spaces, you need to understand how each work.

For our purposes, an “angel” is an investor who invests directly in entrepreneurial businesses (pre-revenue startups and early-stage companies) in return for stock in or debt convertible into future investment rounds of the companies. Angels look to invest in innovative companies that can grow quickly in sales and value, commonly aiming for $50 million in sales within three to seven years of startup. Most angels, historically, were accredited investors. However, because of the JOBS Act, this will not be the case for much longer.

The term “angel” was coined by Broadway theater insiders to describe the financial backers of Broadway shows. They invested as much to display their wealth (and earn favors) as for a return on the investment. — Robert T. Slee, Private Capital Markets (Wiley, 2011)

Many angels are or were entrepreneurs themselves, as well as corporate leaders and business professionals. Some angels mentor and coach their portfolio companies, and introduce entrepreneurs to potential customers, suppliers, distribution channels, and venture capital investors.

Angel Groups

An angel group or club is an organization of angel investors, usually locally organized, who pool their capital and share their expertise to evaluate and invest in entrepreneurial ventures. An angel investor network or platform, on the other hand, matches entrepreneurs with angel investors, usually by means of a membership website.

Angel groups are most abundant in metropolitan areas where technology is an important sector in the local economy.

Angel investments typically range from $20,000, from an individual, to $500,000, from a group. Capital from angel investors is likely to cost at least 10 percent of a company’s equity, and sometimes more than 50 percent. Some angels also charge a management or advisory fee and require board seats.

Examples of angel-backed businesses include Google, Yahoo, Amazon, Starbucks, Facebook, Costco, and PayPal.

But what is the difference between angel investing and VC? The first difference is money. Angel investors invest much smaller amounts. Basically, VC begins above the financial capability of angel groups. The second is an operation model. VCs, as we see below, create funds that are managed by professional fund managers. Fund managers are supported by a team of professionals that are involved in an investment decision process. Angels are individuals who invest their own money, experience and expertise in the chosen company.

Practical Advice for Beginners

Marianne Hudson, the executive director of the Angel Capital Association, stated in Forbes that “more than half of all angel investments lose some or all of their money.” She notes that perhaps the most important question to ask when starting as an angel investor is “[h]ow much are you willing to lose?”

Hudson says that education is key for beginners. Many experienced angel investors have produced a lot of information to help beginners gain knowledge. She also suggests attending workshops and other events “where you can meet entrepreneurs, watch pitches and get a sense of your interests and the questions investors ask to assess a deal.’

Despite the stories of grand slam home runs hit by lucky and/or gifted angels, Hudson told Mint that a fellow angel says angel investing really allows you to “do good, have fun, and make a little money – not necessarily in that order.”

Who are ‘We’?

You will notice that throughout this series, I use the Alternative Investment Guideterm “we.” This is done to acknowledge the great editorial assistance of the Financial Poise Editorial Team. This series is based on my book The Investor’s Guide to Alternative Assets: The JOBS Act, “Accredited” Investing, and You.

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About Jonathan Friedland

Jonathan Friedland views his role as a business lawyer simply: to help clients make money at every opportunity and to protect their interests at every turn. His national practice emphasizes corporate structuring, corporate governance, counseling on day-to-day business affairs, M&A, and corporate restructuring. Most of his clients are privately owned businesses and their owners, particularly…

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