The benefits include superior deal flow (both numbers and quality), the chance to diversify (instead of investing £100,000 in one business, this can be spread across several businesses alongside co-investors) and sharing the experience and knowledge of other investors in the group when appraising investments and also in providing post-investment support to investee businesses.
The need to invest via groups arises from the contraction of the venture capital industry. In the past angels could pass on to venture capital funds those businesses in their portfolios that needed further rounds of investment. However, this is no longer possible as there are few venture capitalists willing to invest less than £5m. Most angels who invest on their own are not financially able or willing to commit several rounds of funding to an investee business. This puts them at a significant dilution risk. But the collective financial strength of angel groups can provide the “deep pockets” needed to make follow-on investments. Indeed, two-thirds of the investments made by Scottish angel groups are follow-on investments.
This development has had a number of benefits for the entrepreneurial ecosystem.
First, it has stimulated the supply side. The attractions of investing as part of a group have attracted high net worth individuals who would not have considered investing on their own.
Second, it has enhanced the efficiency of the market. Solo angels are largely invisible and hence difficult for entrepreneurs to find. However, angel groups are, for the most part, visible and so easy to approach, for example via a website. Groups have also opted for professionalised routines to smooth the investment process.
Third, angel groups are filling the finance gap created by the breakdown in the traditional funding escalator and which extends from £250,000 to £5m. Angel groups are becoming part of “bundled” deals in excess of £500,000, investing with other angel groups, specialist investors (eg. The Carbon Trust), crowdfunding platforms such as Syndicate Room, and government Co-Investment Funds. And by making follow-on investments, entrepreneurs are not faced with the lengthy and risky process of seeking new investors each time they need to raise a new funding round.
Finally, angel groups can provide better post-investment support because of members’ collective breadth of knowledge and experience.
But there are also potential downsides. First, there are concerns that angel groups will morph into venture capital funds or fund managers and hence lose the valuable, distinctive features of angel investing. A related concern is that groups will become dominated by passive angels putting pressure on the band-width of the manager and active angels. This is likely to result in groups making fewer, larger investments.
Second, there is the danger of group think and convergence around particular practices and processes, making it harder for ideas from leftfield to attract investment.
Third, angel groups have overheads – notably salaries of managers and administrative staff – that they need to recoup from the investment process by charging fees to entrepreneurs. This raises the cost of raising capital.
Finally, it slows the investment process. Solo angels could make rapid investment decisions because they were not answerable to anyone else. However, angel groups typically have a manager who performs a gatekeeping role on behalf of the group members. A key function is making the initial screen of investment proposals, assessing them both in terms of their intrinsic merits and their likely appeal to members. Angels only get to consider those investment proposals that get past. But group managers screen investment proposals in ways that are subtly different to that of individual angels. Developing a pitch that appeals to both mangers and angels is a fresh challenge for entrepreneurs in this new of angel investing.
Colin Mason is professor of entrepreneurship at the Adam Smith Business School, University of Glasgow