How Angel Investors Get Their Wings

(page 2 of 2)

Browse Issues

Browse the BusinessWeek Archive

Sonia Roy

Story Tools

• post a comment
• e-mail this story
• print this story
• order a reprint
• digg this
• save to del.icio.us

But to get a wider range of perspectives and deals, and to pool resources, many angels—including Reid, who lives in a largely agricultural community with a population of 1,032—join angel groups.

THE "REAL DEAL"

Reid belongs to a group of 26 angels affiliated with a larger umbrella network, RAIN Source Capital, based in St. Paul, Minn. RAIN organizes small groups of angels in mainly Midwestern states into a network of some 400 members. That makes it easier to develop a deal flow, pool money, and share expertise. Angels living in Grand Rapids, Mankato, St. Cloud, and similar Minnesota towns have invested some $7 million in Reid's company. "We get prospects in front of the network to find the members who will say: 'I used to be in that business' and to tell us whether it's a real deal," Reid says. There could be a deal coming in Mankato, he says, that "we never would have seen without the RAIN network."

The level of professionalism at angel groups is all over the map. Some mimic professional venture funds, a number have forged close ties to universities, and others are more like social clubs engaged in for-profit philanthropy. A common mantra among angels and angel groups is the importance of due diligence. That means pursuing questions like: What is the market opportunity, barriers to entry, and business model? What's the company's competitive edge? Is there an exit strategy? What is the entrepreneur's background? "The biggest fallacy is that 98% of people think if they have a wonderful technology the business will take care of itself," says Holdren. "But the character of the entrepreneur is more important than the technology."

What sort of return can an angel expect? There's that rate of return of about 27%, on average, a result reached by professor Robert Wiltbank of Willamette University and Warren Boeker of the University of Washington in a study of 539 angels from 86 groups in North America from 1990 to 2007. The return figure comes from 1,137 "exits" during this time period through mergers and acquisitions, initial public offerings, bankruptcies, and shut doors.

Of course, averages can be a bit misleading. Remember, on average Lake Erie never freezes, and the stock market returns, on average, some 11% a year. With the return number for angel investing, keep in mind that 7% of the venture exits that the professors studied had returns of 10 times investment while 39% had a multiple of less than one times investment. The Center for Venture Research estimates that angels enjoyed a rate of return in 2007 between 20% and 40%. "Invest what you could lose without changing your lifestyle," advises Jeffrey Sohl, director of the Center. Inevitably, part of the reward will be psychic. But it's fun to remember the outcome of a $100,000 investment that Sun Microsystems ("SUNW") co-founder Andrew Bechtolsheim made to two Stanford University graduate students. The check allowed the students to move out of dorm rooms and start marketing their revolutionary idea. The result: Google ("GOOG").

Farrell is contributing economics editor for BusinessWeek. You can also hear him on American Public Media's nationally syndicated finance program, Marketplace Money, as well as on public radio's business program Marketplace. His Sound Money column appears on BusinessWeek.com.