Angel Investors: Replacement or Fixture? –

There are many who now regard angel investors as a permanent part of the venture capital landscape, a group of individuals willing to take risks that big traditional venture capital cannot afford to. But they may be in for a disappointment.

Fundamentally, angel investing is no different from traditional venture investing, with the same level of expectations. But unlike standard VC, angel investing is more personalized and labor-intensive. And totally unscalable.

As VC has become more bureaucratized and risk-averse, the real mission of venture capital – investing in innovation and entrepreneurs – seems to have been usurped by individual investors, popularly termed angels. Indeed, if you believe the buzz, angels are the only ones currently investing in innovative ideas and early-stage companies, while most VCs are busy licking their wounds or pretending to be workout investors and merger specialists.

The truth may be a little more textured. Yes, VCs are staying away from investing in ideas and technology that take long to produce products and even longer to generate sales and profit. And yes, individual investors – many of whom were lucky enough to cash out of their Internet investments – are stepping into the early-stage capital gap. But large-scale angel investing may have been a phenomenon driven by the Internet and the go-go stock market rather than a fundamental shift in the venture capital process. As the initial public offering market has collapsed and venture capital for early-stage companies has dried up, so has the level of angel activity. Stories of angel-backed companies floundering because their angel investors have backed away are commonplace. More significantly, many angel-backed companies have found it difficult to attract new investors because the deals they struck with their initial backers were too complex or too rich. There isn’t much left for a new investor.

Over the last few years, the Web has become the lightning rod for much of the burgeoning angel activity. Scores of portals have been launched to bring entrepreneurs together with angels. Groups such as – read Guy Kawasaki – and Offroad Capital received the same kind of publicity given to such incubator companies as CMGI Inc. and Internet Capital Group. But these sites generated more publicity than capital. In 1999, for example, these Web-based matchmakers are estimated to have raised less than $50 million for their entrepreneurs, an Angel Society report states. Last year, that number was rumored to be even lower.

What portal owners quickly discovered was that it was easier to put together listings of individuals who wanted to invest and entrepreneurs who wanted money than to get money to actually change hands. Entrepreneurs who turned to angels for money were those already turned down by VCs or with deals that weren’t investor ready. And these Web sites simply couldn’t provide the tools to advance the process. More important, many potential investors simply froze when it came to consummating a deal.

To be sure, angels are no newcomers to investing in entrepreneurs. When in 1938 World War I flying ace Eddie Rickenbacker wanted capital to launch Eastern Airlines, it was Laurance Rockefeller who acted as the angel investor. And it was Rockefeller again in 1938 acting as an angel to fund the start-up of McDonnell Douglas. Since then, many successful entrepreneurs have acted as angels to fund ideas and businesses in which they themselves had some special knowledge and expertise. Real angels are specialists of sorts. They invest heavily with their time and money and expect the same level of returns as traditional VCs. And while the total extent of angel capital in the economy is a matter of guesswork and hype – the Small Business Administration puts it as high as $35 billion – there is no doubt that angels are a legitimate source of equity capital. (The SBA’s notion of angel capital might include all non-institutional individual infusions of capital into businesses, equity as well as debt.)

But in recent years, it seemed any individual with a bulging wallet wanted to play angel, lured no doubt by the easy path to IPO and subsequent returns. As the IPO market weakened and the dreams of a quick score vanished, many simply abandoned their investments and walked away.

Still, angels are here to stay. There are plenty of successful entrepreneurs who have successfully exited the firms they started and don’t want to return to another start-up or join a venture capital firm. And many of them, such as former Digital Equipment Corp. co-founder Harlan Anderson, Rolm Corp. founder Ken Oshman and Netscape’s Communications Jim Barksdale, have gone on to finance ideas and provide valuable enterprise-building ideas to their investments.

Expect similar successful entrepreneurs to continue to play the mentoring and investing role they have been playing. But, don’t expect angels to replace the capital and the role that traditional venture funds provide.

Udayan Gupta is the author of Done Deals: Venture Capitalists Tell Their Stories.