Robert Ochtel’s Blog

An Experienced Approach to Venture Funding

Many Angel Groups Have “Cheapened” the Reputation of Traditional Angel Investors

Traditionally, a typical angel investor was a high net worth individual that had success as an entrepreneur, by starting their own company, being successful in the market, and then continuing their profitable private operations, going public or selling out to a third party.  These traditional angel investors had real entrepreneurial experience and the required insight to what it takes to develop an idea, bring it to market on their own, and fight through the trials and tribulations of a successful start-up company.  In addition, as a result of their own entrepreneurial business success, these same individuals often used their financial resources to help other entrepreneurs, by investing a significant amount of their own monies in early stage companies and mentoring the development of these same companies.  These traditional, entrepreneurial-based, angel investors were risk takers that had earned their stripes through the school of hard knocks by having gone through many of the same trials and tribulations of a typical entrepreneur and at the same time had real start-up experience to draw upon when mentoring their start-up company investments. 

During the last 20 years, a new angel investment structure called the “angel group” has developed across the United States and the world.  Here, bands of individuals, in many cases, with little or no entrepreneurial experience, invest small amounts of their individual members’ monies, aggregated as a group investment, into these same start-up companies.  In many cases, this angel group investment structure has “cheapened” the reputation of traditional angel investors – opening the door to many individuals with little or no start-up experience, who claim, by virtue of investing a small, insignificant amount of their own money, to be experts in mentoring entrepreneurs and their start-up companies. This article outlines my reasoning for this opinion and provides a basis for this discussion.

“Accredited Investors” – A Very Low Bar for Entry

Most angel groups, due to Security Exchange Commission investment rules, require their investors to be “accredited investors”. This accreditation has nothing to do with personal entrepreneurial experience; it is purely a financial measure providing a basic assurance that an individual has the financial resources to risk their own monies in a high risk type of investment.  At the same time, his accreditation is also used to protect this same angel group against future legal actions pertaining monies lost on these same high risk investments.  This SEC accreditation requirement, in its basic form, looks at the individual investors, their spouses, and their financial resources in determining if they can take realistically invest some of their monies in high risk investments, with a minimum peril to their overall financial well being. 

As defined under the R-501(a) of Regulation D of the Securities Act of 1933, an accredited individual investor must meet at least one of the following guidelines:

  • A natural person whose individual net worth or joint net worth with that persons spouse at the time of the purchase exceeds $1,000,000,
  • A natural person who had individual income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 in each of the two most recent years and has a reasonable expectation of reaching the same level of income in the current year.

To most entrepreneurs, the above criteria may seem like a high bar to pass for individuals looking to participate as investors within the structure of an angel group. But in fact, the first criterion, as outlined above, is a very “low bar” for many potential group-based angel investors. This individual net worth criterion includes an investor’s home, and therefore in states such as California, where home values often exceed $1,000,000, this criterion is easily met by many individuals who wish to become an angel investor within an angel group.  Therefore, many individuals with no entrepreneurial start-up experience have the financial capacity to be an “accredited investor”, as defined by the Securities Exchange Commission.

 $10,000 to $25,000 – An Insignificant Investment Often with Little Additional Value

Most angel groups require their angel investors to invest a minimum of between $10,000 and $25,000 per individual start-up company investment.  For start-up companies that are looking for up to $1,000,000, for their first round of third party investment, this is really an insignificant amount of money, as measured on an individual basis.  In addition, for these same individuals, who meet the above outlined SEC criteria, this investment, again is a small amount of their net worth (e.g. $10,000 is 1% of a $1.0M). So, the amount of risk that these individual angel investors are willing to incur, as part of an angel group, is insignificant.

Beyond their financial commitment, in many cases, these angel group-based investors are often retired individuals who are looking for something to do to occupy their time, and at the same time, have something to discuss during cocktail parties or while they are out on the golf course.  With their individual investments being insignificant amount of their total net worth, if they make a return on this nominal amount of money, fine, if not, well they are not out much money anyway and they can write their investment off on their taxes. This type of angel group investing, while low risk for the investors, often yields little additional value, beyond the initial amount of cash for the entrepreneur and their start-up company, as many of these same investors are not really involved in their investments, do not know the market space, and as a result cannot add significant value beyond their individual minimum financial investment.

Where is Your Start-up Experience?

Many of these same individual, angel investors that participate as part of an angel group have little or no personal start-up experience.  These angel group members are not entrepreneurs by nature, or through personal experience. In many cases, these angel group investors are ex- corporate lawyers, bankers, accountants, etc. that have worked for large corporate enterprises their whole professional careers and have, through their safe career paths, accumulated enough assets to become an accredited investor members of a given angel group. These same individuals have never started a company, met a payroll, nor have they taken on any significant personal or financial risk in their whole lives.  They, more often than not, have lived within the protected “cocoon” of a corporate enterprise and have been successful in a very narrowly defined “job” scope.  But, often, it is these same individuals believe they have the necessary experience and business savvy to direct a start-up company through the trials and tribulations of their development. This does not make sense to me. With only their large corporate enterprise experience to draw upon, it is impossible for these same these angel group investors to provide real world based entrepreneurial advice to their start-up company investments. 

Entrepreneurs, Beware of the Angel Group “Dog Pile” Experience

 Many of these same angel groups are headed by individuals with strong personalities and opinions, but little real world entrepreneurial start-up experience.  In addition, many of these same individual angel investors, due to their lack of experience with start-up companies, are “followers” throughout the start-up company due diligence process and do not add any significant value.  These individuals often follow the lead of other strong personality members of these angel groups and as a result entrepreneurs often experience uninformed or undue criticism from individual investors within these same angel groups. The result is that, many times during due diligence review meetings, one of the lead members, with a strong personality, exposes a potential hole in the entrepreneur’s business plan and all of the follower investors “dog pile” on with more uninformed criticism. This results in an insulting experience for the entrepreneur and a resultant bad reputation for the angel group.  The lack of understanding of the difficulty of starting a company and personal real world entrepreneurial experience, from the individual angel members, can really expose the personality of an angel group and give entrepreneurs a “stay away” attitude toward a given angel group.

“Pay-to-Play” Angel Groups

Today, there are many “pay-to-play” angel groups out there. Here, the individual angel group members may or may not pay annual dues to become members of a given angel group. At the same time, the organizers of a “pay-to-play” angel group work to find investment opportunities for their angel group investors.  These investment opportunities are typically presented to the members of these same “pay-to-play” angel groups on a monthly basis.  Here, it is the entrepreneurs that pay $1,000 to $2,500 per angel group review meeting, in a given city, to present their company’s business plan in front of a group of potential angel investors.  More often than not, the entrepreneurs who are presenting do not know who, or how many potential investors are in the room.  In addition, the inherent problem with this “pay-to-play” angel group business model is that these same angel group investors do not get the best companies to present, only those that have the immediate financial means to “pay-to-present”. Therefore, by definition, they may not get the best start-up companies with the highest potential returns for their invested monies. This seems like an inappropriate angel group business model to me, and is, at the same time, very expensive for the entrepreneurs, with no guarantee of receiving any investment monies. That being said, there multiple angel groups in the market that use this business model.

 Many Angel Groups “Think” They are Venture Capitalists

One final problem with many angel groups is that, by virtue of their investment monies, they think they are venture capitalists and often treat the entrepreneurs very poorly.  With their limited financial resources, and more often than not limited network of contacts or experience in angel funding, they expect the respect, equity positions, and stock purchase agreements that the venture capitalists typically get for making much more significant financial investments.  They forget they are in reality inexperienced early stage investors that are looking invest in and then get their start-up companies ready to receive the next level of investment funding, from this same professional venture capital community.  Today, this venture capitalist mentality is too often prevalent among angel investment groups. This can make the angel group funding an unpleasant experience for these same entrepreneurs.

As outlined, angel groups in many cases provide an alternative for individuals, who make insignificant investments, incur minimal risk, and have little or no start-up experience to invest in early-stage, start-up companies. This type of group investment structure provides a funding avenue for entrepreneurs that was not available 20 years ago. This group angel investment structure, through its diverse membership, varied backgrounds and experience, deviates significantly from the traditional single angel investor, with a proven entrepreneurial background and significant real-world start-up experience.  As outlined, the result, in many cases, is that this angel group structure has “cheapened” the reputation of traditional angel individual investors and provided a funding experience that may be difficult at best for individual entrepreneurs.

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May 18, 2009 - Posted by | Angel Group, angel investors, Venture Capital, venture finance

3 Comments »

  1. This article makes a number of good points that are consistent with my experience in dealing with angel groups. The composition of most Angel groups in New England is heavy with professional service providers and relatively light on true entrepreneurs.
    However, in my contacts with venture capitalists I also run into very few individuals with an entrepreneurial past. Most VC’s I meet are former consultants and investment bankers who – just like your description of Angels – have never worried about how to make payroll at month’s end. They are more or less the same individuals playing on a full-time basis a game similar to the one Angels play on a part-time basis. The one difference is that sometimes they have more sector experience than the Angel groups do.
    The bigger problem I see is two-fold: (1) VC’s are following fads and compete heavily in a narrow sector of investment opportunities while ignoring many other sectors and (2) the returns in venture funding seem to flow to the late rounds, when late investors with lots of money to invest impose terms that divert the value created by early investors (and founders) into their own pockets.
    In an industry where most VC’s want to invest like LBO firms and where early-stage investors distrust late-stage investors, entrepreneurs become distrustful of Angels and VC’s and look towards strategic investors. Unless the VC industry (angels and institutions) finds models that more equitably allocates returns commensurate with risk (i.e., to the early rounds) and overcomes its fascination with “fads”, it will become a side show in financing of new technologies.
    Add-on acquisitions of technology probably have never been as cheap as they are today.

    Comment by Christoph Knoess | May 18, 2009 | Reply

  2. Exceptional insight Robert – I truly appreciate you efforts. Your blog is a valuable learning tool for both entrepreneurs and investors, I will continue to spread the word.

    Comment by Greg George | May 19, 2009 | Reply

  3. Given the deficencies outlined in this fine post, it seems that the processs could be simplified greatly.

    Why not let anyone risk up to 5% of their net worth without all these regulations? If any fool can go buy a $40,000 automobile just based on their credit, what’s the harm in letting the average Joe invest in a venture, as long as he or she has legal and CPA representation?

    Considering that the car will likely end up in the junk pile in 8 or so years, and considering the well publicized abuses on Wall Street – and the ineffectiveness of regulators, the experienced gained by novice investors might make for a more informed electorate – one that is more appreciative of the risks that entrepreneurs take in order to fill the coffers of the tax collectors.

    Comment by Bill Scaglione | May 21, 2009 | Reply


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