Public Policy

Building Angel Groups / Networks.

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Building a new Angel organisation may be divided into two elements, Network Design and Establishment, and Network Manager Training.

The final design of the network will influence the nature of training required for the Network Manager. For example a “manager led” network, in which the manager has primary responsibility for deal sourcing and deal making, will require more in-depth management training than would be required for the manager of a network designed to be more of an introductory service, where the individual members are expected to do the majority of the work in relation to due diligence, deal completion and post investment support.

Any project intended to assist the establishment and angel organisation should help to design the most appropriate structure and operating process to meet the specific needs of the local Angels. Based on local needs the areas of assistance to be provided may need to include:

  • Refinement of the operating budget for the network.
  • Funding sources (membership fees, sponsorship etc.).
  • Development of the network manager’s role and job description.
  • Meeting structures / timing / frequency.
  • Public relations.
  • Establishment of investment criteria.
  • Membership rules / Code of ethics.

The assistance should provide guidance as to how to maintain network momentum and membership to ensure future sustainability. The life cycle between initial investing and successful exits can be long. Depending upon the nature of the investee company, and the form of investment, an exit can take many years, a considerable time to keep members interested and active. Tactics to build long-term momentum may include:

  • Ensuring appropriate attention is given to the social aspects of the network
  • Practical issues such as the timing and location of meetings to encourage membership participation
  • Participation in other wider group activities
  • Ability to leverage the group for personal and intellectual development such as judging entrepreneurial competitions and mentoring young entrepreneurs
  • Active participation of members in the investment process, through membership of screening committees, due diligence teams and participation on portfolio company boards.

The specific activities relevant to any individual new Network will depend upon the nature, motivation, objectives and availability of their members, and may change over time as membership grows and develops.

The level of investment knowledge and skill required at the outset of a Network will depend upon the degree to which the manager is expected to “process” investments and the amount of work individual members are able / willing to take on. This will depend on the nature of the initial members, and may well evolve over time. The following sets out the range of training that we have delivered in the past, depending on specific network needs and available time:

  • Day-to-day operation of the network.
  • Member recruitment & relations.
  • Deal flow management.
  • Investment screening evaluation and post pitch processes.
  • Managing the membership (including how to get rid of inactive/disruptive members!).
  • Building and maintaining the network culture
  • Developing a suitable ongoing training program for the network Angel members.
  • Meeting structures / timing / format.
  • Public relations
  • Getting investments done!
  • The development of various documents and guidelines including (LINC have an extensive library of examples which we will share):
    • Investment screening criteria.
    • Confidentiality agreements.
    • Guidelines for presenting companies / “standard” pitch decks.
    • Scoring criteria for investment opportunities.
    • Term sheets and other legal documents.
    • Due diligence schedules and process documents.

 

Building a viable angel organisation does take time and resource. Given that the prime source of funding for new high growth potential businesses, and the associated economic benefits, are organised angel groups it is appropriate for government to invest in ensuring their viability and effectiveness.

Do we know what a Business Angel is anymore?

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The conventional definition of a Business Angel has been:

“an individual investing their own capital in an unquoted business with which they have no prior (especially family) connection and to which they make a value-added contribution through active involvement in the business”.

The Global Entrepreneurship Monitor (GEM) survey has blurred the distinction between the ‘classic’ disinterested business Angel investment and kinship and affinity-based ‘family and friends’ money to the extent that no more than 10% of informal investment reported in GEM may meet the definition of classic Business Angel investment.

Local culture also plays a part, with Angels in some countries much more likely to form syndicates with family members, and to invest in business they have a family connection to.

The growth of Angel syndicates and equity crowdfunding has also thrown doubt on the continuing relevance of this definition.  Within European Angel networks, groups and syndicates (and those of other countries outwith the USA) a large proportion of members seem in practice to be relatively passive in terms of both the investment process and post investment support of investee companies. Most of the “work” is done by a small number of “Lead Angel” investors. This, at least in part, reflects the nature of many of the European Angels, who are often still in some form of full time employment and do not have the time to take on the lead investor role. It also reflects the growing number of individual Angels that are now likely to syndicate in any one deal. Too many for all of them to be particularly active in the process[1].

Angel investing is very much a personal activity. An individual voluntarily choses to invest their own money in companies they select.  It is extremely rare to find an individual who is a full time Angel investor (some individuals are full time Angel group / network managers), so the activity is typical practiced on a (very) part time basis, and could be likened to a “hobby”. Angel investing is often also referred to as “informal” investing, and this combination of self-motivation and determination within an informal framework is often a key attraction to individuals to become involved.

Angel investors also have varying motivations. Many Angels do not have profit maximisation as their principal motivation. They may simply like being involved in the process, or being part of the Angel club. As a result, it would be inappropriate to suggest that there is one “correct way” to be an Angel investor, and attempt to enforce a rigid training structure on all. Just because an investor does not adopt a particular technique or strategy does not mean that they are a “bad investor”.  For example, while many would recommend Angel investors mitigate their high risk by having a large portfolio of investments (and this advice is likely to form part of an Angel training program), if the investor is investing for largely non-pecuniary reasons they likely, and to them rationally, don’t care about optimal portfolio sizing. If investors are not trying to maximize their financial returns, then there is no reason for them to have large portfolios. Some may specifically want smaller, concentrated portfolios because they enjoy working closely with the entrepreneurs or just want to invest locally so that they can give back to their community.

The traditional, “western” definition of an Angel is increasingly being diluted – and this is a good thing. It allows more individuals to be comfortable bringing increased amounts of capital to fund new and expanding ventures.

[1] Bridget Unsworth who manages the New Zealand Angel Co-investment Fund estimates that as few as 5-7% of Angels in groups are truly active Angels.

How Do Angels Deal with High Risk Investing?

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Angel investors make decisions to invest under conditions of extreme uncertainty. Angel investors face cases in which uncertainty is so extreme that it qualifies as unknowable: they decide on investments in ideas for markets that often do not yet exist, and they propose new products and services without knowing whether they will work. For experienced Angel investors rather than being undesirable, unknowable risks are deliberately sought, on the basis that it is by investing in companies with unknowable risks that they can find the most attractive, most profitable investments.

Experienced Angels do not seek to maximize each decision but instead seek potentially extraordinarily profitable opportunities and accept a high failure rate. They rely on building a large portfolio to spread risk and accept that the overall failure rate, by number of investments, may be as high as 70%, even in the most developed capital markets[1], with 85% of all returns coming from just 10% of investments made. They are willing to accept that most of their investments will be total losses.

A key role for “training” therefore needs to be providing nascent Angels with an understanding of the characteristics of the Angel market, tactics to deal with the high risk, and thus confidence to join with others in making their first investments.

Experienced Angel educators suggest that individuals new to Angel investing tend to seek out training on subjects such as valuation, looking for the “correct” valuation method or formula, reflecting a desire to reduce uncertainty (and perceived risk). In practical terms valuation training will likely highlight that there is no “right” answer, instead presenting a number of different methodologies, and suggesting that several should be used in each case and the results compared, but that local comparatives are likely to be the most significant influencer. Many of those new to investment struggle with this lack of a definitive answer but gain confidence when they see that all Angels face the same issues.

[1] 2016 Angel Returns Study, Angel Resource Institute, 2016.

Angel Decision Making – How do they get to Yes?

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Reading the available  academic research and discussions with experienced Angel investors suggest that “technical” subjects (valuation, financial modelling, technical due diligence) play a relatively limited role in the overall decision-making process, significantly due to the lack of “hard facts” in so many aspects of an Angel type investment. It is not a formalistic driven process. There is no proven formula for success, and no hard data to put into a formula should one exist.

Rather, decision making is based on a mix of technical analysis and intuitive assessment (what Angels frequently refer to as their “gut feeling”), with recent research suggesting that intuitive assessment is favoured over technical analysis[1].

The typical Angel decision making process begins with a subjective assessment as to whether the investment is likely to ‘fit’ with their personal investment criteria rather than a technical analysis. This may include location, amount sought, knowledge of and interest in the sector, and their own ability to add value.

Experienced investors rely heavily on their prior experience and previous investments to inform their present decision making and typically prioritize their intuitions about the entrepreneur over process and “hard fact” (e.g. business viability data).  Finance, in terms of the financial structure of and projections for the venture, is the most important criterion for both nascent and novice Angels but ranks only fourth for experienced investors[2].

The Learning Process

Investors who may now be classified as experienced consistently said that initially investing with other, and then more experienced, Angels had been their most valuable source of learning.  A number added that they had learnt more from failed investments than successful ones!

This suggests that the most effective way to improve the skills of new Angels is through engaging with experienced Angels in actual real investments. How do they get that engagement? Join an existing, active local Angel group, attend their meetings, help with the due diligence and join in a few syndicated deals.

 

[1] Managing the Unknowable: The Effectiveness of Early- stage Investor Gut Feel in Entrepreneurial Investment Decisions, Laura Huang and Jone L. Pearce, Johnson Cornell University, 2017.

[2] Heuristics, learning and the business Angel investment  decision-making process, Richard T. Harrison, Colin Mason & Donald Smith, 2015.

Nelson at the Peru VC Conference June 2017

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A fantastic experience talking at the Perue VC Conference – Amazing people and a fantastic location for the event

“Investor Ready” is not enough

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While numerous enabling programs exist, offering services in business planning, technical development, market analysis, financial forecasting, etc., few enabler managers or entrepreneurs have been through the fundraising process.  As such, most “Investor Ready” programs fail to prepare entrepreneurs for the actual capital raising process.

Entrepreneurs are left facing various challenges, including:

  • Inability to identify an appropriate source of capital
  • Lack of understanding of common investment instruments
  • No understudying of, or preparation for, the investment process. What happens after a pitch?
  • Misalignment of priorities between the investor and entrepreneur
  • Limited knowledge on due diligence requirements
  • Misalignment of structure and valuation
  • No focus on the exit event for investors

The lack of preparation and ability to effectively engage investors contributes to a perception of poor quality “deal flow”, which is a hindrance to attracting individuals to become Angel investors, or to consider investing in certain locations.

Additional training is needed to help prepare companies not just to be able to pitch to investors, but to prepare them for the investment process – screening, due diligence, valuation, deal structuring, the content and impact of the legals, and critically, the post investment relationship with the investors. Such sessions should also help to break down the barriers resulting from lack of trust some founders have in potential investors, a lake of trust significantly resulting from a lack of understanding of the process.