Failure™ Magazine

Fool’s Gold?

Debunking the myths of angel investing.

Written by Jason Zasky   Filed under Business

What are angel groups? That’s a relatively new term, isn’t it?
Angel groups are groups of people that get together to make angel investments collectively. Sometimes members do due diligence together then invest individually; sometimes members evaluate deals together and invest in the same companies. Some are very formal, where the group may be structured as a fund and people pool their money into the fund. Then the members of the group make an evaluation, and if it’s positive the fund puts money into the company.

Angel groups haven’t been around that long. Most experts think the first group was the Band of Angels, which dates to the 1990s. The number of angel groups has been growing rapidly. But I suspect in 2008 there will be a decline in these groups—or at least the rate of growth of these groups—because of the economy.

There are a couple things about angel groups that tend to make them better performing angel investors. First, because of disclosure reasons with the SEC [Securities and Exchange Commission] it’s very difficult to have an angel group that isn’t restricted to accredited investors. So the groups are made up of wealthier and more sophisticated investors. Another thing is that collectively people are more diversified because each person can put a little bit of money into multiple companies. They can also share expertise, and that collective action helps individuals to be better investors.

What would you like entrepreneurs to take away from your book?
First, you want to avoid believing the myths about the specialness of angels. There is a tendency to believe that angels are “smart money” and that friends and family are dumb money. The reality is that there is a lot of variance among angels. Some are smart money but many aren’t, and the typical one isn’t all that different than the typical friend and family investor. As a category, you don’t want to consider angels to be special. You just want to find a good angel.

Second, you want to understand what angels really look like so you can find them and understand what they are looking for in companies.

Lastly, realize that the decision making of angels is haphazard and involves human biases. It’s important that entrepreneurs remember that these are human beings making decisions for very human reasons and there can be all kinds of idiosyncratic behavior.

What would you like potential angel investors to take away?
One thing is to be realistic, to understand what people typically earn from investing in start-ups. If there’s one thing that the current financial crisis has shown people it’s the problem of unrealistic expectations. If you think the stock market is always going to go up 10 percent a year and it doesn’t, you are going to be very unhappy. If you think the typical angel investment is going to return an internal rate of return of 30 percent per year, you are going to be very disappointed unless you are really lucky.

Another thing is to understand what motivates people to invest. Are they doing it because they care about making money, or because they want to work with entreprenuers or help their community? Understanding why people do this will help you recognize what kind of company you might want to invest in. If you think you are doing things for one reason and are actually doing them for another you could be very disappointed with the outcome.

Finally, if your main motivation is to make money it’s important to know how the small number of people who make a lot of money at this activity tend to do it, so you’re doing it right.

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