Angel Groups: Giving Startups Their Wings

Entrepreneurs and the companies they start are pivotal for stimulating the innovation needed for economies to grow and societies to progress. We all know the stories of the founders who built their global companies out of a one-car garage or their freshman dorm room, but the individuals and groups that provided them the needed funding in the beginning are less often discussed. Angels and angel groups are these important financiers that provide a path for these innovators to make the leap from a person with a great idea to the founder of a successful company.

Venture capital (VC) is usually the first group that comes to mind when people think of funding sources available to entrepreneurs. However, it is rare that a founder can take an idea with little proof of concept to a VC and walk out with a large check. In fact, VCs have been increasingly investing in larger, more mature companies over the past several years. [1]

Constructed using Preqin data.

Constructed using Preqin data.

This is where the angels come into play. The typical investment timeline, outlined in the chart below [2], starts with an early seed round, moves to multiple rounds of financing from VCs and early stage private equity (PE) funds, and ends with an exit opportunity such as an IPO or an acquisition. Before receiving seed funding, founders tap their own credit cards, family, friends, and accelerators to help finance the startup. However, that money eventually dries up, and if the entrepreneur has not yet developed a “VC-ready” product, they can find themselves in the Valley of Death.

Adapted from: Applegate, Lynda M., and Kaitlyn Simpson.    "CommonAngels (A)."    Harvard Business School Case 810-082, February 2010. (Revised January 2014.);

Adapted from: Applegate, Lynda M., and Kaitlyn Simpson. "CommonAngels (A)." Harvard Business School Case 810-082, February 2010. (Revised January 2014.);

The proverbial valley appears when the entrepreneur’s idea has transformed into a product, but it and the company are not ready to scale at the pace that attracts VC investment or generate enough revenue to support the operation. At this stage, angel investors are critical to help companies make it through the financing valley. 

But who are angels, and how do they add value to the companies they finance? Initially, angel investing was done by successful entrepreneurs with the time, money, and expertise to dedicate to aspiring entrepreneurs. More specifically, angels offered three key resources [3]:   

  • Mentorship of the founder and the company’s team (arguably more important than money).  

  • A check, often between $100 thousand and $1million in size.  

  • Access to crucial networks and a “stamp of approval” for the startup.  

Starting in the 1990s, individual angels began to aggregate into groups. This “formalization” allowed for more powerful investments through the pooling of the resources outlined above. At first glance, these groups may sound like a version of VC; however, they are distinct along several important dimensions highlighted in the table below.[4]

William Kerr, Josh Lerner, and Antoinette Schoar, “The Consequences of Entrepreneurial Finance: A Regression Discontinuity Analysis,”  NBER , (2010).

William Kerr, Josh Lerner, and Antoinette Schoar, “The Consequences of Entrepreneurial Finance: A Regression Discontinuity Analysis,” NBER, (2010).

While angels offer a crucial financial resource for entrepreneurs in bridging the financing gaps, perhaps even more important is the mentorship and network that angels offer. Recent academic research discussed in Kerr et al. (2014)[8] and Lerner et al. (2015)[9] investigated just how important this mentorship can be. The researchers found that not only do angel-funded startups have a 70% greater likelihood of obtaining more financing in the future, they also have a 9-11% greater chance of ultimately completing a successful exit than comparable companies without angel funding. Angel-funded startups also add more employees and are more innovative. 

However, angel investing is not easy, and a number of issues continue to plague the sector. One such issue is biased investing. Research from Michael Ewens and Richard Townsend (2018)[10] suggests that early-stage/angel investors exhibit “homophily”— that is, the tendency to invest in entrepreneurs that are similar to them in terms of gender or ethnic status, instead of entrepreneurs that are different. Since the clear majority of angel investors are white (87.6%)[11] or male (78%)[12], high-potential startups with diverse founders could be excluded from valuable angel funding. 

Another issue is risk. As with any early stage investment, angel investing is inherently risky. While young and untested companies might perform phenomenally, they often fail completely. Research from the OECD and the World Bank sheds light on this, estimating that just over 50% of an angel group’s portfolio fails, 35% result in a marginal gain or loss, and fewer than 10% return 10 times the original investment or more.[13] Despite this skewness, a well-diversified portfolio of angel-style investments can perform quite well and produce outsized returns. Angels accept this risk for a number of non-financial reasons as well, including the interest in supporting new entrepreneurs, the desire to “stay relevant”, and simply for the fun of it—one angel noted, “It’s cheaper than buying a yacht and more fun.”[14] 

Angel groups can increase their chances of investing in high-quality startups by integrating best practices into their organizational structures. In short, groups need to understand their entrepreneurial ecosystem, choose the correct organizational structure, and implement a sound investment process to find the most promising opportunities.  

Understanding the entrepreneurial ecosystem involves carrying out an extensive “community assessment.” According to research from the World Bank, the community assessment should cover[15]:  

  • The angel community to determine if there are enough potential members.  

  • The startup community to determine if there is enough potential investment opportunity.  

  • The entrepreneurial infrastructure to determine if there is adequate support.   

  • The potential for follow-on funding needed to fund the startup moving forward.   

Once the assessment is completed, groups need to implement an organizational structure that strikes the right balance between an informal, decentralized structure and a more formal, centralized one. Groups that expect to remain small typically choose a member-led structure in which responsibilities are shared by all angels. Larger groups, on the other hand, tend to be manager-led and more formal. Because of their size, larger groups often need to employ a full-time manager and support staff to cover administrative and other responsibilities.[16] While the manager and other staff provide crucial support and structure around the investment process, employing staff can add significant overhead costs to the angel group.  

Fortunately, there are a variety of approaches that groups can use to fund themselves. Such approaches include membership dues, sponsorships by service providers, grants from government organizations, and fees from events that the group organizes. More experienced angel groups might even raise a fund, which provides the group with a reliable stream of management fees on the funds’ committed capital.[17]  

The last issue for angels to consider is implementing an efficient investment process. Put simply, many angel groups need to “Say ‘yes’ fast, and ‘no’ faster.” This means that angel groups need to give quick feedback to entrepreneurs – if the angels aren’t interested, it’s best to tell the entrepreneur fast. On the other side, angels should not burden promising entrepreneurs with an onerous diligence process, taking them away from the important job of growing a business.[18,19]    

Marianne Hudson,“ACA, Angel Groups, and Angel-Backed Companies”,  Angel Capital  Association, September 2012 “Creating Your Own Angel Investor Group: A Guide for Emerging and Frontier Markets” Washington, DC: World Bank, 2014. License: Creative Commons Attribution CC BY 3.0:pp: 54

Marianne Hudson,“ACA, Angel Groups, and Angel-Backed Companies”, Angel Capital Association, September 2012
“Creating Your Own Angel Investor Group: A Guide for Emerging and Frontier Markets” Washington, DC: World Bank, 2014. License: Creative Commons Attribution CC BY 3.0:pp: 54

It’s important to remember that the angel’s job is not over once the investment is made. Entrepreneurs may have brilliant ideas, but often those ideas are not bundled with the needed business or management acumen. Angels help develop the business by listening to the needs of the entrepreneur and connecting them to the right people to help grow. This mentorship represents the true value an angel adds to a startup—positioning it to become a future success.   

There is no “one-size-fits-all” plan that guarantees an angel group’s success—but the best practices described above can help any group start on the right foot. At Bella Private Markets, we have worked with a range of clients on a variety of related projects: from startup ecosystem evaluation to strategic reviews of angel groups. In a recent engagement, we partnered with an angel group to perform a top-down assessment of their group’s organization and operations. Based on years of experience and extensive primary and secondary research, Bella provided a series of recommendations targeted to the group’s needs.  

For more information on our work on angel investing best practices or ways that Bella can help foster growth in your entrepreneurial community, contact us at info@bella-pm.com and subscribe below to receive our free monthly email newsletter.

[1] Constructed using Preqin data. 
[2] Adapted from: Lynda M. Applegate and Kaitlyn Simpson, "CommonAngels (A)," Harvard Business School Case 810-082, February 2010 (Revised January 2014.). 
[3] Jill Krasny, “What Can Angel Investors Do For You?” Inc.com, 2013. 
[4] William R. Kerr, Josh Lerner, and Antoinette Schoar, "The Consequences of Entrepreneurial Finance: Evidence from Angel Financings," Review of Financial Studies 27, no. 1, 2014. 
[5] Data from Pitchbook and NVCA Q2 2019 Venture Monitor, with analysis by Bella Private Markets. 
[6] Ibid. 
[7] Darian M. Ibrahim, “The (Not So) Puzzling Behavior of Angel Investors,” Vanderbilt Law Review, Arizona Legal Studies Discussion, 2009.  
[8] William R. Kerr, Josh Lerner, and Antoinette Schoar. "The Consequences of Entrepreneurial Finance: Evidence from Angel Financings," Review of Financial Studies 27, no. 1, 2014. 
[9] Josh Lerner, Antoinette Schoar, Stanislav Sokolinski, and Karen Wilson, "The Globalization of Angel Investments: Evidence Across Countries," Journal of Financial Economics, vol 127, no.1, 2018. 
[10] Michael Ewens and Richard Townsend, “Are Early Stage Investors Biased Against Women?” Journal of Financial Economics (forthcoming), 2018. 
[11] Laura Huang, Andy Wu, Min Ju Lee, Jiayi Bao, Marianne Hudson, and Elaine Bolle, “The American Angel,” Angel Capital Association, rev1ventures, Wharton Entrepreneurship, 2017. 
[12] Ibid. 
[13] World Bank, “Creating Your Own Angel Investor Group: A Guide for Emerging and Frontier Markets,” 2014, p. 11. 
[14] Darian M. Ibrahim, “The (Not So) Puzzling Behavior of Angel Investors,” Vanderbilt Law Review, Arizona Legal Studies Discussion, 2009. 
[15] World Bank, “Creating Your Own Angel Investor Group: A Guide for Emerging and Frontier Markets,” 2014, p. 15. 
[16] Ibid., p. 34 
[17] Ibid., p. 44 
[18] Marianne Hudson, “ACA, Angel Groups, and Angel-Backed Companies,” Angel Capital Association, September 2012  
[19] World Bank, “Creating Your Own Angel Investor Group: A Guide for Emerging and Frontier Markets,” 2014, p. 54.