Expected Returns to Stock Investments by Angel Investors in Groups

Abstract

Angel investors invest billions of dollars in thousands of entrepreneurial projects annually, far more than the number of firms that obtain venture capital. Previous research has calculated realized internal rates of return on angel investments, but empirical estimates of expected returns have not yet been produced. Calculations of realized returns are a valuable contribution, but realized returns do not drive investment decisions. Rather, expected returns drive investment decisions. We use a new data set and statistical framework to produce the first empirical estimates of expected returns on angel investments. We also allow for the time value of money. Previous research typically has ignored this. Our sample of 588 investments spans the period from 1972 through 2007 and contains 419 exited investments. We conduct extensive tests to explore potential bias in the dataset and conclude that the evidence in favor of bias is tenuous at best. Our results suggest that angel investors in groups earn returns that are similar, at least in broad measure, to the returns on venture capital investments. Estimated net returns are about 70 percent in excess of the riskless rate per year for an average holding period of about 3.67 years. Returns have a large variance and are heavily skewed, with many losses and occasional extraordinarily high returns. Our estimate of 70 percent in excess of the riskless rate is reasonable compared to Cochrane’s (2005) estimate of 59 percent per year for venture capital, which tends to invest in safer, later-stage projects. Our results are robust to the inclusion of very short-term projects.