Attitudes and behaviors of informal investors toward early-stage investments, technology-based ventures, and coinvestors

Abstract

Seed capital financing for new firms is important to the commercialization of business innovations. Yet few entrepreneurs have the personal resources necessary to finance very-early-stage ventures, and they often find themselves relying on external sources of seed capital. Their personal financial capabilities can easily become exhausted, and the venture capital industry represents only a partial source of needed capital for start-up and infant firms. In recent years researchers have “discovered” the individual of financial means who invests a portion of his assets in early-stage risk ventures. This individual is variously termed an “informal investor” or an “angel.” Following an initial study by Seymour and Wetzel in 1981, researchers have expanded the knowledge about the backgrounds, investment interests, and behavioral patterns of informal investors. The fact that informal investors generally invest within 50 miles of their homes or offices makes their participation in the entrepreneurial process particularly important for local economies. Our understanding of the general role of informal investors in risk venture financing has been greatly enhanced by prior studies. However, additional work is needed to identify characteristics of persons committed to start-up firms or to technology-based ventures, two especially important types of business activity in the regional competition for economic development. Fifty-five informal investors participated in a mail questionnaire modeled after prior studies sponsored by the Small Business Administration. Respondents differentiated themselves on a scale of very-early-stage (start-up) versus later-stage risk venture investments and on a scale of technology-oriented versus nontechnology-oriented investments. Informal investors in this sample also differed on the average number of coinvestors (including institutions) per investment. Implications arise from the study for individuals interested in regional economic development and for entrepreneurs seeking seed capital. First, persons more committed to start-up investing are more likely to have been (or to be currently) entrepreneurs themselves. Also, these individuals may not be the most visible community members in terms of past entrepreneurial success and acquired wealth. In fact, persons committed to start-up investing tend to have a lower annual income and lower net worth than persons investing in later-stage risk ventures. Individuals playing this important financing role are particularly hard to identify. A valuable key to their identification may lie in the fact that they tend to have worked (or currently work) in ventures similar to those In which they invest. Individuals committed to investments in technology-oriented risk ventures give very little information about their personal characteristics. However, they do indicate a considerable amount about their investment patterns. These investors play a higher-risk, higher-return investment game than do persons less committed to technology-based firms. Technology-oriented investors also report a number of actions that appear to help them manage the risks inherent in their Investment behaviors. Contrary to conventional wisdom about informal investors in general, technology-oriented investors use friends as referral sources less frequently. People more interested in technology-based ventures in the future look more to business service professionals—investment/business brokers and accounting/law persons— as referral sources. Finally, a person's pattern of coinvesting indicates that individual's orientation toward risk. A greater number of individual coinvestors in a typical deal is associated with a willingness to invest further from home, for example, and with a lower return expectation. Also, persons investing with a fewer number of different types of coinvestors (individuals and institutions) tend to have more personal entrepreneurial experience, to invest more in very-early-stage ventures, and to be more interested in financing inventors. This study is relevant to community leaders and entrepreneurs in several ways. First, the project begins to ask pertinent research questions about types of informal investors who play particularly important roles in local economic development. Second, a more differentiated view of the role of the informal investor is suggested because special characteristics of start-up investors and technology-based investors can be distinguished. Third, some initial clues about identifying these key individuals emerge. The study demonstrates a productive line of thinking for community leaders and entrepreneurs in the risk venture financing process.