April 21st, 2006
Greenstone Venture Partners
On The Wings Of Angels
"And to her that means nothing,
But to me it means everything.
She talks to angels,
Says they call her out by her name.” – Black Crowes, She
Talks To Angels
Venture Capitalists invested US$1.6B in
companies in Canada and US$21.7B in the US in 2005.
While we busy money managers have been doling out this
capital to companies that we hope will become Google or
Skype someday, we are dwarfed in size by another class
of investor: the individual.
Aaaah, the angel. The most important cog
in the investment cycle. Without the angel, the VC
would be forced into earlier stage, riskier investing.
The supply of angel fed companies is mainly what VCs
feed on. How big is the angel investment though? Who
counts this stuff? It took me all of 3 mouse clicks to
find the VC data… but angel data, very tough to find.
Let’s try and compare apples to apples for
a minute. Take that US$23.3B in VC investment in North
America and subtract about 40% of it, which went into
Series B, C, D, E rounds of financing in established
companies. In other words, remove the large chunk that
individual investors do not participate in. In round
numbers, VCs (the “professionals”) invested about US$14B
in comparable round funding (seed and Series A).
According to the
Centre For Venture Research at the University of New
Hampshire (the only place that actually tries to count
angel investment in the US), angels in the US doled out
a whopping US$23.1B in 2005. Interesting.
In Canada, a few cursory efforts have been
thrown at counting angel investment, the most quoted
being the GEM (Global Entrepreneurship Monitor) studies
that talk about “informal investment” around the globe.
It states in a
2004 report that total informal investment in Canada
is 1% of GDP, which would amount to $10B in total in
2005 (of our $1 trillion GDP). Even if you take out the
65% that GEM claims is invested by the entrepreneur
themselves (in sweat and credit cards), this number is
still obscenely high. The only credible counting of
angel investment has been done in BC and for BC only.
This is due to securities legislation that forced a lot
of this normally “informal” investment to be reported by
“sophisticated investors” through investor exemptions
and the use of our VCC tax credit programs over the
years. The result for BC is CDN $355M (in 2004) by
extrapolating the roughly 30% of angel investments
caught by this reporting mechanism. If we then factor
that amount across Canada using the average BC venture
capital rate of 12-13% of Canadian investment, we get a
number more like US$2.3B for Canada, which is about 10%
of the US angel amount and MUCH more believable.
So, angels invested US$25.4B in a year in
North America. Wow. That’s a 1:0.95 ratio angel
investment to total VC funding and a 1:0.55 ratio
of angel to early stage VC funding in a given
year across North America. Of course they invested in
many more companies (roughly 50,000 for angels vs. 3,000
for VCs) and, as we all expected, spend less per
investment. In round numbers (because I am cramming
together US and Canadian data which may be collected
very differently), angels invest $500,000 per company
and VCs about $5,000,000 in a given year (at early
stages only, seed and Series A). A couple of points
on this math: 1) not all angel invested companies
receive VC financing (clearly some go out of business
and others grow into larger businesses without the need
for VC type capital), so you don’t need to worry about
47,000 companies a year perishing for lack of VC,
although quite a number of them will not survive. 2)
Angel money tends to trickle in while VC rounds are
binary, so $500,000 a year per company is not really
what they are raising in angel investment in total, but
the VC number of $5M is a more indicative average amount
of a financing at Series A stage (because it lasts for
more than a year).
Is a ratio of angel investment to total VC
investment at roughly 1:1, a healthy number for
commercialization? In BC it is CDN$355M to CDN$248M in
2004 (1:0.7), which indicates even more angel capital to
venture capital available than the North American
average (probably partly due to the angel tax credit
program here and partly due to a lack of later stage VC
investment). Is the number of companies financed by
angels at more than 10x the number funded by VCs a
healthy ratio? I wish I had the number for the Silicon
Valley or Washington State to compare, but that
information is not available… at least without hiring
the Centre of Venture Research for a few thousand
dollars! It would be very interesting to compare.
My interest in all these numbers is to try
to understand the right balance of capital needs to
innovation to level of experienced talent that creates
great companies. As I have said before, if any of these
is under or over abundant, the equilibrium is wrecked
and the industry as a whole suffers. Since angels spend
more money than VCs, don’t you think a little more
analysis of how and where they spend their money is
warranted? I don’t mean just here in BC, but
everywhere? Wouldn’t it benefit angels themselves to
know what patterns of investment and what portfolios
tend to work better for the big payoff? Anecdotally,
the “spray and pray” theory appears to be the most
favoured portfolio strategy. An angel will invest small
amounts in many, many start-ups over time and look for
that 10-50x deal that comes along once in a decade to
make up for all of the other failures or wash-outs.
Everyone now knows the legend of Ram Shriram and
Google. He made about $2B on a $100,000 investment in 5
years. Let’s say Ram invested $100K in 40 other
ventures in that time, well $4M down the drain you might
say… but of course, you can’t bet it all on one deal
when you invest sooooo early.
Local angels have similar stories with
Angiotech (doctors on the north shore), ALI (Milt Wong
and Paul Lee) and Datum Telegraphic (Haig Farris).
These were not quick hits and in the case of people like
Paul and Haig, many other bets were made on start-ups
and ideas over the decade or so it took them to hit it
big. When Dick Hardt cashed out some of his earnings
from ActiveState and bought into Flickr, he had a very
quick return by angel standards, but it is not typical
for the really big home runs in angel investing. Most
angels will tell you that the greed factor is not the
only driving factor behind making these risky
investments. A huge part of the decision process is
based on the love of technology, great innovation and
good people to put money behind. It’s almost a feeling
of giving back to the community. A lot of technology
angels were entrepreneurs and engineers themselves and
feel a camaraderie with the starving start-up folks.
That’s the reason that you have your head scratchers
sometimes when you see very smart angels make
investments in weird stuff. It happens.
I believe there is another route to good
returns for angels and that is through investment in
companies that may not need the big capital raise from
VCs. These are smaller, regional businesses and or
service companies that need <$1M in capital to get
going. There is no less risk in the businesses
executing, but they are quicker to customers and revenue
than heavy development companies and the financial risk
(the risk of raising big money) is not there. A smart
program of investing in these types of businesses might
work. Take IronPoint for instance. I mentioned them a
few months back as another example of a company making
it big without VC investment. Lo and behold, they are
acquired this week by Active Systems, the same company
that bought Class Systems a couple of years ago. Angel
investors in IronPoint did very well.
It goes without saying that the angel
plays a crucial role in the ecosystem of the start-up.
I just added some numbers to the argument that shows how
crucial. Angels are shy about giving data.
Nevertheless, some more data would help understand the
business of informal investment.
Letters From Last Time –
Chris Loge at Nokia informed me that with 400-450 employees,
I forgot to mention them in my past article about the
big technology companies in town. Thank you Chris for
giving me the data and I meant no slight to you and your
friends at Nokia.
I always enjoy your commentary on BCTechnology.com, and
particularly the recent April 3rd
installment. It is hard for us ordinary folk to get a
perspective on the entire industry in BC and you have
done it well. Thanks for that.
Just wanted to let you know we’re listening out here!
Ken Lalonde, P.Eng.
Thanks Ken. I try to give that perspective and I
appreciate the support !
What Do You Think? Talk Back To Brent Holliday
Something Ventured is a bi-weekly column designed
to supplement the T-Net British Columbia web site with
some timely, relevant and possibly irreverent insight
into the industry. I hope to share some of the
perspective and trends that I see in my role as a VC.
The column is always followed by feedback (if its
positive or constructive. I'll keep the flames to
Something Ventured Archive