It seems everywhere I travel I find another “center of excellence” in Biotechnology and Life Science.  R&D in these arenas seems to grow and flourish.  Those with a focus on commercializing this science are then quite disappointed when angels express low enthusiasm for their particular projects.  Let me explain why.

Bill Payne, a prolific US investor who has set up four Angel investment networks, is in New Zealand for five months to offer his expertise as the BNZ University of Auckland, business school entreprener in residence.

The Australian Association of Angel Investors (AAAI) held their 3rd annual meeting in Adelaide last week.  Attendance was over 125, showing a steady increase over the past three years.  The messages of interest were consistent with what we are learning around the world.

To provide members with a broad selection of opportunities to invest in quality start-up ventures, angel groups encourage and are prepared to manage rather high deal flow.  Here are typical deal flow statistics for angel groups:

I read a blog post by Bill Burnham this week entitled Don't Take Angel Investment from VCs.  He gave the following example to make his point (my paraphrase):  An angel/VC that invested in the angel round tried to pre-empt the Series A fundraising in a company with a low-ball term sheet.  The entrepreneur thought he could do better and politely told the angel/VC “thanks, but I’d like to test the market”.  The response was swift and furious.  The angel/VC told the entrepreneur he had to accept the offer or the angel/VC wouldn’t invest in the Series A round  -  dramatically reducing the chance of raising money because other VCs would assume that the angel/VC wasn’t investing was because there was something wrong with the company.

 Back in the ‘70s, David Birch of MIT startled the world by reporting that US government data showed the predominance of new jobs in the US were created by startup companies.  Most mainstream economists scoffed at these results, since “everybody” knows that big companies create new jobs.

In my last post, I confessed that a decade ago I was skeptical about the value of national organizations of angels and angel groups, but I was wrong.   Despite my doubts, I participated as a member of the organization committee of the Angel Capital Association in the US.  Since then I have been engaged with AANZ (New Zealand), AAAI (Australia), BBAN (UK), NAO (Canada) and EBAN (Europe).  

In recent posts, I have described the growing US capital gap between typical angel and VCs round size.  US angels generally invest in rounds of $200K and $1 million, while VCs have moved from rounds of $2-3 million in the ‘90s to rounds of $7-8 million today.  This gap is quite troubling for entrepreneurs seeking investment between $1 and $5 million and for us angels who provide seed capital for their startups.

In an earlier post, I reported that angels in some US groups are investing in more angel-only deals, that is, startups for which less than $1 million in funding will provide sufficient runway to achieve positive cash flow.  Angels are electing to seek out and invest is such deals because venture capital in the range of $1 to $5 million is less available than in the past.  As I pointed out earlier, the world of venture capital in the US is changing rapidly – and not for the better.  VCs are funding fewer deals with a higher fraction as later stage deals.   US VCs are investing larger sums in total in each venture and waiting longer, hoping for larger exits.

I have been suggesting for some time that the US VC model is, indeed, broken.

In my last post, I described the trend among angel groups in the US to fund more angel-only deals, primarily because of the changing world of US venture capital.  I did so without really describing the characteristics of angel-only deals.

Because the US is a large country with huge demographic variety, venture capital has thrived in a few regions and is virtually unavailable elsewhere.  Venture capitalists prefer not to travel to portfolio companies, investing instead close to home.  Consequently, while angel groups in a few regions do a high percentage of their deals with VCs, most angel groups seek and fund deals that will not require subsequent VC funding – “angel-only deals.”

In my last post, I concluded that convertible debt securities are seldom appropriate for angel investments.  My primary conclusion was that using convertible debt was likely to substantially reduce the ROI of “smash hits,” those 7% of angel investment that provide 75% of our ROI.

Just after the Internet bubble burst in 2001, many of us angels were “crammed down” unmercifully by subsequent investors in our portfolio companies.  These new investors were funding our companies at valuation far below the pricing we had agreed to earlier, resulting in substantial dilution to our ownership.  To avoid these “cram downs”, some angels began investing in startups using debt instruments that convert to equity at the same time and under the same terms as subsequent investors, with a small discount in pricing, based on the greater risk in our earlier investment.  While there are some advantages to using convertible debt for early stage investments by angels, I dislike these instruments and seldom use them.

Until the mid-‘90s, the quality and consistency of term sheets offered by angels to entrepreneurs varied considerably.  Some were sophisticated while most were not – as if written on the back of an envelope.  Angels and entrepreneurs did other deals with only a hand-shake - no term sheet at all!

I’ve been asked for thirty years if due diligence on angel deals really pays off.  Are we angels better served spending substantial time with entrepreneurs before investing or should we simply to throw darts at a list of deals to pick companies in which we invest?  Frankly, I didn’t have a quantitative answer until November 2007.

Bill Payne, Entrepreneur in Residence at The Kaufman Foundation, says that most start-ups fail due to a lack of execution.

 I’ve been funding startups as an angel investor since 1980 without having a good answer to this question.  Early stage VCs seem to earn over 20% IRR (annual internal rate of return), so my thought has been that angels should earn even more.  After all, we generally invest earlier with more risk than do seed VCs.  My own portfolio has done well, but one cannot base any conclusions on one lucky chap.

Wait a minute. Before describing why I think It’s a GREAT Time to be an Angel!, let’s level the playing field. Just what is an angel investor? Wealthy investors have been providing funding and advice to new entrepreneurs for thousands of years. In 1983, Professor Bill Wetzel at the University of New Hampshire recognized the analogy between “Broadway angels” – those who funded new plays in New York City – and “business angels” – those who fund and bring business savvy to new business ventures, hence the term “angel investors” (or business angels in some regions of the world).