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| MIT Prof. Antoinette Schoar |
It has long been argued in entrepreneurial circles
that having professional venture capitalists invested in your deal at an early stage adds significant value to the entity
going forward. But what about angel investors?
Do they add value? Do they diminish value?
Many institutional VC’s have taken the position that angels don’t add incremental value to a deal, and
that a deal funded by angels may actually carry a handicap into its future. VC’s readily point to potential fights over
dilution with each succeeding investment round, expecting angels to prefer a slower growth strategy and to resist future venture
financings. Many VC’s also fear that angels may become overly protective
of founding entrepreneurs, delaying their replacement or augmentation by professional management teams when the time is right.
Well, there is
good news now for both founders and angels. Angels really DO add value to startups! In a new academic working paper, William Kerr and Josh Lerner of Harvard, and Antoinette Schoar of MIT, have joined together to report on their Kauffman
Foundation funded study of the influence of angel investors on the future prospects for startups. While highly technical in nature, the paper is very creative in its analytical approach to studying the
question. The authors plowed through hundreds of deals presented to two major
angel investor groups, one on each of the two coasts of the US, and they very cleverly chose to compare the future success
of two otherwise very similar cohorts of companies. One cohort was comprised
of those companies who pitched their deals to the angel groups, but who just barely failed to garner enough votes from the
angel group members to obtain their funding. The second cohort was similar to
the first in all other respects, except that it was made up of those companies that just barely made it through the angel
group vote and were therefore funded. By limiting their study to these two cohorts
(clustered so closely together around the “discontinuity” of the thumbs-up or thumbs-down vote), the authors eliminated
the obvious problems of comparing the clear winners against the clear losers. Their
intent was to isolate the subsequent effects of the angel financing event itself from all other possible variables separating
applicant companies (e.g., IP strength, management experience, market size, product viability, etc.). About one fourth of the deals in the two cohorts were in the bioscience or healthcare area.
The results of
the study are remarkable. Startups that received angel funding were 27% more
likely to survive for at least four years (the length of the study database). Using
website traffic as a very rough surrogate for the success of these otherwise non-comparable ventures, the angel funded deals
showed an improvement of 39% versus their non-angel funded brethren. While the
analysis shows no statistically significant difference in the ability of the startups within the two cohorts to access VC
funding later down the road, when the authors considered all angel funded deals against all of the deals where the angels
had declined (i.e., not limiting their analysis to the cohorts near the discontinuity line), there was a 44% higher probability
of securing subsequent VC investments for the angel funded companies. In fact,
angel funded deals closed an average of 3.8 more follow-on financing rounds than the non-angel funded control group. Thus, according to this study and contrary to popular belief, having angels in a startup
early on doesn’t seem to hinder a firm’s ability to attract major venture capital funding later. The caveat here for all these study conclusions is that the authors only examined investments made
by very large angel groups on the two coasts, and presumably these groups included entrepreneurs and executives with significant
experience in, say, bioscience deals. It thus remains an open question as to the value contribution of smaller,
less experienced angel groups. But still, the authors' results are really noteworthy!
In this troubled
time for the VC community, angels are more active than ever. They’re getting
a look at potential startups that were previously snapped up right out of the university labs by VC’s before ever being
exposed to the angel community. Meanwhile, as discussed in my previous blog postings,
VC’s have been forced to avoid most startup funding, instead retaining as much dry powder as possible for follow-on
investments into their favorite portfolio companies during these lean times.
For entrepreneurs,
angels are one of the first places to go for equity money these days. According
to the Angel Capital Association, there are some 300 recognized American angel groups, comprised of an average of 42 high net worth member angels in each
group. The typical group invested a total of about $2 million spread over an
average of seven new deals each year. That works out to be about $300k per deal. While probably too modest an amount for a typical biopharma startup, this is enough
capital to give a nice kick-off to a capital efficient medtech or diagnostics venture.
And some of the larger angel groups can go as high as $1 – 3 million for a really attractive opportunity.
So founders, give
angels a shot! They’re really fun to work with, they can make decisions
on your proposal very quickly (often in a matter of just a few weeks), and they can provide access to lots of free expertise
and valuable contacts from within their ranks. And now you know something else: They aren’t likely to hurt . . . and they may, in fact, help . . . raise subsequent
financing from VC’s.
You can send
your comments to me at: Reed@MackinawBio.com
 
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