Angel investors, A concise definition and discussion

What are Angel investors? Definition and discussion

So-called angel investment arrangements have long been existing even prior to the popular use of the terminology. Etymologically, the term angel was ascribed to individuals who provided financial support in staging Broadway shows. It was in 1978 when William Wetzel, while in the pursuit of completing his research about sources of seed capital, borrowed the term and ascribed it to individuals who finance the early stage of businesses. After all, entrepreneurs felt as if money came down from heaven with the arrival of these seeming informal and non-venture capital investors.

Throughout the history of angel investment arrangements, angel investors have made notable deals that paved the way for the emergence of some of the largest and most valuable companies in the United States. The multinational computer technology and consumer electronics manufacturer Apple Inc. for example received funding and expert assistance from business angel Mike Markkula who poured in an investment amounting to $91,000 and exited with a value amounting to $154 million. The electronic commerce giant Amazon also received funding from business angel Thomas Alberg who invested an amount of $500,00 and exited with a value amounting to $26 million.

Definition: What are angel investors? Who are they:

In formally defining angels investors, Wetzel described them as individuals or groups who play a key role in providing seed capital for entrepreneurs and even inventors for startup and small technology-based companies operating within a high-risk capital market.

Separate studies from R. Aernoudt and H. Landstorm further shed light to the characteristics of this unique breed of investors. Accordingly, most, if not all, of these individuals have strong business backgrounds; including demonstrated entrepreneurial and managerial experience. They fall within the age range of 35 to 65—considered relatively young as they intend to see how their investments would make a difference although they are merely interested in minority stake and they are making amounts less than 25 percent of their assets allotted for informal investment.

In addition, most of these individuals sit on large wealth that they obtained from selling their companies or shares on highly advantageous terms. Angel investors are thereby individuals or groups of individuals who seek to make something out of their unused wealth. At the same time, these individuals and groups intend to share their expertise through whatever means. Their motivations may be triggered by wealth creation, finding something to do, and/or just plain helping aspiring entrepreneurs who possess necessary competencies and breakthrough business ideas.

Structure and regulation of angel investors

With regard to structure and functions, angel investors operate either as independent individuals or as angel groups. In his study, Yilmaz Bayer mentioned that individual angel investors usually form a group to have more discretion as regards the evaluation of proposed business ventures that are seeking financial support. These groups are relatively new. In the United States for example, organised angel investors first emerged during mid-1990s although individual angel investors have been existing way back. Nonetheless, the growing number of angel groups and networks further promotes organisation and formalisation.

Despite being an alternative and informal source of investments, angel investors still operate under a systematic fashion. According to Bayer, they follow a typical step-by-step cycle that include: (1) awareness of investment opportunity; (2) initial assessment and identification whether the proposed venture fits in their invest portfolio or area of expertise; (3) meeting with the entrepreneurs; (4) negotiations; (5) investments and provision of hands-on support or managerial advise; and (6) exit from the business through initial public offering or selling of shares.

Regulations of investments from business angels fall within various legal domains. In the working paper presented to the U.S. Government Small Business Administration by Dr. S. Shane, business angels do not have a fiduciary relationship to other investors and as such, they are usually not regulated by the federal government. In addition, this lack of fiduciary relationship allows these investors to use an array of financial instruments to include pure debt and pure equity. However, there are business angels who are regarded as accredited investors. Take note that the federal securities laws subject these accredited investors under the watchful eye of the Securities and Exchange Commission.

Economic importance of angel investors

The economic impacts of angel investors are worth mentioning. According to the study of Paul A. Gompers, these investors have paved the way for the emergence of small businesses and upstarts during the 1980s. It is important to take note of the fact that prior to this decade, large and established companies in the U.S. were starting to lay-off a considerable number of employees. By the end of 1970s, the continued downsizing of these large companies left millions of individuals without a job.

However, by 1980s, the role played by these business angels in financing small businesses and upstarts nonetheless reignited employment rate. By the end of this decade and with the arrival of 1990s, small businesses and upstarts—that most of the time, are more innovative than large and established companies are—have become the prime driver of growth in employment rate. As thousands of companies emerged, millions of jobs were created.

An empirical research conducted by D. Polis revealed that angel investors not only help individuals pursue their entrepreneurial visions by providing necessary funding needed to meet capital requirements, they also do so by adding value to the emerging businesses. To be specific, they add value by providing their expertise, competencies, and experiences needed to manage and direct the growth of startup businesses.

Further details of the study of R. Aernoudt are in the article “Business angels: Should they fly on their own wings?” published in the journal Venture Capital. More details of the study of H. Landstorm are in the article “Informal investors as entrepreneurs” published in the journal Technovation.

Further details of the study Bayer are in the article “Angel financing in early stages of company development” published in the journal International Journal of Economics and Finance Studies. More details of the working paper of Dr. S. Shane are in the article “The importance of angel investing in financing the growth of entrepreneurial ventures” published by the U.S. Government Small Business Administration.

More details of the study of Gompers are in the article “The rise and fall of venture capital” published in the journal Business and Economic History. More details of the study of Polis are in the article “Business angels and value added: What do we know and where do we go?” published in the journal Venture Capital.