Josh Lerner of Harvard Business School and Antoinette Schoar of the MIT Sloan School of Management are two of the foremost scholars on finance and entrepreneurship. In recent years, the two have teamed up for a series of studies on what they call the “neglected segment of entrepreneurial finance”—angel investing.
How are angel investors neglected? In their report released today by the think tank Third Way, Lerner and Schoar write that venture capital has vastly overshadowed angel investors in the realms of academic research, policy initiatives, and popular discussion. Partly, that’s because VC has been so successful: in 2014, 63% of market capitalization in the U.S. consisted of VC-backed public companies. But the total size of the American angel investment market has been the same size as the VC market for the last decade (until the recent focus on large VC investments in unicorns). Last year angels invested an estimated $24.6 billion into 71,000 companies.
So why is angel investing so neglected? Data on angel investors, it turns out, is very hard to come by. Most angel investments are made on an individual basis, so they’re not subject to regulatory disclosures. And few have studied the characteristics of individual angels – although the new “The American Angel” study is working on that – angels please take the 10-minute survey. Plus, the records of companies applying for angel funding are typically kept confidential.
After years of persistent digging and number-crunching, Lerner and Schoar have opened a window into the inner workings of angel investor groups. And the information pouring out shows exactly why angels deserve more recognition. I came away from reading the report with four conclusions that everyone involved in startup finance should know:
- Angel groups have significant advantages over individual angels: Increasingly, angels are coming together in semi-formal networks. Pooling their funds allows them to spread out the costs of expensive due diligence on startups applying for funding. Acting as a group projects more visibility to entrepreneurs. And when sophisticated, active investors combine their expertise, it makes for better decision guidance for the startups.
- Firms selected by angel groups get a tremendous boost: For one study, Lerner and Schoar accessed the records of two of the biggest angel groups in the country, Tech Coast Angels in Southern California and CommonAngels (now called Converge Venture Partners) in Boston. The researchers compared companies that won funding from these angel groups with very similar companies that applied for funding but were denied. The results: funded firms were 20-25% more likely to survive for four years. Funded firms were 16%-19% more likely to have grown to 75-plus employees or achieved a successful exit during the study period. On average, funded firms had 16 to 20 more employees. And they were 10-17% more likely to have a successful exit.
- Some angel groups actually outperform venture capital: Lerner and Schoar write that because angels aren’t professional investors, there is sometimes concern that their decisions are suboptimal—that they’ll choose companies for likeability over profitability, for example. Not so, according to the data. When the authors compared the VC industry with one of the angel groups, the one with the highest returns was…the angel group. (Pardon my “woo-hoo”!)
- Angel investors add value all over the world: In another study, the authors compared angel investor groups internationally. This one was particularly interesting. The researchers gathered records of 13 angel investment groups based in 12 nations with financing applications from 21 nations. Across countries, the study showed that angel investors don’t just pick the right firms, but that they also improve the growth of the firms funded. For example: “Start-ups funded by angel investors are 14%-23% more likely to survive for the next 1.5 to 3 years and grow their employment by 40% relative to non-angel-funded start-ups.”
You can’t read this scholarship and come away with anything other than appreciation for the role of angel investors. But Lerner and Schoar end their report with a word of caution on the angel model in the crowdfunding space. Because the success of angels is so rooted in close, hands-on relationships—the jury is still out for online funding groups that don’t provide support in addition to funding. Only time will tell if they will have the same success. Still, some platforms for accredited investors, like AngelList, are experimenting with models that allow a few select investors to provide direct guidance. And those are experiments well worth continuing.
Here’s hoping more policy makers will look into angel investing and work on policies that support the creation of more and more sophisticated angel investors in their communities and the nation. Policymakers who neglect angel investing do so at their economic peril.