Why Entrepreneurs Need Angels - And How Angels Are Improving

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Many people assume that venture capitalists provide startup funding. But that hasn't been the case in the last decade - VCs usually step in with growth funding, after a new firm has proven itself to some degree... By Angie Chang (Co-Founder & Editor-in-Chief, Women 2.0)

Here is an interview with Marianne Hudson, executive director of the Angel Resource Institute about the importance of angel investors to early-stage entrepreneurs:

Angel investors, or simply "angels," are high-net-worth individuals who provide money for startup firms with growth potential. Often former entrepreneurs themselves, angels can bring value to new firms through mentoring and industry connections as well.

Angel investing was long done in an informal, isolated fashion but is now becoming more systematic and organized in a quest for higher quality. The Kauffman Foundation has been helping to advance this work — notably through the founding of the Angel Capital Education Foundation.

Marianne Hudson, who directs the Kauffman Foundation's activity in this area, talks about the opportunities and challenges.

Why does the Kauffman Foundation care about angel investing? Marianne Hudson: Our guiding principle is to use education and research to create the best possible environment for high-impact entrepreneurs to start and grow their businesses. Angels invest in innovative entrepreneurs. Moreover, they do so at the crucial stages where the ventures are just getting off the ground. In fact we estimate that angels are responsible for up to 90% of outside equity (i.e., money not from friends or family) in startup and early-stage firms.

Many people assume that venture capitalists provide startup funding. But that hasn't been the case in the last decade - VCs usually step in with growth funding, after a new firm has proven itself to some degree - and recently it is even less true. In the past three years, less than 3% of venture capital funds have been invested in startups.

The result is a large capital gap for entrepreneurs who need more than $100,000 but less than $2 million to get their businesses started.

Angels, particularly those who invest through groups, are beginning to fill that gap.

While the angel investing community is vital, it has its challenges. Most individual angels are very private, which contributes to the inefficiencies of early-stage equity markets. Also, some angels, despite their own entrepreneurial experience, may not be very sophisticated investors. This limits their helpfulness and can even get in the way of additional funding. More than one entrepreneur has not been able to attract venture capital or other growth financing because an angel investor proceeded in ways that made the firm unappealing to follow-on funders.

The Kauffman Foundation wants to address these issues by providing education about the angel investor processes and systems, and by gathering and analyzing data regarding the impact of angels on the economy and various communities.

What has happened to angel investing in the last decade? Marianne Hudson: Like all investors, angels have experienced ups and downs, particularly through the high-tech bubble and its collapse. However in the last two years, angel investing has been on the increase. In 2004, it is estimated that angels invested more than $20 billion in new ventures, a significant rise from 2003.

While data on angels is hard to collect and verify, some experts estimate that their investments have been equal to or greater than the amounts of venture capital invested in the United States during most recent years.

What are the current trends in the field? Marianne Hudson: One big trend is the formation of angel groups. These are typically regional; they help angels in a given area to network and collaborate. The number of such groups has quadrupled since 1999, to about 200, and every month the Kauffman Foundation hears from several communities that want to start new ones. Within angel groups there appears to be a growing focus on developing excellent investment processes. Some local groups have begun cooperating with others, in order to better fill the capital gap.

A few states are now developing tax incentives to promote angel investing, along with education programs for angels and entrepreneurs and support for angel groups. In general, too, angel investing is becoming more known through media coverage. Ideally this all will lead to the provision of more - and higher quality - resources for startUp entrepreneurs.

What is the Kauffman Foundation doing to capitalize on the trends and advance angel investing? Marianne Hudson: Our focus is on using education and research to raise the sophistication of individual angels and angel organizations. The groups offer several advantages: they're more visible to entrepreneurs; they help investors learn from each other; and they facilitate larger, pooled investments.

That's why the Kauffman Foundation initiated its angel investing initiative. This initiative, which began as the Angel Capital Association (ACA), was the first umbrella effort of its kind in North America. It has used its educational influence to help start and strengthen numerous regional and specialized angel groups.

These groups are already reporting positive results — such as reduction in the time needed to start a new group and improved administration, operations, and investment practices. These efforts have educated and benefited thousands of people as evidenced, in part, by the list of angel groups whose members have participated in the Kauffman Foundation's angel education programs.

The Kauffman Foundation is also educating individual angels through "The Power of Angel Investing," a workshop on the key components of the craft. The workshop is conducted in fifteen to twenty communities per year; it has educated thousands of angels since it was introduced four years ago. Finally, we're working on building robust data on angel investing and supporting research in the field.

What are the Kauffman Foundation's plans for the angel investing initiative going forward? Marianne Hudson: The Kauffman Foundation has decided to establish an independent 501(c)(3) organization, which is called the Angel Capital Education Foundation. It will continue the seminars, summits, publications, and other educational and research programs begun at the Kauffman Foundation, but with ongoing support from Kauffman and from others. Being independent will allow the new organization to expand its reach and influence considerably.

Some of the people who have been affiliated with these educational efforts have also decided to create a separate, nonprofit professional association for groups of angel investors that will focus on bringing angel groups together for knowledge exchange, networking, collaborative efforts, and the development of best practices and professional standards.

This separate organization will retain the name of Angel Capital Association. This restructuring will better support taking the angel group investing industry to the next level.

In addition, there are three other areas for the Kauffman Foundation to work on in the coming years: 1) develop more information and education for entrepreneurs, so they better understand angel capital and are prepared for attracting it; 2) through education and mentors/role models, get more women and minorities involved as investors and stimulate investment in women- and minority-owned firms, which are extremely underrepresented in the equity financing arena; and 3) increase university understanding of early-stage equity as it relates to innovation.

This post was originally posted at Kauffman Foundation.

Angie Chang co-founded Women 2.0 in 2006. She currently serves as Editor-In-Chief of Women 2.0 and is working to mainstream women in high-growth, high-tech entrepreneurship. Previously, Angie held roles in product management and web UI design. In 2008, Angie launched Bay Area Girl Geek Dinners, asking that guys come as the "+1" for once. Angie holds a B.A. in English and Social Welfare from UC Berkeley. Follow her on Twitter at @thisgirlangie.