The origins of angel investing

I was recently reading Angel Investing: Matching Startup Funds with Startup Companies–The Guide for Entrepreneurs and Individual Investorsand it got me to really think about early stage finance from a historical perspective. The perspective adds a lot of insight into why people are angel investors and what the affect on our society is. Often, returns from venture capitalists into early stage companies are reported and these returns are what shade the view of possible angel investors. In a 1999 study, Mason and Harrison found that angels have a much smoother return profile than venture capitalists do. Surprisingly, not much has changed in how VCs operate today, and the same goes for angel investors. The media does talk about those top tier VCs as being the winner takes all firms, but angel investing doesn’t have the same profile.

Since the late 1980s, a growing pool of individuals with moderate wealth have been adding early stage investments to their portfolio. Regardless of whether they are the orthodontist, the real estate flipper, or the middle manager at Boeing or Microsoft, the number of these private investors with truly moderate wealth have been investing in the local economy for over three decades and we are seeing a shift in who is allocating capital from the venture capitalists to the individual investors at the early stage. Many micro VCs or investment partnerships are being built as well as steady growth within the existing network of angel groups. These individuals who used to be lovingly referred to as “Aunt Agatha” and “The rich Uncle” have transcended those nametags and are now providing enough capital for startups to truly get off the ground.

What is incredibly fascinating is that this slow shift in our economy to allocate more capital to more entrepreneurial endeavors is what has continued to fuel our economy. Mainstream media and markets like to gripe about employment, but what is often missed is the structure of that employment (yes there is a category for government workers and so on), but the structure in terms of what size companies are doing the hiring should be more prominent. during the time-span 1979 to 1995, Fortune 500 companies lost more than four million jobs, yet 24 million jobs were created in the entrepreneurial economy. During that time new business creation rose 200 percent (in comparison with a 17 percent population growth). That is an incredible rise in the affect entrepreneurs have on our economy and it hasn’t slowed down since that time frame.

The history runs much deeper in our society though, in 1874 Alexander Graham Bell used angel money to found Bell Telephone. In 1903 Henry Ford used a $40k investment from five angel investors to launch Ford Motors. In 1977 Apple accepted $91k from a single angel investor to grow. Heck even the Golden Gate Bridge was financed by the angel investor A. P. Giannini after the architect spent 19 years searching for funding. Angel investing and angel investors have been a critical component to the growth of the US economy and the standard of living we enjoy today in our society. Fast forwarding to today, investments by angel investors in the sharing economy, investments into AirBNB or Uber are continuing to change the way our economy functions just as angel investments have done throughout time. Buying shares of stock on the stock market don’t have this same affect, investors buying shares of corporate ownership there are buying them from some other investor, like a used pair of jeans from the thrift store, those shares are well worn and none of the money spent on those shares makes its way back to the company. Those dollars don’t do anything to help that company grow. Direct investment into private companies, where you are buying shares directly from the company is a completely different story. Like a new pair of jeans, most of that money winds up in the pockets of the business you are investing in and that money can be put to use hiring staff, purchasing equipment, and everything else that is required to grow.

So who are these angel investors? There is no real standard profile of an angel investor, I’ve interviewed and spoken with hundreds of angel investors and none really have a similar profile. The majority, not all, have a college education. Many have had success in their own entrepreneurial endeavors and many have also had success as a middle manager at a larger company. This is true anecdotally as well as in a number of surveys that have been taken over and over again since the 90s. In one of those studies in the 90s, Freear, Sohl, and Wetzel looked at how much of their wealth do these angels allocate, 46% allocate 10-24% of their overall net worth to angel investing, while 26% allocate a smaller percentage and 28% allocate more. The fascinating thing is that those numbers seem to be higher than most of the recommendations I hear from people (the most often restated recommendation is 10% maximum); however, after interviewing so many angel investors, I can see anecdotally that many allocate more than 10% and would suspect that in reality 10-24% gets allocated over 10-20 years of investing in early stage companies even though many of those angels start out investing under 10% of their net worth.

So what are some of those returns like? That angel investor who put $91k into Apple received a return of 1,692x their investment (yes $154m). Thomas Alberg received a 260x return on his Amazon.com investment turning $100k into $260m. These are huge returns on just one or two of the investments in an early stage portfolio. You can see why investing in 29 losers at $100k makes sense if the 30th investment returns more than 30x. You can see the drastic difference in the return potential Andrew Filipowski received a 48x return on his Blue Rhino investment (yep, the propane company). Ian McGlinn received a 10,500x return on his Body Shop investment. The returns are all quite varied and aren’t exclusive to tech investments. These are just the types of returns that occur with such small high growth companies if they are successful (remember many fail). It is this high growth that grows the number of possible jobs in the economy.

What is incredibly interesting is that the returns mentioned above are for angel investors, yet because of poor transparency, we don’t have great numbers to offer the media and the press around angel investor returns. The ARI, Kauffman foundation, and Nasdaq want to fix that problem though. If you’re an angel investor and you haven’t filled out the 2015 ARI returns study now is a great time to do so, this will help all angels understand their relative returns better and add value to portfolio allocation decisions.

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