Private Equity Solutions

Susan Preston. Source: Teresa Esser.Appleton, Wis. The head of an alliance of angel investment groups came to wisconsin recently to encourage angels to band together.

On October 19th, Susan Preston, entrepreneur in residence at
the Kauffman Foundation, gave a lecture at the Radisson Hotel in Appleton, Wisconsin.

Preston said that in 2003, U.S. venture capitalists invested $18.3 billion in companies of various sizes, but only $354 million was given to 166 companies at the seed stage. During the same year, private angels invested $18.1 billion in 42,000 ventures, primarily in seed and startup rounds.

Back in 1996, there were 10 established groups of angel investors in the United States. Today, there are at least 200. The concept is catching hold, Preston said.

One of the angels in attendance said that he and his friends had been making investments in young high-growth business for the past twenty years, although they didnt know that what they were doing was called angel investing. We called it the country-club capital route, he said.

Angel investors join investment networks because they want to see more deals, and better deals. They believe they will have greater clout in negotiating terms with entrepreneurs when operating as a group, rather than as individuals. They also appreciate having the chance to share the work of performing due diligence on each investment.

Its arduous, and its boring, Preston said. No one wants to perform due diligence, but it is a necessary part of investing in young corporations. When angels band together in networks, they have a chance to share the tedium of due diligence, the pain of financial loss, and the thrill of success with other members of the group.

Angel investors must be willing and able to lose every penny they invest in young companies. But even though angels may know, rationally, that they are taking huge risks with their money, Its still a little disconcerting to lose more than you were expecting, Preston said.

How angel networks work

Preston showed the group a series of bar graphs which provided information about the way that angel networks are structured. Most groups have between 50 and 100 members, but only about 60 percent of the members are likely to attend a given meeting.

Most groups have 12 meetings each year, and these meetings usually happen over dinner. Most groups charge an annual membership fee of between $500 and $1500, which covers the cost of due diligence and the price of 12 chicken dinners.

Prestons group chooses three companies to present at every meeting. After a company has presented, the angels kick the entrepreneurs out of the room and discuss the presentation amongst themselves. If any angels are interested exploring the opportunity further, they form a sub-group and perform due diligence.

Instead of hiring consultants, as many professional venture capitalists do, most angel investment groups perform due diligence by themselves. Many service providers are happy to help angel networks, often providing their services pro bono, because they appreciate having the opportunity to meet with high-net-worth individuals. Some angel investors pay university professors $500 or $700 to evaluate new technologies.

Most angel investors do not take a seat on a companys board of directors, but many angels do like to have an advisory role, or observation privileges, at company board meetings.

Angel investors need to be prepared to wait a long time to see any kind of return on their investments. Two or three years is a short time frame, but eight or 10 years is not unreasonable.

Great angel investment groups do a fabulous job of recruiting and orienting new members. They allow prospective members to attend one meeting for free, but after that the members must pay. If you want to come back to another meeting, you have to pay one-tenth of the annual membership fee, Preston said. It works out to be a very expensive piece of chicken.

Great investment groups let new members know how much time is required to be a member, and what the groups code of ethics is. Its real work, Preston said. Preston often goes out and looks at companies that her angel investment network is thinking of investing in. She screens deals that come in, and when she chooses a company to present to the group, she coaches the entrepreneurs on how they should structure their presentation.

Most angel investment groups receive 30 or 40 applications each month from companies seeking investment, but they only select two or three companies to present at each meeting. Most angel investment networks choose to invest in fewer than five deals each year. A lot of companies are just much more appropriate for an SBA loan, Preston said.

Regardless of whether angel investors choose to invest in the companies that present to them, the experience of presenting can be beneficial for an entrepreneur. Its valuable for a young entrepreneur to understand how they should seek to grow their company, Preston said.

Most angel investment groups purchase a 30 percent stake in companies they invest in. The company usually decides what is the minimum investment amount they will accept, but most companies ask for between $250,000 and $500,000. Most companies that raise money from angel networks have valuations of between $1.5 million and $2.5 million.

Angel investment networks often develop relationships with local venture capitalists. If the VCs are impressed with the deals they are seeing, but the dollar amounts are too small, they may refer a deal to a group of angel investors.

Most angel investors anticipate that companies they invest in will return to them when they need to raise their next round of funding, since professional VCs are incredibly risk averse.

They want the company to be ready to go IPO before they are ready to invest, Preston said. Most companies never have public offerings, since 80 percent of liquidity events are acquisitions. Another reason most companies are not appropriate for professional venture capital investment is because they do not have the market capitalizations that VCs need. However, these companies can still offer an excellent rate of return for small investors.

Preston said that the Kauffman Foundations Angel Capital Association (ACA) has only begun to collect information about angel investment networks. We need more statistics to understand what has worked, she said. But the ACA is absolutely certain about one thing: Every angel investment group needs to have a champion. This champion needs to make a significant time commitment to ensure the success of the group. This champion will influence the ultimate organizational structure, and promote membership in the organization to desired individuals. In addition to spending time on the group, the champion needs to make a commitment to use his personal connections to help companies succeed.

Its hard work to do this, Preston said.

Additional Resources

Preston encourages angel investors to join a new organization called Angel Capital Association, the professional alliance of angel groups, which is sponsored by the Kauffman Foundation.

She also encouraged people to check out National Association of Seed and Venture Funds, the National Venture Capital Association, the Wisconsin Technology Council, and the Wisconsin Department of Financial Institutions.

Preston has just written a book, called Angel Investment Groups, Networks, and Funds: A Guidebook to Developing the Right Angel Organization for Your Community. The book is published by the Kauffman Foundation.

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Teresa Esser is a contributing columnist for the Wisconsin Technology Network and author of the book, The Venture Caf. She can be reached at teresa@wistechnology.com.

The opinions expressed herein or statements made in the above column are solely those of the author, & do not necessarily reflect the views of Wisconsin Technology Network, LLC. (WTN). WTN, LLC accepts no legal liability or responsibility for any claims made or opinions expressed herein.

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