Joe Johnson, Ph.D.
Entrepreneur. Investor. Startup Expert.
Prior to making any investment in a project, whether time or money, it’s always wise to ask oneself, “Does this really matter?” Allocating one’s resources in the most effective way means constantly reassessing all available information to aid in determining the best path forward. The interpretation of that path will differ from day to day and person to person. If you’re interested in angel investing, it’s imperative that you ask questions – especially of yourself.
As a first principle, you must satisfy yourself on the overarching issue: “Does angel investing matter?” I believe that the profound importance of angel investing and of supporting businesses in need is self-evident. However, it’s always smart to examine the relevant figures. By focusing on the statistics surrounding angel investing, we can determine not only whether it constitutes a relevant funding stream, but also whether (and to what degree) it contributes to economic growth.
In their book Financing High-Growth Firms: The Role of Angel Investors, the Organization for Economic Co-operation and Development (OECD) found that “…angel investment is the most significant source of outside equity for seed and early stage start-ups.” Venture capitalists, conversely, tend to focus on later-stage startups, i.e. those that have already begun to establish themselves in the marketplace. In other words, angel investors are essential for helping to launch new ideas. For many startups, angel investment is the only means available for propelling their business forward. The hurdles that must be cleared in order to secure a traditional bank loan (including the banks’ institutional reluctance) remain high and, after bootstrapping, many businesses have few other options available to facilitate scaling their operations. In those cases, the cash infusions received from angel investors are the only avenue of growth assistance forthcoming.
Trends by the Numbers
Once you’ve determined for yourself that angel investing is meaningful and worthwhile, you should focus on becoming familiar with the overall angel investing landscape. To help give you a better idea of angel investing’s current state, I’ve aggregated some recent data from the Angel Resource Institute (ARI) and the OECD.
Also known as the return on investment or ROI, the cash-on-cash multiple tells you how much profit your investment has produced. A 1x cash-on-cash multiple means that you’ve broken even on your investment, whereas a 2.5x cash-on-cash multiple indicates that your investment has more than doubled. This return, of course, is not instantaneous and can take years to realize. The most recent ARI report quotes an average cash-on-cash multiple of 2.5x for angel investments from 2007 to 2016 over a 4.5 year-hold. In other words, the average investment netted a 250% return over four and a half years. It’s important to note that angel investment not only requires asking plenty of questions, it also requires patience.
The creation of a well-rounded investment portfolio absolutely requires that investors are aware of current failure rates. In angel investing, a failure is an investment that yields less than a 1x cash-on-cash multiple. According to data from the 2016 Tracking Angel Returns report, the failure rate of angel investments has climbed to almost 70%. While this statistic appears to bode poorly for the future, it’s important to note that the time period included in the report covers the Great Recession, which led to difficult financial straits for numerous businesses. The last measured failure rate prior to the recession, in 2009, was closer to 55%. It’s also possible that the increased failure rate may be tied to the overall growth of angel investing activity.
The Geography of Investing
While the tech industry and its Silicon Valley unicorns draw much of the business media coverage, angel investing isn’t solely about the California software machine. In fact, about 75% of angel investors concentrate on businesses located in their own geographic region. In 2015, only 20.9% of angel deals occurred in California. The largest area of growth was actually New England, which received 15% of all angel dollars (second only to California). Ever greater numbers of investors are seeing the benefits of making deals in their own backyards and further enriching their own communities.
Software and healthcare investments remain the most popular. In 2015, the software industry received 30% of all angel dollars. The healthcare industry (which does not include pharmaceuticals or biotech) received almost 23% of all angel investment dollars and represents the largest growing investment sector. However, due to the nature of angel investment, it’s a simple matter to invest in any industry that captures one’s interest.
Not All Angels are Created Equally
The motivations that inspire such a wide range of individuals to become involved in angel investing are as varied as the people themselves. This diversity helps to ensure that more startups receive funding across business sectors. Whereas venture capitalists are generally concerned with later-stage startups and their return on investment, this isn’t always of primary importance for angel investors.
While many angel investors naturally desire to make a profit, there are some whose sole aim is to support other entrepreneurs or their community in general. Similarly, whereas venture capital frequently focuses on specific industries, angel investors distribute their funds across a wider range of interests, thereby enabling them to invest in businesses that others might pass over.
Most angel investors are also entrepreneurs. They understand the importance of startups and small businesses while valuing the wide range of different ideas they bring to the table. They know that, by supporting these companies, they are also supporting job growth. The net effect is that, because angel investors are adept at understanding the needs of other businesses, it enables them to make smarter investment decisions.
Angel investors are helping to shape the future of business. With more investors focusing on their respective geographic regions, the nation continues to be pushed toward a more prosperous business climate replete with economic growth. Angel investors have clearly demonstrated the importance of their financial activities and continue to expand their networks and reach. As time goes by, an ever greater number of groups and foundations are available to assist first-time investors and their ability to offer financial assistance continues to increase. For those interested in angel investing, the future seems ripe with opportunity.
Tables made with data from:
About the Author
Dr. Joe Johnson is an entrepreneur, investor, and startup expert. He is the founder and principal of GoodField Investments and the GoodField Foundation (www.GoodField.com).
Joe has a Ph.D. in Entrepreneurial Leadership and an MBA. He is the author of the upcoming book on The Science of Why Most Entrepreneurs Fail and Some Succeed.
Most importantly, he is the incredibly blessed husband of one amazing wife and father of six wonderful children. He resides in Bradenton, Florida. For more information on Dr. Johnson and his work, go to www.JoeJohnson.com.