The Lowdown on Angel Capital from CommonAngels’ James Geshwiler
For startup entrepreneurs who need less than $5 million in capital, the venture capital industry might as well not exist. The average U.S. venture capital fund has doubled in size since 2000 to over $200 million, according to Dow Jones/VentureOne. That means most venture partners see investments of under $5 million as a waste of their time, according to James Geshwiler, managing director of Lexington, MA-based CommonAngels. Only a gigantic return on such an investment would “move the needle,” or provide adequate returns, for such a large fund, Geshwiler points out.
And that’s what has created an opening for the angel capital phenomenon. As of 2008 there were 168 angel capital groups nationwide with more than 6,500 members, says Geshwiler, who ran a well-attended tutorial on the angel investing business at the last Web Innovators Group meeting in Cambridge on December 9. That’s up from about 20 groups when CommonAngels got started in 1998—and it doesn’t even count the thousands of non-affiliated angels. Most of them are wealthy individuals who are industry veterans or former entrepreneurs themselves, who like to invest relatively small amounts (usually on the order of $25,000 to $100,000), and want to be more involved in their portfolio companies than they would be if they simply became limited partners in venture funds.
Angel groups have helped to get hundreds of new ventures off the ground—including Xconomy, which is a CommonAngels portfolio company. These types of groups, like Tech Coast Angels in San Diego and the Alliance of Angels in Seattle, just to name a couple, work by assembling many individual investments to fill what Geshwiler calls the “funding gap” between the $500,000 and $5 million levels. Geshwiler tailored his overview of the angel industry for startup entrepreneurs working to launch small, pre-venture-funded startups, focusing on questions like how to approach angels, what sectors are most interesting to these investors, what levels of equity they usually expect in return for their investments. (Geshwiler has posted the PowerPoint deck from his presentation here.)
The “very nature of angel funding has changed tremendously” over the past 10 years, with the Internet having a big impact, Geshwiler says. Most individual investors “are not interested in letting the world know that they have money,” he says. But organizing into regional groups with their own websites has given angels a new way to filter proposals and function almost like mini-venture funds. (Xconomy’s other bureaus have seen a couple examples of this in action recently, with Redmond, WA-based Healionics collecting $2.6 million from a syndicate of angels in the Northwest, and San Diego-based MicroPower Appliance scoring an interesting round of financing from the Tech Coast Angels.)
Angels, like all other investors, have been hit hard by the financial crisis, with most seeing their personal portfolios shrink by 30 to 50 percent in the last year, Geshwiler says. But the good news, he points out, is that the risks involved in angel investing aren’t necessarily any higher than in the past—they’re just different. It may be harder these days for small, growing companies to obtain follow-on investments, but on the other hand, there’s less competitive risk as fewer companies enter each niche. That also makes its easier for small companies to attract and hold on to great employees.
“This is not our recession, it’s Wall Street’s recession,” Geshwiler says. “You guys [entrepreneurs] haven’t bought into the story that the economy is over. I wish we’d just get over all this hand-wringing.”
Angel investors are a good resource for many startup entrepreneurs because they’re typically future-oriented, backing companies that can reach exits in five to seven years, at a lower, more realistic, acquisition price than venture funds would require, Geshwiler says. And angels, in turn, like tech companies that require less capital investment to reach the break-even point. When that happens, their initial investments won’t be so diluted down the road by follow-on fundraising.
By the way, Geshwiler says he dislikes the term “angel,” even though the group he runs is called CommonAngels.”It’s a loaded term—it makes the investors sound too nice or too naïve,” he says. He prefers the term “individual investors,” and says the main thing that distinguishes this group is that they want the full return on their investments, sans the asset management fees kept by the managing partners at VC firms (which can be as steep as 2 percent of a firm’s committed capital per year).
But not all angels are alike. Citing a study by the MIT Entrepreneurship Center and Harvard Business School, he divides angels into a two-by-two matrix, with “industry experience” on the vertical axis and “entrepreneurial experience” on the horizontal. Some angels are in the lower left quadrant—low on both types of experience—and are mainly looking for financial returns. But most angels around New England, Geshwiler says, are in the upper right quadrant, with lots of both kinds of experience. The study called these folks “guardian angels”—people who “just sold their company, made a lot of money, and are bored with golf,” in Geshwiler’s words. They have the time and expertise to advise companies on getting through the tough startup years.
Speaking specifically about CommonAngels, Geshwiler said the group’s strategy is to put together investments totaling $1 million to $3 million, usually as part of a syndicate (a group of investors). The plan is to support companies that will need no more than $20 million altogether before they become self-sustaining or get acquired. The group focuses mainly on companies in the New England area that are exploring areas of information technology where the CommonAngels membership has some expertise, and that are likely to reach a “liquidity event” (an acquisition or IPO, in which investors cash out their stakes) within 5 years.
Entrepreneurs submit 30 to 60 plans per month to CommonAngels, and a screening team narrows down the submissions to between one and three that will be presented at the group’s monthly common meeting. For the companies that make the final cut, due diligence and term sheet negotiations are coordinated by Geshwiler himself and his co-managing director, Chris Sheehan. CommonAngels typically takes 25 to 40 percent of a company’s equity in the first investment round. That may sound like a lot, but founders tend to “get too worked up about that,” Geshwiler says. “The dilution in the first round pales next to what happens later,” he says.
While an entrepreneur might think they need a personal introduction before submitting a business plan to CommonAngels, things aren’t so formal, Geshwiler says. “People can submit to angel groups without a referral,” he says. “We all have LinkedIn, and this is not that big a town—figuring out who someone is usually takes only a click or two.”
Geshwiler left the budding entrepreneurs in the room with one parting piece of advice: try to get to break-even on your first investment round. “That doesn’t exclude raising more capital,” he says. “What it means is that you can walk away if someone offers you a lousy [acquisition] deal. It’s a matter of timing. We all want to build exciting companies—the question is how do we do it and not die in the process because the resources were not available on a particular day. I think as an entrepreneur, your best story to an investor is, ‘I can get by on the first round of money you give me, and I can build a great company on the second or third round.’”