Do Angel Investors Make Money?
- Posted by Jeff Carter
- on October 1st, 2012
It’s a good question. Especially in this economic climate. Bonds are returning next to nothing. The stock market feels as though it’s a house of cards ready to topple. Right now, for many a mason jar in the backyard feels like the safest place to put money.
However, there are two other ways to increase your wealth. The first one I advocate is start your own business. An investment in yourself always trumps all others. No one will work harder for you than you. The second way to build wealth is invest in a start up business-or be an “angel investor”.
Angels are generally the second round of capital in a business after a friends and family round. The F+F round just gets the business going. The angel round intensifies that development and becomes the make or break round of capital for the business. If it goes well, they likely will get more investment and continue. If they don’t hit their metrics, they die.
Angels take a lot of risk. But do they get rewarded for it? Andy Rachleff doesn’t think so.
How low are returns for angels? I don’t know of good statistics on returns for angels who invest in tech companies, but I can deduce returns from what I know about the venture capital business. As explained in the Kauffman Foundation research, the overall return for the venture capital industry has been quite poor (the average VC fund barely returned investor capital after fees). According to an annual seed financing survey by Fenwick & West, only 45 percent of companies that received seed financing in 2010 went on to raise venture financing in the next 18 months. Twelve percent were acquired, but likely in talent acquisitions that lost money for the angels.
If the average VC fund barely makes money, and seed investments represent even less compelling opportunities than the ones pursued by venture capital firms, then the typical return for angels must be atrocious. Even Ron Conway’s second angel fund, which had the good fortune to invest in Google (a 400x cost winner), only broke even (that means close to a 0 percent IRR)!
He doesn’t sound too optimistic. However, his conclusions are not based on data but gut feel. Here is some data from the Angel Capital Association. The difference is, it’s from angel groups. I think that if groups are run correctly, they function like a marketplace. Marketplaces allocate capital more efficiently than individuals. This study is from 2009.
The average return of angel investments in this
study is 2.6 times the investment in 3.5 years—
approximately 27 percent Internal Rate of Return
(IRR). This average return compares favorably with
the IRRs of other types of private equity
This fits with various narratives on VC and angel investing as well,
Fifty-two percent of all of the exits returned
less than the capital the angel had invested in
Seven percent of the exits achieved returns of
more than ten times the money invested,
accounting for 75 percent of the total
investment dollar returns.
When you dig down into the reasons for success or failure, there is some commonality. First, the quality and time you engage in due diligence correlates to higher levels of success. The longer the period of due diligence, the better the chance.
Secondly, some familiarity with the industry is important. If you understand the mechanics of the industry, you have some “local knowledge”. In many respects this is like having insider information when it comes to the stock market.
Lastly, the investment made in a company cannot be passive. You have to get your hands dirty. Investors that did had more success than investors that didn’t. Getting your hands dirty takes on many different angles. Sometimes it’s mentorship. Just helping an entrepreneur through rough times. Sometimes it’s finding new employees. Sometimes it’s finding customers. Other times it’s finding new sources of financing. Each company is different, and each situation is different. And of course, there are a lot of differences between entrepreneurs. But getting involved pays dividends.
I really believe that when people describe the US as the “American Experiment”, what they are really referring to is the entrepreneurial spirit that we built upon. People emigrated here for centuries and started building better lives for themselves by starting businesses. They were optimistic. American entrepreneurship is open to everyone. Everyone ought to invest in that spirit. No one has the market cornered on good ideas and it’s not limited to race, creed, gender or sexual orientation. Anyone with an idea can try to execute and become an entrepreneur. Entrepreneurship is truly merit based. That’s exciting and invigorating.
The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.
Jeffrey Carter is an angel investor and independent trader. He specializes in turning concepts into profits. He co-founded Hyde Park Angels one of the most active angel groups in the United States in April of 2007. He previously served on the Chicago Mercantile Exchange Board of Directors. He has done market commentary for (More...)
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