2010, angel funding totalled $20 billion into 61,900 companies compared to $23 billion of VC funding into 1,012 companies. The average amount of money raised from angels was approximately $300,000, compared to nearly $23m from VCs, which shows that angels are much more important than VCs at the smaller end of the market.
Technology dominates the type of venture backed but where the investment is made varies widely from year to year. For example, in 2010 investments in healthcare rose to 30% (from 19% in 2007) and investments in software were down to 16% (from 27% in 2007). In the USA, Silicon Valley businesses account for the lion’s share of all angel investments and in the States there are more than 250,000 active angels.
In the UK a 2009 research report ‘Siding with the Angels’, published by NESTA (an independent body with a mission to make the UK more innovative), concluded that business angels have grown in importance in the UK since 2000. The percentage of all early-stage deals with angel involvement increased from 16% in 2000 to 41% in 2007. Indeed, the report concluded angels are often the only source of capital at the smaller end of the market. The report estimated that there were between 4,000 and 6,000 angel investors in the UK with an average investment size of £42,000 per investment.
In contrast, the UK Business Angels Association (UKBAA) said on its website in 2012:
“an estimated £850m per annum is invested by angels annually in the UK. This is more than 2.5x the amount of venture capital invested in early stage small businesses annually. Whilst it is also estimated that there about 18,000 angel investors around the country, there is a need for more individuals to become business angels to provide finance to meet the needs of the growth potential entrepreneur”.
Obviously there is disagreement in the figures here and I do not have an explanation for the discrepancy in these two estimates of the market size. Suffice it to say, however, that the UK angel market is large and growing.
There is no doubt that tax advantaged schemes, developed over many years by successive governments, have been a major factor in the growth of UK angel activity. In a 2011 Budget Commentary, NESTA referred to the impact of the Enterprise Investment Scheme (EIS, see Chapter 6) and stated:
“Since its inception, EIS had provided 48% more finance to early stage businesses than the VC industry; and
“EIS provided more funds than VC for amounts less than £2m. In 2006-7, for amounts up to £2m, EIS provided 63% more funding than the VC industry.”
The commentary also cited a survey in which 80% of business angels said they had used the EIS at least once. Notably, 53% of them would have made fewer investments without EIS tax incentives.
Angels and innovation
Innovation and the founding of new ventures are crucial to economic development because successful new companies create both wealth and jobs.
‘The Vital 6 Per Cent’, a 2009 NESTA report, highlighted the importance of the small number of fast-growing businesses that between 2002 and 2008 generated the lion’s share of employment growth in the UK. These businesses were in all sectors and included established firms and start-ups, small businesses and large ones.
A follow-on report in 2011 entitled ‘Vital Growth’ argued that high-growth businesses remain vital to the economy. However, it highlighted some challenges that such businesses face. In particular, they have both a greater need for capital than lower growth firms and, ironically, may find banking harder. Coupled with this, the report found there had been a sharp decline in risk capital funding in the UK since 2008.
Angels are an essential and growing source of funding to the smaller and younger members (and potential members) of this high-growth group because of the absence of alternative sources of equity capital.
Where angels fit within the financing spectrum
Investment by angels is a vital bridge between start-up finance from ‘friends and family’ and venture capital.
Friends and family
Ever since aspiring entrepreneurs have started new ventures they have needed money to pay for goods, staff and other things. It is a rare venture that does not need financial help in some way or other. The first port of call is usually the piggy bank – which is often empty – followed in short order by family and friends or, as the Americans jokingly call, it FFF (friends, family and fools).
Family and friends are excellent investors as they are loyal and helpful. Indeed, in some cultures it is common for families to work closely together in businesses that then manage without external help partly because salaries only get paid when there is money to do so.
However, many would-be entrepreneurs today have business ideas that cannot be developed without substantial amounts of cash and their families, however supportive, do not have sufficient money to help them beyond a very early point.
Banks
Having exhausted the support of family and friends, the entrepreneur naturally looks to their bank – or used to. In reality, though, banks have never been very helpful with early stage ventures. They want readily realisable security for the money they lend and firm evidence that it can be returned from the cash flow of the business. Many start-ups simply cannot provide this.
Having failed with their bank, the entrepreneur often next thinks, or used to think, of venture capital firms – an institutional rather than personal source of equity capital – if only because they are easy to find.
Venture capital
The provision of venture capital in the UK evolved dramatically during the second half of the twentieth century.
In the 1970s, the principal source of venture capital in the UK was what was then called ICFC (now 3i). ICFC was started in 1945 with a government push and the backing of the then clearing banks. Its role was to provide long-term capital to private companies. ICFC dominated the market until the mid-1980s when independent venture capital firms (VCs) started to spring up like mushrooms.
These venture capital firms backed many start-ups and small ventures in the early days of the industry’s growth. Over time though most of the industry migrated upmarket to become today’s private equity groups because of the easier pickings. As a result venture capital for early stage companies became harder to find.
In contrast to venture capital, private equity groups typically buy – not back – existing large companies with predictable cash flows and partly use huge sums borrowed from banks to do so. They then hire new management who are incentivised with significant equity stakes.
The reasons for this are compelling from the private equity firm’s point of view. The large size of the deals means the management fees (1% to 2% on the capital raised from institutions) pay the private equity team fat salaries. Added to this are performance fees (typically 20% of profits made after the benefits – in good times – of heavy leverage from bank debt) that are also large on big and successful deals.
All of this means the private equity principals get rich provided they hire the right management to run their companies and the economy is stable so that leverage works for, and not against, them. The financial collapse in 2008 did, however, bring the risks of the highly leveraged deal into sharp focus.
Regrettably, today there is only a small and declining number of specialised venture capital firms who will consider investing in small start-up or early-stage ventures and they do very few deals.
Government-sponsored funds
Successive governments have expressed alarm at the decreasing number of VCs who make smaller investments. To counteract this trend, both the UK government and the European Community have sponsored a wide range of providers of equity capital for young businesses. Often, though, the availability of this capital depends on where