[Editor’s note: a version of this article first appeared in Inc. Magazine.]
It feels like there is more written about angel investing lately than ever before. This form of early-stage investing seems to be having its 15 minutes of fame. Is it a passing fad? I don’t think so. As someone who worked with venture capital in the run-up to the first dot.com boom and is presently an active angel and co-head of one of the largest and busiest U.S. angel groups, I've watched and charted these market changes since the early 1990s.
In just a couple decades a handful of seismic forces affecting early-stage financing have combined to make angel investing a very different business. The result? Angel investors have become a serious source of capital for savvy high-growth entrepreneurs.
Seven key trends have fueled this radical transformation.
1. Professionalization of Angels
As the post-war trend of using risk equity to finance entrepreneurial endeavors has become more mainstream, word has gotten out about the financial (and non-financial) returns professional angels can earn. The impact? Today more angels take angel investing seriously. In just the last 10 years, the U.S. has seen the formation of the Angel Capital Association, (ACA) a resource that helps angels become more professional with forums for sharing what works with other angels and the entrepreneur ecosystem. (Note: I am currently Vice Chair of ACA.) Tools like Seraf (parent of this blog) are also a vitally important part of this ongoing-professionalization.
2. Angel Group Formation
Not that long ago tapping into angel dollars required an entrepreneur to string the deal together herself, using her limited personal network. It was a time- and labor-intensive way to gather resources, and the quality of the deal terms varied widely based on the individuals involved. The emergence of investor groups resolved these inefficiencies. For example, since its formation, the number of groups in ACA's membership has increased from a dozen to several hundred worldwide. In the U.S., angel groups have increased four-fold since 2000. These groups provide access to faster learning investing efficiencies and critical angel connections. More recently, accredited investing portals have emerged to create connections between entrepreneurs and angels, bringing additional fluidity and ease to this market.
3. Angel Group and Portal Syndicates
In parallel with the formation of groups and accredited portals is the trend toward the formation of inter-group investment syndicates to share deals. An entrepreneur reaching agreement on a deal with a group of angels can also choose to syndicate the resulting term sheet with other groups. This brings additional investors into the deal on the same terms and at a very low cost to the entrepreneur in terms of time and effort.
4. The Mainstreaming of Entrepreneurship
These groups and syndicates are only flourishing because entrepreneurship itself has changed. What used to be the domain of loners and iconoclasts who didn't want to work in a large corporation has become a mainstream career choice. Today the gold watch and pension after 30 years at one company is increasingly rare.
Nowadays, through a host of meet-ups, courses, and mentoring activities, entrepreneurs are more savvy about their careers and financing options. They want more control over the staging of capital into their companies and more control over the valuation at which that capital is raised. Angels allow them to bring investment in smaller steps and, with the achievement of milestones, increment the value of their company upwards between rounds.
5. Internet & Cloud-based Technologies
Technology is making many companies far less expensive for entrepreneurs to start than they used to be. Cloud-based infrastructure as a service allows entrepreneurs to easily deploy web-scale solutions on a pay-as-you-go basis. Likewise, internet and mobile marketing and distribution enable the connection to, and servicing of, customers with radically lower costs and much greater reach. Today, technology entrepreneurs can build significant companies for far less money than used to be possible.
6. The New Exit Math
Starting companies for less is a good thing because most are selling for less and very few go the IPO route. The market for IPOs below about $100M in size has become much more difficult since the 2001 dot.com meltdown. The tech companies going public today are generally much later stage and the deals are often much larger than $100M in total size.
Entrepreneurs today typically seek personal and investor liquidity through acquisition by a strategic buyer (or less commonly, a financial buyer such as a private equity firm). These acquisitions are far smaller than IPOs, with the average M&A transaction in the U.S. pegged by Strategic Exits' Basil Peters and many experts in the neighborhood of $20M. An entrepreneur looking for a very good return cannot raise and burn too much capital if she is selling her company for $20M.
7. Changes in the VC World
Yet, despite these realities, the larger venture capital funds have grown from the tens and occasionally hundreds of millions we saw in the "cottage industry" era of the 1950s, 60s and 70s to today's billion-plus dollar funds. These mega funds have a lot of capital they must put to work, and are generally forced to focus on "venture scale" opportunities where they can employ huge amounts of money and generate huge returns, which will move the needle for their funds.
These mega funds are not a perfect fit for many smaller, but still very high quality, startups. Perhaps the entrepreneur may not want to raise so much money out of the gate at a low initial valuation (thereby losing voting control of her company), or she may want to preserve the option of staying true to her vision and growing the company more organically; or selling it earlier (and starting the fun early stage part of the process again). Thinking of VCs as expansion capital--and in later rounds as they grow--is increasingly perceived as the better fit for most entrepreneurs just starting out.
Combine all these trends and what do you get?
Sophisticated entrepreneurs building lighter-weight companies who often cannot (or should not) get the desired type of support from venture capital, but who can completely meet their inception to exit financing needs, from an increasingly organized community of professionalized angels, groups and syndicates.
Is it time for you to recalibrate your assumptions about angel investing as a serious form of capital? I think so.