Angel Financing Research Articles

The Consequences of Entrepreneurial Finance: A Regression Discontinuity Analysis

This paper documents the role of angel funding for the growth, survival, and access to follow-on funding of high-growth start-up firms. We use a regression discontinuity approach to control for unobserved heterogeneity between firms that obtain funding and those that do not. This technique exploits that a small change in the collective interest levels of the angels can lead to a discrete change in the probability of funding for otherwise comparable ventures. We first show that angel funding is positively correlated with higher survival, additional fundraising outside the angel group, and faster growth measured through growth in web site traffic. The improvements typically range between 30% and 50%. When using the regression discontinuity approach, we still find a strong, positive effect of angel funding on the survival and growth of ventures, but not on access to additional financing. Overall, the results suggest that the bundle of inputs that angel investors provide have a large and significant impact on the success and survival of start-up ventures.

Angel finance: the other venture capital

Abstract The procurement of capital is an important consideration for an entity transforming from an entrepreneurial idea to a revenue generating company. Angel financing is one of the most common, but least studied methods, to finance new ventures. The term “Angel Investor” generally refers to a high net‐worth individual who typically invests in small, private firms on his or her own account. Using a unique dataset of firms financed by angels between 1994 and 2001, our research provides some insight into the role of angels in funding, monitoring and guiding their investments. Although exposed to greater uncertainty by investing earlier in the life of a firm compared to venture capital investors, angel investors do not rely on traditional control mechanisms such as board control, staging, or contractual provisions to protect against expropriation. Angels may use more informal methods of control such as investing in close geographic proximity and syndicating investments with other angels to mitigate risks. The results of the study indicate that angels have a complementary role to venture capital in the financing of new ventures. Copyright © 2009 John Wiley & Sons, Ltd.

A Theory of Financing Knowledge Assets

This paper develops an incomplete contracting theory of financing choices by integrating the incentive effects of knowledge sharing in corporate VC, independent VC, and angel financing together with the incentive effects of financing ideas inside or outside the boundaries of an existing firm. I model these financing choices using (i) ownership of the idea; and (ii) reciprocal access between the financier's and the innovator's knowledge. The theory provides the following key insight: while ownership asymmetrically increases the incentives of the owner and dampens those of the non-owner, access symmetrically enhances the incentives of both agents. By distinguishing the financing of knowledge assets from that for physical assets, the theory rationalizes why venture capital financing is dominant in the knowledge intensive sectors but not in the traditional sectors. The theory generates the following novel empirical predictions. First, independent VC financing of startups is more likely than corporate VC but less likely than angel financing if intellectual property (IP) protection is stronger or if product market competition is more intense. An increase in the strength of IP protection affects these financing choices disproportionately more when product market competition is intense. Second, whether an idea is optimally financed inside or outside an existing firm is determined by the relative abilities of the innovator and the financier and how easily their knowledge can be expropriated. Absent IP protection, this choice between financing ideas inside or outside existing firms is irrelevant.

Angel Finance: The Other Venture Capital

Angel financing is one of the most common, but least studied methods, to finance new ventures. In this paper, I propose a model to explain angel behavior. I use a unique dataset of angel-backed firms to test the predictions of the model and examine the characteristics of angel financing. Although they are exposed to greater uncertainty by investing earlier in the life of a firm compared to venture capital, angel investors do not rely on traditional control mechanisms such as board control, staging, or contractual provisions to protect against expropriation. Instead, angels reduce expected agency costs by forcing entrepreneurs to hold a larger stake in the firm, thereby aligning the interests of the entrepreneur with the outcome of the firm. In addition, angels use more informal methods such as investing in close geographic proximity and syndicating investments with other angels to mitigate risks.

Executive forum: Seven ways to stimulate business angels' investments

Government policy to stimulate growth, innovation and especially the creation of new enterprises is rather focused on access to finance mainly through increasing the supply of capital. As formal venture capitalists are moving towards larger deals and shifting their investments to a later stage of development, creating a ‘second’ equity gap, business angels become more important in the financing of seed, early stage and second round phases. Government policy to stimulate financing should hence be considered as a priority. However, policies have to be focused both on the supply side and the demand side and combined with a cultural change. Government should look at innovative ways to stimulate business angel financing rather than coping with market failures by bureaucratic subsidy schemes. The paper identifies seven ways to stimulate business angel investment. Coping with the second equity gap can mainly happen by stimulating syndication and by setting up co-investment schemes. Investor readiness, corporate orientation, business angel networks, business angel academies and the integrated finance concept can be considered as key concepts in coping with the information asymmetry problem.

The Role of Angels in Technology SMEs: A Link to Venture Capital

The presence of angels among early-stage financiers of new technology-based firms should improve chances of eventual venture capital financing. Reasons to expect that firms with private investment would have easier access to venture capital are discussed. This study presents findings that support this expectation. A total of 57% of the firms that had received private investor financing had also received financing from institutional venture capitalists; only 10% of firms that had not received angel financing obtained venture capital. Angel investor financing was a significant explanatory variable (among others) of differences between venture capital recipients and firms that had not received venture capital. It would appear that angels help firms to become more ready for future stages of investment by, among other contributions, being closely involved with the firms in which they invest. They usually provide advice and networking opportunities. They also serve on Boards of Directors and Advisors, and provide hands-on assistance and business intelligence. Angels also fulfill an important accreditation role. Overall, this study provides empirical support for the expectation that involvement of angels can substantially increase the attractiveness of firms to institutional venture capitalists.

Financial bootstrapping and venture development in the software industry

Access to finance has been identified as a significant constraint on the development of technology-based businesses. Although important, institutional venture capital and business angel finance are used by only a small proportion of new and growing ventures. The role of bootstrapping – defined here as access to resources not owned or controlled by the entrepreneur – has been largely overlooked in studies of small firm financing. This paper redresses this omission by analysing the role and importance of bootstrapping in product development and business development in the independently-owned software industry. Results from two regions of the UK – Northern Ireland and South East England – are compared with equivalent data from the USA (Massachusetts). Overall, bootstrapping techniques are less extensively used in the Northern Ireland industry than in South East England, and in both regions bootstrapping is less common than in Massachusetts. This may account for the smaller employment size, growth profile and stronger service/consulting orientation of these firms. Moreover, there appear to be considerable variations in the use of bootstrapping. Larger firms tend to make more use of bootstrapping for product development, and consider it more important than do smaller firms, who more highly value business development-related bootstrapping. Small firms are also more likely to use and value cost-reducing bootstrapping techniques, whereas larger firms make more use of the exploitation of value-chain based relationships.

Women entrepreneurs securing business angel financing: tales from the field

While women-led businesses are the fastest growing segment of venture creation in the US economy, the amount of private equity capital investment they receive is disproportionately small. Informal venture capital, or business angel, investment is as large as venture capital activity, and business angels provide the majority of the critical seed and start-up stage capital. This research explores the investment decision process involving women entrepreneurs and business angels from the perspective of demand. Successful strategies of women entrepreneurs are investigated using in-depth interviews. In particular, pre-investment processes, trust, comprehensiveness, the post-investment relationship and gender are examined.

Nurturing a Venture: A Venture Capitalist's Perspective

The concept of venture capital originated in the US in 1946. A number of new technologies which could be commercially exploited had come up after the Second World War and funds given for such ventures were called venture capital investment. Though the venture capital movement has been in existence for more than three decades in India, it has only recently gained momentum. New ventures found it difficult to get funding from the banks as they did not have any collateral to offer. Hence, venture capital industry was started in India to fund such enterprises. Gujarat Venture Finance Limited (GVFL) was set up by the World Bank in 1990. Till date, it has funded 56 companies from all over the country. GVFL supports only technology-oriented companies. Funding is provided in stages. The money given at the seed or early stage is called angel funding. This paper documents how GVFL funded and nurtured a venture called Permionics which was involved in manufacturing an innovative water filter and helped it to grow into a commercially viable enterprise. This was not smooth sailing and the venture did not take off initially as the project required a lot of product innovation and market research for its feasibility. However, the venture capitalist persisted with the efforts in making the venture successful as he had faith in the product. Thus, he went beyond hand-holding and helped in the company's promotional effort, getting expert advice, solving internal disputes, coordinating strategic tie-ups, etc. After some trial and error, the product was finally relaunched and was a great success. The main conclusions emerging from this paper are: A venture capitalist's contribution is not just funding an enterprise but also seeing to its proper functioning. A venture capitalist provides necessary linkages to the entrepreneur for the growth of the enterprise. A venture capitalist not only provides moral support but also helps in forming the company. He is more of a partner than an outsider. A good venture capitalist sees the enterprise through its ups and downs until it becomes a commercially successful venture.

Angels, Venture Capitalists, and Entrepreneurs: A Dynamic Model of Private Equity Financing

We develop a theoretical analysis of an entrepreneur's choice between venture capital (VC) and angel financing at various stages in a private firm's life, and characterize the dynamic evolution of the firm's contract with its financier (VC or angel). In our model, an entrepreneur has information superior to a potential financier about his own firm; however, this information advantage diminishes as the financier interacts with the firm over time. Venture capitalists and angels differ in two ways. First, venture capitalists can add value to the firm by exerting effort, which, together with the entrepreneur's effort, increases the chance of project success; the angel is unable to add significant value. Second, venture capital financing is scarce relative to angel financing. The equilibrium VC contract maximizes value-addition by ensuring that both the entrepreneur and the VC exert optimal effort. We develop the following results in the above setting. First, we characterize the optimal financing path of the firm: depending on firm characteristics, a firm may use angel financing in its early stages and switch to VC financing in later stages, or vice versa. Second, VC financing contracts resemble convertible debt, while angel financing contracts may resemble a variety of financial securities, including equity. Third, for firms which use venture financing in earlier as well as later rounds, earlier round financing contracts will have more of a fixed income component and less of a warrant (upside) component compared to later round financing contracts. Fourth, later round financing contracts between an entrepreneur and a VC who financed it in an earlier round will have a greater warrant component compared to such a contract between a VC and a previously angel-financed firm. Fifth, we characterize how the structure of VC financing contracts relate to: (i) the experience and productivity of the VC; (ii) the nature of the firm's industry; and (iii) the scarcity of VC financing. Finally, we develop predictions for the relationship between the financing path of a firm and the probability of its having a successful exit (IPO or acquisition), and for differences in the compositions of VCs' and angels' investment portfolios.

Barriers to investment in the informal venture capital sector

Much of the government intervention into the market ‘gap’ for start-up and early-stage equity finance in the UK is based on the belief that the problem is on the supply side. Based on an analysis of the informal venture capital market this paper argues that there is no shortage of finance available. A survey of business angels reveals that many are willing to allocate a higher proportion of their investment portfolio to investments in unquoted companies, with recent tax incentives having a positive effect on their willingness to invest. Over 90% are currently looking to make more investments. However, there are constraints on their ability to invest: they do not see enough deals that meet their investment criteria, the majority of the investment proposals that they receive are of poor quality, and they are often unable to negotiate acceptable investment terms and conditions with entrepreneurs. The implication is that there is a need for further interventions by policy-makers to remove these barriers so that more small firms can take advantage of the substantial pool of angel finance that is available.