Until the mid-1990s, so-called "angel investors" were either the Lone Rangers of the investing world or loosely formed groups of several individuals that put up seed and startup capital. But with the Internet era came a slew of new deals and angel investors banded together.
Unlike their better-known cousins, the venture capitalists, who are traditionally passive investors, angels invest a lot of their time in the entrepreneurial ventures they back. Angels mentor entrepreneurs and help find key partners and employees. Investors, meanwhile, benefit from an angel network's organizational structure.
A decade ago there were around 10 such bands of angel. Today, there are more than 200 nationwide. The increase is due largely to the dot-com bust, which prompted some angel investors to reduce the peril from their high-risk investments, says John May, chairman of the Angel Capital Association, a trade group for angel investors.
"We learned if we band together, you minimize risk," he says.
The angel clubs have evolved from a group of golf buddies investing together to membership-based networks of up to 150 angels who host monthly pitch meetings, jointly review hundreds of business plans and have snazzy Web sites where entrepreneurs can submit their ideas.
While that's good news for entrepreneurs searching for startup capital but who can't attract VC funding, some industry watchers say with more angels pooling their money they're starting to act more like venture capitalists – bypassing seed-stage investments.
"What one could ask is, 'Are we creating a new venture capital industry here?'" says Jeffrey Sohl, the director of the Center for Venture Research at the University of New Hampshire, which released a report on the issue. "The classic test is if you look and feel and act like a fund, you are one."
Overall investment by angels increased by 15 percent to $12.7 billion through the first half of 2006 over the same period in 2005. Yet, even as angel investment dollars grew over that period, the number of entrepreneurial businesses they funded, which the study estimated to be 24,500, dropped 6 percent, according to the report.
"It's clear that some angel clubs are beginning to act more like VC firms, but I don't believe you can make a sweeping generalization," says John Garcia, who heads Angel Strategies, an investor group in Orange County. "I know of many angel clubs that are acting just like they were prior to 1999."
Another reason for the widening funding gap in seed-stage and startups is that venture capitalists – once the early-stage investors – are now sticking to more mature startups.
Venture capitalists are concentrating on larger and larger deals and turning away from early-stage deals. Angels put up between $10,000 to $1 million in early-stage and seed capital, an investment range too low for venture capitalists
Ten years ago, more than 40 percent of venture capital dollars went toward early-stage funding. Today, that number has dropped to less than 20 percent.
RELYING ON ANGELS
"The first round is usually done by angels and it's only in the next round that VCs come in and put in $5 million to $10 million," says Luis Villalobos, founder of Tech Coast Angels, one of the largest early-stage venture capital groups in the country. "That's the way it's currently working."
Mr. Villalobos disagrees that angels are moving away from seed-stage companies. In fact, he says, angels have had to step up their investments to make up for the steady lack of early-stage venture capital.
"For every deal we do, we're looking for more capital," Mr. Villalobos says.
For his part, Mr. Villalobos is hoping to narrow the funding gap through his recently formed venture capital fund, Angel Venture Partners. The fund, he says, plans to invest in companies from eight angel networks it has partnered with as well as ventures originated from the AVP management team.
AVP is currently raising $40 million from individuals Mr. Villalobos calls "non-angels."
"The individuals that we would bring into our fund are typically individuals like a partner in a law firm that is very busy with his or her career and understands this kind of investing, but doesn't have time to do anything," he explains. "But from the other side, we'll be working closely with angel groups."
Mr. Villalobos says that by collaborating with specific angel networks on both coasts, he will generate significant value by leveraging their strengths.
To attract investors, Mr. Villalobos is banking on AVP's management team, which claims to have a proven track record of 4.9 times return on capital from 71 early-stage ventures over the last 20 years. To become a limited partner, individuals need to invest at least $1 million. Institutional investors are asked to commit at least $2 million.
ROLLING THE DICE
Still, even with a smarter and safer approach to angel investing, it continues to be one of the most high-risk asset classes. Angel investing is risky, but the process is half the fun.
"You do this as a financial investment and the non-financial aspects – the mentoring, the psychic reward of being part of something new and exciting, and you're giving back to your community," Mr. May says. "You tend to have non-financial benefits, which you live off and which you use to justify your craziness."
Although angel groups continue to be the most visible sources of angel funding, they still only account for about 5 percent of all angel deals. Individual angels represent the majority of early-stage funding.
Despite the recent activity in angel investing and robust growth of angel networks, most investors shy away from this kind of investing.
"It's still the pimple," Mr. May says. "There are probably between four to six million millionaires that could be angels."
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