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Angel Funds – The Devil is in the Detail

Nate Lentz
April 18, 2011

I love the role that Angel investors play in the formation and early funding of early stage ventures.   Individual angels are pretty much in every deal we do.   In most cases these angels represent friends and family of the entrepreneur who have bet on the idea and on the individual.  This is the easiest money for a new venture to raise and can be the hardest on the founders as the entrepreneur sees these people all the time.   Great motivator!

We also invest after or along-side angel funds.  These are groups of high net worth individuals who want to invest in a portfolio of early opportunities and who want more structure and more expertise than they personally have.  These groups have structured leadership, deal flow processes, investment committees, and effectively leverage specific domain expertise of their members.   Many of these groups are a pleasure to work with.

One thing we have seen when working with these angel groups is that structure matters – for us as co-investor and even more for the management of the company.   The distinction comes down to angel funds versus angel networks.  I support the angel fund concept.   I think the angel network concept goes stale beyond extremely early stage investing.  Here is a real world example.

One company in our portfolio has multiple angel groups who have invested millions of dollars over the last several years.  One is an angel fund and one is what I will call an angel investing club.   The angel fund has commitments from its members and invests as an entity – one investment amount, one reporting structure.  This fund’s members commit to an investment level, an investment focus and a process.   Capital calls occur much like a venture fund.  Reserves are kept on all investments.  The only difference versus a venture fund is that no one is full time and that there is no carry or management fee given that the investors do the work.

The angel investing club is a different beast entirely.  This group looks at companies as a group, appoints a lead, but in effect each individual makes an independent investing decision.   This means each signs individual documents, each is a shareholder of record, and each is solicited for shareholder votes.   Each round of investment has a different set of names – some old ones don’t participate, some new ones do.   A director may be selected to represent the group but the director cannot speak for the group and how it will vote as investors.   This creates a myriad of challenges for the CEO, especially as time goes on and multiple rounds of funding take place.  These include:

  • Logistics challenges which create time consuming and more costly processes and which slow down rapid action by the company.
    • It is challenging to have several dozen individual shareholders who are represented by leadership but who act as individuals
    • CEOs often need to hold separate Angel Club investor meetings to pitch a group of what should be informed inside investors
  • Behavior of the crowd means broad emotional swings and mixed participation by round makes for difficulty in long-term thinking
    • Having many people in for $5k – 20k in a deal means that when a deal is exciting, the momentum is strongly positive.   When things get challenging, individuals leave it to others to figure it out.
    • With each round having different mix of Angel Club investors, no round is truly an “inside round” and typical venture behavior like bridging a company to an exit to protect invested equity becomes a challenge
  • Angel Club investors do not invest with reserves.  As a venture investor, we like to invest alongside entities that can support a business through a challenging period by having adequate reserves and a culture of multi-round investing.
    • Angel Clubs do not have formal reserve structures and need to resell the angel club members on every financing.

At Osage, we value Angels.  Friends and Family angels are critical and often continue to invest alongside our capital in later rounds.  Angel Funds with structured capital commitments are tremendous participants in the early stage capital eco-system.   We look forward to seeing more of them as the Angel market continues to gain in sophistication.    More and more informal angel groups are adding formalized structures which make them easier to co-invest alongside and which make them easier for a CEO to consider as investors in his or her company.  This is a very welcome change from our perspective.  When it comes to Angel Investing Clubs – loose affiliations of people connected by a common investing interest – we will continue to be extremely wary when considering an investment where such a club is a co-investor.   The mettle of an investor is determined in challenging times and in such difficult times, a club can become a mob.