Fortune Magazine SPECIAL FEATURE
Despite a recession that has venture capitalists running scared, angel investors are pouring millions into fledgling companies. Here’s why.
Fortune Small Business
Thursday, October 17, 2002
By Anne Field
For six years, Steve Jablon funded his company by any means necessary, selling his house, car, and even his Rolex watch. But last year he realized he needed a bigger cash infusion if he wanted to expand Advanced Ultrasound Imaging, a maker of diagnostic ultrasound equipment. So, over a five-month period, the Scottsdale, Ariz.-based entrepreneur made presentations to five branches of the Gathering of Angels, an angel-investor group. The marathon effort worked: He raised about $600,000 from 20 different investors. “People understood our concept. We were lucky,” he says.
Perhaps. But, while luck had something to do with Jablon’s success, there’s at least one other factor at play: Despite the volatile economy and declining stock market, angel investors are still at it. In fact, although venture capital has gone into hiding, especially for new companies, investments from wealthy individuals have not. The total amount available has dropped, but the decline is peanuts compared to the decline in funding from VCs. Venture financing for early stage companies decreased from $3.3 billion in 1999 to $800 million in 2001, according to a PriceWaterhouse Coopers/Thompson Venture Economics/National Venture Capital Association Money Tree survey. But investments by angels have increased from about $40 billion to $30 billion during that time period, according to Center for Venture Economics in Durham, N.H.
Plus, there’s lots of activity among the approximately 150 organized angel groups in this country. In late October, for example, representatives of 30 to 40 associations plan to meet at Stanford University to consider forming a national organization. And new structured angel groups, in which members pool their money in a sort of mutual fund, continue to start up; there are now about 12 in the U.S. “Angels are still slugging away, just with a little less spring to their step,” says John May, managing partner and co-founder of several angel groups, including New Vantage Group, Investors’ Circle and Private Investors’ Network.
At the same time, the party is nothing compared to what it used to be. Investors are less likely to put money into the deals they’re considering than a few years ago. Investments by individual angels are smaller. And pure startups are having a harder time.
Why the continued interest? In part, it’s thanks to the ailing market. Angels’ portfolios have declined so precipitously that many are looking for alternative investments. Funding new companies seems to make as much sense as anything else. Jim Duffie, an Atlanta mortgage broker and one-time entrepreneur, made his first investment as an angel when he put $30,000 into Jablon’s company this summer. “When you look at the risk, it’s not that much greater than in the open market right now,” he says.
While angels are still writing checks, the amounts are smaller, however. The total amount invested per deal was $95,000 in 2000, compared to $50,000 in 2001, according to Center for Venture Research. Duffie, for example, had intended at first to make a $100,000 investment in the company. But, when the value of his portfolio plummeted by about 75% over the four-month negotiation period, he was forced to take a more conservative tack. Or look at Mike Franks. The managing director of Goodman’s Angel Investor Network, a new Toronto-based angel group, and an angel himself, Franks has invested in four companies over the past four years. But, thanks to his concern about tying up money in an illiquid asset, Franks has dramatically reduced how much he invests, from $100,000 four years ago, to $20,000 last year.
With money tighter, entrepreneurs can also expect an audience that is considerably more skeptical. The average time angels spend conducting due diligence has increased from three months in 2000 to four months today, according to Franks. “They’re more cautious with their investable dollars,” says Tarby Bryant, who runs The Gathering of Angels in Santa Fe, N.M. Meaning: A business must show not only a strong management team, but a reputable board of advisers, accountant and lawyer. Plus, there’s a greater focus on how much and how strong the competition is. Last year, for example, Simon Algar, a Phoenix-based angel, backed away from investing in a financial services processing company when his research uncovered too steep a competitive barrier. “There’s no point pouring money and time into something surrounded by vigorous competition,” he says. One consequence of this increased scrutiny: a drop in the actual number of deals. The yield rate, or the number of deals funded divided by the number of proposals seen, dropped from 24% in 2000 to 11% in 2001, according to Center for Venture Economics.
Ironically, another result of this increased scrutiny is that more angels are looking at companies with a track record and shying away from pure startups. “A lot of angels won’t invest money unless the company has some cash flow coming in the door,” says Algar. In fact, some are even considering public companies. Albuquerque-based Cell Robotics was founded 12 years ago to sell medical work stations and went public in 1995. But, when recently appointed CEO Gary Oppedahl wanted $1.5 million to start selling a new laser-based medical device for drawing blood, he realized he had to go elsewhere. So, he started making the rounds of angel groups. “A few years ago, this might not have been something I’d consider,” he says. “Now it is.” He’s in negotiations with several interested investors.
Still that’s not to say no startups are getting money. Boston-based Common Angels, for example, a 55-member group, hasn’t changed its focus on software startups since its founding three years ago. Last year, members invested a total of $7.2 million in 11 companies. Says managing director James Geshwiler, “There are as many different ways of investing as there are angels.” That’s more than you can say about venture capitalists these days.