A normative definition that I use as a recovering angel investor myself is that an angel investor actively helps a seed stage startup succeed with both mentorship and capital in exchange for those intangible benefits of mentorship and a return on investment. In World Bank parlance, then, they automatically provide both investments and technical assistance with no agency costs; a great recipe for solving multiple problems (funding capacity, entrepreneurial capability and access to early stage finance) in a cost effective way. Knowing that 318,480 of them invested $22.5 billion on 66,230 ventures in the US and achieved 27% annual returns forms the basis of our hypothesis that angel investing could work well in the developing world.
$1.5 billion Untapped Funding Capacity
There are 11 million high net worth individuals (HNWIs) in the world controlling an investable wealth of $42 trillion. 20% of HNWIs hail from the developing world (~$15 trillion). We know that US angels comprise roughly 10% of HNWIs in the US (out of 3.35 million in 2012) and invest about 0.2% of their investable wealth ($11.4 trillion in 2012). Share of the investable wealth going into angel investing increased by 12.1% in 2011 reflecting growing comfort in the asset class despite contraction in total investable wealth and currently matches the venture capital funding in the US. Ultimately, a very crude supply-side math translates into $1.5 billion potential early stage investments in the developing world. There is no research on the level of angel investing in the developing world, but infoDev’s experience in the field points to evidence that we are nowhere near this potential.
Increasing Entrepreneurial Capability
In our minds, angel mentorship is more important than funding. After an angel makes an investment, his or her participation in the venture—through mentoring, coaching, financial monitoring, and making connections—is significantly related to that venture’s outcomes. An active angel realizes 7x returns versus an inactive one. Successful angels also engage actively with pre-investment startups (60 hours due diligence yields almost 6 times the returns than 10 hours due diligence). It is not easy to do such quality mentorship unless there is a practical match and of course investors whose investments match their industry expertise realize twice the return.
Increasing Angel Investment Capability
One of the more efficient ways for individual investors to increase their capability is to be part of a community or network and learn from peers in action. Formal networks have other benefits such as diversification through angel syndicates , and ability to work with other syndication partners (co-investment funds, venture capitalists, etc.). infoDev’s experience with functioning angel networks in Chile, Turkey, Jordan and South Africa is that the limiting factor is the project match between angels and startups rather than lack of capacity or capability. Adding new angels into the community with different backgrounds therefore increases both the funding capacity and investment capability of the community.
Some Controversy and a Way Forward
In my mind, it is easier to teach “term sheet” mechanics and other investment capability skills to entrepreneurs and other business persons who have already been successful in the past so that they are now “principal” investors and capitalize on their willingness to help startups than to convince venture capitalists and other types of “agent” investors to consider financing and mentorship at a much riskier and lower capital stage. Likened to “black swan farming” by the founder of wildly successful Y Combinator, Paul Graham , I like to think about seed stage investing as behaving per laws of quantum physics versus even early stage investing as per Newtonian physics: a whole lot of strange phenomena happening that can only be grasped by different frameworks. It is no wonder that the outdated “fund management” model fails miserably to bring returns at seed stage. Catalyzing and finding ways to work with angels and angel networks provide one such different framework. Among many examples, I would like to highlight our recent catalyzing of the Lagos Angel Network which has been profiled by the Economist. It took proverbially a single match to light a fire which will hopefully cascade into an inferno of funding and mentorship. We hope that apart from convening them intelligently and providing training, education and other “kindle” material, we also bring global opportunities to our Nigerian colleagues and their portfolio companies.
Crowning these “push” technical assistance interventions would be our “pull” co-investment fund designed specifically for the most mature and experienced angel networks. Dubbed as Early Stage Innovation Financing facility (ESIF), it will help us co-investing with angels. I believe this would be beneficial for them (increase their capability and diversify their capacity), their companies (increase capacity), and us (virtuous recycling of returns at best, and subsidizing ecosystem benefits at worst). More on ESIF in another post.