- October 1, 2019: Vol. 6, Number 9

Angel investing has caught fire with affluent individuals and families

by Anna Robaton

David Rose is third-generation angel investor — a rare breed in the high-risk-high-reward business of underwriting startup and early-stage companies. Lately, he has seen a lot more interest in his once-esoteric line of work.

“Angel investing has gone mainstream,” says Rose, author of Angel Investing: The Gust Guide to Making Money & Having Fun Investing in Startups and CEO of Gust, an internet platform that connects accredited investors with early-stage companies.

During 2018 alone, the number of active angel investors grew by 16 percent over the prior year to nearly 335,000, and the number of ventures that received angel funding climbed by more than 7 percent to 66,110, according to the Center for Venture Research at the University of New Hampshire.


What’s behind the growing popularity of angel investing? The hit reality TV show “Shark Tank” has certainly shined a spotlight on the practice. But the record-long economic expansion and bull market, which have produced many more millionaire and billionaire investors, has not hurt.

Many of today’s angels are cashed-out entrepreneurs, often hailing from the tech sector, drawn to opportunities to leverage their money, expertise and professional connections. It is no coincidence that angels have tended to gravitate toward tech-oriented ventures, such as software, biotech, social media and e-commerce startups. This past year a whopping 65 percent of angel dollars flowed to the information technology and healthcare sectors, according to the Angel Capital Association, a collective of accredited angel investors.

As depicted on “Shark Tank,” angels often play an active role in the companies in which they invest. They may be involved in strategic decisions and bring valuable connections to potential suppliers, distributors and customers.

In theory, angels “exit” a deal — selling their shares for more than they originally paid — once a company is sold, acquired or goes public. Estimates of returns vary widely, but suffice to say angels expect to earn substantially more than they would in stocks or bonds in exchange for taking on the risks of underwriting young companies with a high likelihood of failing.

“We have a lot more cashed-out entrepreneurs,” says Jeffrey Sohl, director of the Center for Venture Research. “Those are your classic angel investors: They have capital, knowhow and they’re probably type-A people who like to be highly active with their investment portfolio.”


It’s not just nouveau-rich techies who are eying angel investing. Following the lead of pension funds, endowments and other institutions, family offices have also taken a greater interest in alternative strategies on behalf of their wealthy clients, who may be successful entrepreneurs themselves or hail from the world of investment management.

“As family offices have multigenerational interests, we see the younger generation taking a greater interest in being part of the success of individual investments and helping provide the additional support that’s so vital at the early stage,” says Patrick Gouhin, CEO of the Angel Capital Association.

In recent years, many family offices have reaped big gains on their traditional investments and may view a portion of their earnings as “house money,” says Jeffrey Sica, a veteran adviser to high-net-worth individuals, family offices and businesses.

“There’s a greater appetite for risk than I’ve ever seen,” says Sica, who in 2014 founded Circle Squared Alternative Investments to give qualified, high-net-worth individuals and family offices access to the kinds of deals once available only to large institutions.

The firm has focused largely on direct investment in real estate projects, but also invested on behalf of clients in early-stage tech companies, including Uber long before its IPO. Sica says Circle Squared invests on behalf of its clients in “the real economy” — in other words, tangible real estate projects and companies.

“There’s a psychological dimension to angel investing that has to do with discovering something,” perhaps the next Facebook or Google, explains Sica, adding that the practice requires a high level of due diligence and a high tolerance for risk.

“A lot of the families we work with may have 20 early-stage venture deals at any one time. They know that a good percentage of them won’t work out. But for that one that works out — that one Facebook or Google — it’s sometimes worth it,” he adds.


Angel investors are typically accredited investors, or those that, in the eyes of the SEC, are financially sophisticated enough to understand the risks associated with investing in private companies and able to sustain any associated losses.

There are millions of Americans that technically meet the SEC definition of an accredited investor: a net worth of at least $1 million (excluding the value of a primary residence) or an annual income of at least $200,000 ($300,000 for married couples). But not all accredited investors are cut out to be angels.

“Angel investing is not for everyone; whether it’s for anyone is another question,” quips Rose, who has funded more than 120 early-stage companies with exits to Facebook, Google, Intel and other big firms. Despite his successes, half of the companies in which he has invested have gone out of business.

“What you are looking at,” he explains, “is a very risky universe in which half or more of investments completely fail. One out of every 10 or 100 investments is a home run, but the home run is so big that it makes the whole thing worthwhile.”


How does the smart investor approach the risky (and illiquid) business of angel investing?

Sohl of the Center for Venture Research suggests following the so-called prudent man rule that has long guided pension funds when it comes to investing in alternatives. Under the rule, pension funds tend to limit their exposure to alternatives to no more than 10 percent to 15 percent of their portfolios.

“Anytime we give talks to investors, our mantra is: invest what will not change your lifestyle if you lose it all,” says Sohl. “Even if you don’t lose it all,” he adds, “your money will likely be tied up for seven to 10 years.”

Proper due diligence is critical, but so too is diversification among startups, experts say. Sica of Circle Squared Alternative Investments is a proponent of making small investments across multiple companies.

In fact, the average angel deal size appears to be on the decline, a study by the Center for Venture Research concludes. The study, titled The Angel Market in 2018: More Angels Investing in More Deals at Lower Valuations, found that the average angel deal size was nearly $350,000 during 2018, a decrease of about 10 percent from 2017.

“I tell people, spread out your money and make sure you do a lot of due diligence,” says Sica. “Even if you have the capability to write a big check, restrain yourself,” he adds.


In some sense, today’s angels have a leg up over their predecessors. The angel market, while still relatively young, is maturing, which means investors have access to more information, from best practices to benchmarks, than they once did and much of it is just a click away. What’s more, the number of so-called angel groups has proliferated. Members of angel groups gather regularly to evaluate and invest in startups. In some cases, they decide collectively which deals to pursue.

Rose, who founded one such group, New York Angels, estimates that there are between 200 and 400 angel groups in the United States alone. New York Angels has an extensive and standardized vetting process for companies who apply for funding. Some 125 companies apply each month, and typically only two or three of them make it through the screening process, landing a “patron” among the group’s 125 angels. Each deal may ultimately attract as many as 20 angels, and the minimum investment is typically $25,000 per angel per company, according to Rose.

Equity crowdfunding platforms, a relatively new phenomenon, have also made it easier and more efficient for investors (and not necessarily accredited ones) to underwrite startups. Platforms like SeedInvest and StartEngine have taken off in the years following the 2012 passage of the federal Jumpstart Our Business Startups (JOBS) Act, which lifted the earlier prohibition on public solicitation of funding for privately held companies and thus opened the door to equity-based investments from anyone, according to Waverly Deutsch, the clinical professor of entrepreneurship at the University of Chicago Booth School of Business. The SEC subsequently issued rules governing equity crowdfunding, placing limits on how much nonaccredited investors can commit over a 12-month period and how much startups can raise in a given year, according to Deutsch, who, writing in the Chicago Booth Review, argues that equity crowdfunding is inflating a bubble.


Deutsch is not the only one sounding a cautionary note. While affluent individuals and families are showing an increasing appreciation for angel investing, many registered investment advisers still choose to stay clear of the space, given the risks to investors, liability concerns and other issues.

Though diversification can help to mitigate risk, RIAs may not have the resources needed to source, screen and complete due diligence on enough deals, explains Darren Whissen, founder and president of Atomi Financial Group, a registered investment adviser that adheres to the principles of endowment investing.

“How can an RIA create a portfolio of angel deals diversified enough for it to make sense?” asks Whissen.

Moreover, angel investing is problematic for RIAs given the suitability standard to which they must adhere, notes Whissen. As fiduciaries, RIAs are legally obligated to provide only suitable investment advice to clients, taking into consideration an individual client’s financial situation and investment experience and objectives.

“Given the extraordinary risk of principal loss angel deals represent, it is extremely difficult to demonstrate suitability,” says Whissen.

What’s more, most professional liability policies excluding such investments, meaning that an RIA practice may find itself “out of pocket for any arbitration awards on an investment that will be very difficult to defend,” Whissen adds.

With all the risk and work that comes with trying to suss out the next Facebook, why do some investors keep coming back for more?

For former entrepreneurs, angel investing, says Rose, can have the same appeal as being a grandparent: You get to nurture a startup, and potentially reap the rewards, without the day-to-day hassles of running one.

“It’s like being a grandparent, you have all of the fun, and you don’t have to change the diapers,” he says. “It can be an enormous amount of fun, but it’s very risky.”


Anna Robaton is a freelance business journalist based in Portland, Ore.


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