“Five or 10 years ago, angel investing was a bit of a rich guy’s game,” says Allan May, managing director of Emergent Medical Partners, an investment group that focuses on the health-care, diagnostic and biotech industries.
Not anymore.
Accredited investors in fledgling companies who come together in so-called angel groups now are often in their 30s or 40s, says May. “They’ve made a block of money, they’re not über-rich in most cases. Often they’ve got day jobs or things they do. But they’re very serious angel investors; they’re not hobbyists.”
Advisors also need to take note: As angel investing becomes mainstream, RIAs will increasingly be the go-to people for fledgling companies looking for start-up funds.
What has changed since the 1980s, when the first angel investors were mega-wealthy individuals capable of putting a couple of million dollars into a start-up, is that the cost of starting companies has plummeted as technology development has gotten faster, cheaper and more powerful. Today, more accredited angel investors can fund more entrepreneurs for modest amounts of money.
Going Professional
In the mid-to-late 1990s, as more and more individuals started to invest in start-ups, they looked for kindred souls to help them find new companies and raise capital, according to David S. Rose, managing partner of Rose Tech Ventures and chief executive of Gust, an investor-relations platform. They began to form angel groups of a dozen to 100 people and, as the Internet came on the scene, put up Web sites seeking pitches. They would pool their deal flow and their expertise for doing due diligence on these companies. Then they would pool their money so each person could invest, say, $25,000.
In recent years, the angel group class of investment has professionalized. “One could say it has gone from being a hobby kind of enterprise, a club, to serious investing,” says May. The due diligence angel groups conduct is quantitatively and qualitatively much more sophisticated today. “It’s serious diligence on intellectual property, on the business model, the financial projections,” he says. In addition, the industry groups Angel Capital Association and Angel Resource Institute have educated investors about best practices.
Many angel groups, especially on the two coasts, are loaded with operational talent. More than 90% of Emergent Medical Partners is ex-CEOs, founders, CTOs and CFOs of biotech start-ups. “We bring to the table not only capital, but also commercialization skills,” says May. “We have successfully commercialized the technologies we’re investing in.”
As angel groups have matured, adopted best practices and become more professional, they have syndicated, sometimes in complex arrangements. According to the 2012 HALO Report, 70% of angel group deals involved co-investors. Syndication brings more deals, greater diversity and more investors. May sees this in his angel group, which co-invests with family offices and foundations.
Family offices and family foundations once used venture capital as their screen, and either co-invested or became limited partners in venture funds as the vehicle to address those investments. Now they’re investing directly without the middleman.
“With venture capital having collapsed after 2008, particularly in health care, they’re looking seriously at doing that same thing with angel groups,” May says. “The thought is that if we really focus on investing in deals where angel groups have or are investing and have or are participating in the management of the company, that’s a good filter and a good mechanism for building value going forward.”
The syndication phenomenon has also increased due diligence on prospective investments. In co-investment deals, companies are being vetted not only by the initial group, but also by every group that comes into the syndicate.
RIAs In The Game
Within the last decade or so, the average angel group member in Gust’s network has invested $25,000 or $30,000 per company and done five or 10 deals in total, Rose says. But there is a lot more money sitting around in family offices and under people’s mattresses. The SEC estimates that there are some 8 million accredited investors in the U.S., those with an income of $200,000 or a net worth of $1 million, excluding the value of their home. Big chunks of that money tend to be mentored by RIAs. “As the angel investing world goes mainstream, you’re going to find more of that capital coming in, and therefore more and more RIAs in the mix,” says Rose. “Ultimately, the RIA will be the person to whom the company is pitching on behalf of the client.
The RIA will do the grunt work of angel investing, he says. Because it is a complicated business, most investors interested in early-stage investing would prefer their advisor to handle the entire matter up to making the final decision to invest. In this scenario, it will behoove the advisor to join angel groups.
John Huston, founder and manager of Ohio Tech Angels, a group that invests exclusively in Ohio start-ups, is skeptical about RIAs’ enthusiasm for angel investing. “RIAs would lose fee income if a percentage of a client’s portfolio were taken out and invested with an angel group,” says Huston. “They would much rather put them into other alternative asset class opportunities in which they can get a fee.” Moreover, RIAs generally lack expertise to evaluate start-up investment opportunities, he says.
But Huston concedes that RIAs with clients who have enough interest to look at high-tech start-up deals would be well served to reach out to angel groups, attend meetings and get into the deal flow. He says his own investment advisor, who belongs to two angel groups, brings him deals that his clients bring to him. “One of the beautiful aspects of belonging to an angel group is that the smart RIAs use membership in a group as a big deflection bucket.” By this he means that when clients come in with an investment idea, their advisors can suggest that the idea be vetted by an angel group—people who see a deal every day and can provide a dispassionate assessment. In this way, the RIA takes himself off the hook. “Where so many people lose it is that they just don’t get an adequate return,” says Huston. “Just because a company turns into a great company doesn’t mean it’s a great investment in the start-up realm.”
The Liquidity Issue
One issue with private company ownership shares is lack of liquidity. “If you’re an angel investor and you invest in a company, you’re stuck holding on to that until the company goes bankrupt or is sold or goes public,” says Rose. “There’s no recourse for an angel investor.”
When Facebook and LinkedIn were edging toward IPOs a couple of years ago, a secondary market sprung up for outstanding employee or founder shares. “It was all about companies that people might want to buy into just because of their size or brand name without knowing their financials,” says Rose. “They ‘knew’ it would go public at a higher price. But nobody who was buying shares at that point could make a reasoned decision because there was no public material available about the company or its sales or anything else.” After the companies went public, the secondary market for private company shares dried up.
Rose expects this to change. At a recent Venture Forward Conference in New York City, panelists looked toward the emergence of platforms that would handle both the primary sales offering of a company’s stock and a secondary market for people to buy those shares. During the conference, Barry Silbert, founder of SecondMarket, announced plans for a platform to do primary and secondary sales of private companies.
Other platforms allow companies and investors to encounter one another. On the Gust platform, more than 200,000 start-ups display their financial and business information, and this is accessible to more than 1,100 angel groups searching for investment opportunities.
In July, the SEC lifted the eight-decade ban on general solicitation and general advertising on private securities deals. In a statement, Silbert says that “a much deeper, broader group of accredited investors will have the opportunity to hear about—and potentially invest in—private companies and funds.”
SecondMarket’s platform would be a general solicitation product that would enable issuers to handle a higher volume of investor interest and greater regulatory requirements that will accompany their general solicitation efforts, he says.
“This had to happen,” Rose says. “The general solicitation rules were to bring a little bit of sense into this operation. Now you can tell people that you’re raising money, but you can sell it only to the same people you were selling it to before, who are accredited investors.”
However, May expects angel groups, including Emergent Medical Partners, to adopt rules or practices that preclude investing with an entrepreneur who has advertised for investors on crowd-funding sites. Angel investors in biotech and diagnostics start-ups are going to need more capital than an initial $500,000 or $1 million to exit, he says. “You’re going to need follow-on investors, probably institutional money, whether [it be] venture capital or corporate strategic or family offices; you’re going to need partners.”
Huston’s Ohio Tech Angels will also eschew start-ups that advertise. He says those who invest through crowd funding invest in entrepreneurs they have never met and probably won’t. “Why would they do that? The answer is because they care less about building entrepreneurial wealth than their own wealth. I’m not maligning that. I’m just saying we take a much, much more personal view.”
