T-Net British Columbia: Home Member Login | Employer Login

A monthly column focusing on new and emerging BC publicly listed technology companies     Technology Futures:     December 22, 2008 By Michael Volker The Skinny on Angel Investing I thought it's time to write a column on what’s happening in the investing arena – specifically around so-called “angel investing”. This was prompted by reading a newly released book by Scott Shane called Fool’s Gold? – The Truth behind Angel Investing in America. Shane’s book provided me with some facts and stats that confirmed some of my intuitive and experiential conclusions about angel investing. I sold my company, a video display manufacturer in 1981 and I’ve been doing so-called angel investing ever since. I was surprised to learn how much “smaller” angel investing is than what many believe. What really surprised me, though, is that for once the grass is really greener on this side of the boarder. For that matter, from what I’ve been hearing from my colleagues back East, the grass is also greener here in B.C. than the rest of Canada. Another fact that really surprised me even more was that in the USA, the SEC (Securities Exchange Commission) allows only accredited investors to belong to angel groups. If that policy existed in Canada, our angel events would be sparsely attended. (“Accredited” means that you have to be a millionaire or be pulling in $200K in annual income). As Shane points out, the lion's share of angel investing is being done by non-accredited angels. I’ll summarize and comment on some of Shane’s findings. He comments that the “mythical” angel is a millionaire software entrepreneur who invests $250K in a startup venture for 10% of the equity. The company projects sales of $100 million in 5 years. The company achieves this and does an IPO (Initial Public Offering) at which time it is valued at $500 million. The angel, whose stake has since been diluted 50% by subsequent investment rounds, get 5% or $25 million – a tidy 100 times his original investment. This is the dream. So how often does this happen? Hardly ever. Actually, it almost happened to me. I love to tell my infamous RIM story (the Blackberry Company). In 1987 they needed $30K and offered me 15% of the Company. (Yes, I took the deal but we never closed. Long story.) So how does it really work? First of all, the good news is that there is a lot of capital available to companies from private investors. Supply exceeds demand. In the USA, about $23 billion is invested annually by institutional, venture-capital (VC) investors. The same amount is invested by Angels, a 1:1 ratio. I have trouble believing this ratio. My gut tells me that, relative to VC investing, angels place more capital. I believe this because it is so difficult to track individual investments. Here in Canada, I’m sure the ratio is much higher. I say this based on my own observations over the past decade and the fact that the VC pool in Canada is relatively smaller and very few investments by private investors are reported. Shane defines an angel investor simply as someone who invests his/her own money in a company owned and operated by someone else who is neither a friend nor family member. If you included friends and family members, the angel amount represents only 14% of the total investing done by angels and such informal investors. According to Shane, most angel investors are NOT accredited. In fact, 79% aren’t. Here’s a nugget: the typical angel investor invests only $10K (not the $100K or so that you’d expect) in a deal. How do the companies perform? How many become $100 million dollar companies. The truth will shock you: Only 0.5% hit $50 million in sales in their 6th year (this number is based on a sample of 8,849 startups of which 41 achieved this goal). Just take a look at the companies in the T-Net 100 list. There are only a hand full -11 to be exact - that can boast of sales exceeding $100 million and only 68 exceed $10 million. That's why investors are becoming wary of the hockey stick curve. For a pan Canadian perspective check the Branham 300 list. Only 41 Canadian tech companies have reached sales of $100 million and 163 have exceeded $10 million. It just isn't that easy! There are many myths about angel investing – especially how lucrative it can be. Nothing is farther from the truth. So what are the returns? Can you (or how can you) make money as an angel investor? The answer is yes, but it’s not as easy as you might think. Rob Wiltbank of Willamette University has studied angel investing. In an often-cited recent survey of angel investors in angel groups*, he concludes that the mean investment returned a 2.6X multiple in 3.5 years. On an annualized rate-of-return basis, that equates to 28%. Of course, it’s numbers like this that lure so many of us to the game. Where else can you get this kind of return? [*note: Angel groups in the USA comprise more sophisticated, industry-knowledgeable accredited investors who tend to work together and are more hands-on with companies in which they invest. They deliberately exclude non-accredited, casual and less well-informed investors.] However, Wiltbank notes that 40% of the angels he studied lost all their money! They invest not only their money but also their time. He notes that, on average, angels spent 12 hours/week helping their investor companies. Shane notes that the most successful, active, accredited angels that are part of a group with 15 years of experience, earn about 19% (after taking into account the opportunity cost of their time as well). While on the subject of returns, we often hear angel payouts expressed as multiples: “Hey, I got 10 times my money on that deal!”. Great, but how long did it take you? If it took 10 years, that’s “only” 26%. If it took 5 years, that’s 58%. How about 100 times your money in 5 years? That’s 151%. The “typical” expectation of an angel, according to Shane is to get 5 times in 5 years. That’s 38%. You get the picture. If you want to brag, use multiples – it sounds better than percentages. Shane makes a valiant, but somewhat futile, effort at guesstimating the performance of angel investments with respect to exits. After 5 years of founding, the median value of a start-up is far less than most believe. The median exit price for a company is only .68 times current one-year sales - less than the Angel Capital Association's rule of thumb of one times the pro forma revenue in year 5. He concludes that overall less than 1.5% of angel companies get acquired - a much lower figure than Wiltbank's representative sample in which he found that more than one-third (1137 out of 3097) of investments produced exits of some sort. How are the returns manifested? The lucky companies get acquired by other companies. IPOs are almost non-existent. It’s great to hear about stories like YouTube getting acquired by Google for $1.6 billion, but that’s nuts. In reality, exit values are low. Shane found that they run about 60% of a company’s revenue. What about valuations going into a deal? Well, the dot-com days are definitely dot-gone. Only 36% of companies were valued at more than $1 million – after raising their initial capital. The typical surviving start-up is worth only $204,000 in its sixth year. To get a better handle on M&A activity in the software industry, an excellent source of information are the quarterly M&A Briefings put out by the Corum Group in Seattle. Their 2008 Q3 report - an impressive 144 page document - states that 16% fewer deals were done in the quarter and dollar values were off by 36%. For what's considered the cream of the crop investments by successful angels, more than half - 52% - returned less than the capital invested. That's why I think that angel investing is like playing Blackjack as far as the odds of a payout are concerned – except that it’s less efficient and more agonizing. I love the casino game of Blackjack. I believe you can make more money (and faster) by going to Vegas to play Blackjack (or just stay at home and play in a local Vancouver casino) than you can by being an angel investor. In Blackjack, the house has a small advantage that can be pared down to less than a 1% advantage if you know how to play the game. Many years ago, I and my two business partners and our respective spouses were vacationing in the Bahamas. The six of us played Blackjack every evening just before dinner. The goal was to play as a team at one table, using the same rules and disciplines that we all agreed to, until we won enough collectively to buy ourselves a wonderful dinner. This worked well for five nights. It never took more than a half hour to reach our goal. On the sixth night, we weren’t so lucky. It took us until midnight to earn dinner – but we still did it. Even though some of us lost our money, the winners always won big and carried the team. By the way, knowing that we had close to even odds, the tactic we used was not card counting but simply money management – betting low when losing and betting high when winning – preserving our own cash and taking risks with the house’s money. Earlier, I stated that the key question is: Can how (or how can you) make money as an angel investor. The answer is: pooling with knowledgeable angel group(s). One of the best known angel groups is the Band of Angels in Silicon Valley. This group was formed in 1994 with 12 members. In 2006, they had 105 members who invested $7.2 million in 12 companies. Going back to the grass is greener point I made earlier, let’s compare this to Vancouver’s Vantec angel network: 50% of the companies that present at Vancouver’s VANTEC raise angel funds, which is a very high success rate The mean amount of angel investment reported by companies was $250,000 20% of presenting companies go on to secure venture capital, and the total amount raised since 1998 exceeds $200 million 85% of the 235 companies that presented at VANTEC (up to 2006) have continued to grow and prosper The presenting companies have created approximately 1,000 jobs since VANTEC’s inception in 1998. For a further comparison, our own WUTIF Angel Fund has 125 investors and has invested $5 million in 43 companies in just under 4 years - all in B.C. In the U.S., fewer than 2% of all angels belong to a group. In 2006, the Angel Capital Association reported that its 128 groups invested U$229 million in 512 companies. That makes us look pretty good here in B.C. It might explain why more and more U.S. entrepreneurs are pitching their deals here in Vancouver. But, but – what’s happening right now? Are angels still writing cheques? Admittedly, things are a little slow right at this moment due to the skittishness over the economy. Many investors are holding back because of their own liquidity issues, margin calls, and so on. But the smart ones are investing. The recent October, November, and December angel meetings have been surprisingly well attended. The savvy angels realize that this is the time to shop for some well-priced opportunities. However, the really savvy ones, those that are bin-there, done-that entrepreneurs also realize that a positive side-effect of the economic slowdown is the fact that human resources are more abundant – talent is more readily available, outsource providers are hungry, subcontractors are cutting their prices and wait times are greatly reduced. Shane raises the question as what role the (U.S.) government can play to bolster angel investing. He suggests that one major contribution would be to allow non-accredited investors to join angel groups. This would provide them with better deal flow and learn from accomplished angels. Again, the grass is greener here in Canada. We have no such limitations. Another suggestion he makes is that of offering tax credits up front to stimulate investment – since these apply to all investments - as opposed to capital gains tax breaks – which provide after-the-fact breaks only on winning investments. Apparently the U.S. Federal Government is looking at a 25% tax credit. Currently, 18 states offer tax credits ranging from 10 to 100% (guess where the 100% is? Let’s go to Hawaii!). But that doesn’t help too many investors because state taxes are fairly low to begin with. Greener yet, is B.C.’s 30% refundable tax credit scheme that’s as good as giving cash to investors. The only problem is that is has a budget cap. We could sure use some of those tax credits right now! In summary, it's tough - very tough - to make money as a lone angel. You can improve your odds by joining an angel group and investing through a fund or pooling with others. While the data presented by Shane should make us cautious, Wiltbank's numbers give us hope. For more information on angel investing in B.C., check out Basil Peter’s Angelblog and Bob Chaworth-Muster’s semi-annual Angel Forum and of course, the monthly Vantec Angel Network run by Thealzel Lee and yours truly and the WUTIF Angel Fund. It's about "TIME" Simon Fraser University's TIME Centre in downtown Vancouver recently expanded to SFU's Burnaby campus (Discovery Park) to offer incubator offices to entrepreneurs at both locations. TIME is an acronym for Technology, Innovation, Mentorship, and Entrepreneurship. It's more than just an incubator. Complete, ready-to-go furnished offices with high speed internet, servers, telephone and fax, printing, etc. are only the beginning. New Ventures BC, the Vancouver Enterprise Forum, the VANTEC Angel Network and WUTIF Capital all make TIME their home. Within TIME there is also the TIME Business Centre (a little like an airport business lounge but without booze) that is open to technology entrepreneurs and business people to use as a drop-in downtown office facility. Need to plug-in? Make some calls? Do some work? Hold a meeting? There are some great facilities for holding your company's AGM. Why hang out at MacDonald's when you can work productively at the TIME Centre? Drop by and check it out! It is located at SFU's downtown campus at 515 West Hastings St. You won't believe the price!  Check www.sfu.ca/time for info. Michael Volker, a technology entrepreneur, is Director of the University-Industry Liaison Office at Simon Fraser University and President of the Western Universities Technology Innovation Fund. He is a founder of the Vancouver Angel Network and past Chair of the Vancouver Enterprise Forum and past Chair of the B.C. Advanced Systems Institute. He owns shares in many of the companies he writes about. Copyright, 2008. What Do You Think? Talk Back To Mike Volker   Contact: mike@volker.org Tech Futures Archive B.C. High Tech Links