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Something Ventured
April 21st, 2006
On The Wings Of Angels
“And to her that means nothing,
But to me it means everything.
She talks to angels,
Says they call her out by her name.” – Black Crowes, She Talks To Angels
Venture Capitalists invested US$1.6B in companies in Canada and US$21.7B
in the US in 2005. While we busy money managers have been doling out
this capital to companies that we hope will become Google or Skype
someday, we are dwarfed in size by another class of investor: the individual.
Aaaah, the angel. The most important cog in the investment cycle. Without
the angel, the VC would be forced into earlier stage, riskier investing. The
supply of angel fed companies is mainly what VCs feed on. How big is the
angel investment though? Who counts this stuff? It took me all of 3 mouse
clicks to find the VC data… but angel data, very tough to find.
Let’s try and compare apples to apples for a minute. Take that US$23.3B in
VC investment in North America and subtract about 40% of it, which went
into Series B, C, D, E rounds of financing in established companies. In other
words, remove the large chunk that individual investors do not participate
in. In round numbers, VCs (the “professionals”) invested about US$14B in
comparable round funding (seed and Series A). According to the Centre For
Venture Research (http://wsbe.unh.edu/cvr/) at the University of New
Hampshire (the only place that actually tries to count angel investment in
the US), angels in the US doled out a whopping US$23.1B in 2005.
Interesting
In Canada, a few cursory efforts have been thrown at counting angel
investment, the most quoted being the GEM (Global Entrepreneurship
Monitor) studies that talk about “informal investment” around the globe. It
states in a 2004 report
(http://www.gemconsortium.org/download.asp?fid=365) that total informal
investment in Canada is 1% of GDP, which would amount to $10B in total in
2005 (of our $1 trillion GDP). Even if you take out the 65% that GEM claims
is invested by the entrepreneur themselves (in sweat and credit cards), this
number is still obscenely high. The only credible counting of angel
investment has been done in BC and for BC only. This is due to securities
legislation that forced a lot of this normally “informal” investment to be
reported by “sophisticated investors” through investor exemptions and the
use of our VCC tax credit programs over the years. The result for BC is CDN
$355M (in 2004) by extrapolating the roughly 30% of angel investments
caught by this reporting mechanism. If we then factor that amount across
Canada using the average BC venture capital rate of 12-13% of Canadian
investment, we get a number more like US$2.3B for Canada, which is about
10% of the US angel amount and MUCH more believable.
So, angels invested US$25.4B in a year in North America. Wow. That’s a
1:0.95 ratio angel investment to total VC funding and a 1:0.55 ratio of angel
to early stage VC funding in a given year across North America. Of course
they invested in many more companies (roughly 50,000 for angels vs. 3,000
for VCs) and, as we all expected, spend less per investment. In round
numbers (because I am cramming together US and Canadian data which
may be collected very differently), angels invest $500,000 per company and
VCs about $5,000,000 in a given year (at early stages only, seed and Series
A). A couple of points on this math: 1) not all angel invested companies
receive VC financing (clearly some go out of business and others grow into
larger businesses without the need for VC type capital), so you don’t need to
worry about 47,000 companies a year perishing for lack of VC, although
quite a number of them will not survive. 2) Angel money tends to trickle in
while VC rounds are binary, so $500,000 a year per company is not really
what they are raising in angel investment in total, but the VC number of $5M
is a more indicative average amount of a financing at Series A stage
(because it lasts for more than a year).
Is a ratio of angel investment to total VC investment at roughly 1:1, a
healthy number for commercialization? In BC it is CDN$355M to CDN$248M
in 2004 (1:0.7), which indicates even more angel capital to venture capital
available than the North American average (probably partly due to the angel
tax credit program here and partly due to a lack of later stage VC
investment). Is the number of companies financed by angels at more than
10x the number funded by VCs a healthy ratio? I wish I had the number for
the Silicon Valley or Washington State to compare, but that information is
not available… at least without hiring the Centre of Venture Research for a
few thousand dollars! It would be very interesting to compare.
My interest in all these numbers is to try to understand the right balance of
capital needs to innovation to level of experienced talent that creates great
companies. As I have said before, if any of these is under or over abundant,
the equilibrium is wrecked and the industry as a whole suffers. Since angels
spend more money than VCs, don’t you think a little more analysis of how
and where they spend their money is warranted? I don’t mean just here in
BC, but everywhere? Wouldn’t it benefit angels themselves to know what
patterns of investment and what portfolios tend to work better for the big
payoff? Anecdotally, the “spray and pray” theory appears to be the most
favoured portfolio strategy. An angel will invest small amounts in many,
many start-ups over time and look for that 10-50x deal that comes along
once in a decade to make up for all of the other failures or wash-outs.
Everyone now knows the legend of Ram Shriram and Google. He made
about $2B on a $100,000 investment in 5 years. Let’s say Ram invested
$100K in 40 other ventures in that time, well $4M down the drain you might
say… but of course, you can’t bet it all on one deal when you invest sooooo
early.
Local angels have similar stories with Angiotech (doctors on the north
shore), ALI (Milt Wong and Paul Lee) and Datum Telegraphic (Haig Farris).
These were not quick hits and in the case of people like Paul and Haig, many
other bets were made on start-ups and ideas over the decade or so it took
them to hit it big. When Dick Hardt cashed out some of his earnings from
ActiveState and bought into Flickr, he had a very quick return by angel
standards, but it is not typical for the really big home runs in angel
investing. Most angels will tell you that the greed factor is not the only
driving factor behind making these risky investments. A huge part of the
decision process is based on the love of technology, great innovation and
good people to put money behind. It’s almost a feeling of giving back to the
community. A lot of technology angels were entrepreneurs and engineers
themselves and feel a camaraderie with the starving start-up folks. That’s
the reason that you have your head scratchers sometimes when you see
very smart angels make investments in weird stuff. It happens.
I believe there is another route to good returns for angels and that is
through investment in companies that may not need the big capital raise
from VCs. These are smaller, regional businesses and or service companies
that need <$1M in capital to get going. There is no less risk in the
businesses executing, but they are quicker to customers and revenue than
heavy development companies and the financial risk (the risk of raising big
money) is not there. A smart program of investing in these types of
businesses might work. Take IronPoint for instance. I mentioned them a
few months back as another example of a company making it big without VC
investment. Lo and behold, they are acquired this week by Active Systems,
the same company that bought Class Systems a couple of years ago. Angel
investors in IronPoint did very well.
It goes without saying that the angel plays a crucial role in the ecosystem of
the start-up. I just added some numbers to the argument that shows how
crucial. Angels are shy about giving data. Nevertheless, some more data
would help understand the business of informal investment.