Image by Mykl Roventine

Got ambitions for high-payoff potentials? Allocate a portion of your investable capital to angel investing, a form of alternative investments that offer high risk, high return opportunities.

William S. Podd, executive director of Landmark Angels, suggests, “Angel investing, with its historical high risk/high reward strategy, can provide an opportunity for significant returns for high net worth investors as part of an asset allocation strategy.”

Amazon, Facebook, Google, Mint, PayPal, and Yahoo are just some of the high-profile companies that have made their angel investors very happy.

High Risks/High Returns

A study by Scott Shane, author of “Fool’s Gold?: The Truth Behind Angel Investing in America,” reveals that accredited angel investors see a negative return in 40% of their angel investments, and 7% of investments account for 75% of all returns.

Roughly speaking, out of 10 angel investments, 3 to 4 will fail, 4 to 5 will be “walking dead” (survive but generate little or no return and not dead enough to be a write-off), 1 or 2 will be home runs that make up for the losses and generate a handsome return to angel investors.

Brad Feld, managing director of Foundry Group, explains the concept of home runs:

Understand the difference between 0x and 100x: I’ve had two of my angel investments return over 100x each.

Since I had a strategy of investing the same amount in each company, all I needed was one 100x to allow me to have 99 companies completely flame out and return 0 and I’d still break even.

With two investments at over 100x, I now have a built in gain of significantly over 3x across all of my investments since I’m [sic] made about 75 of them and I’m now deliciously “playing with house money” on all of the rest.

Financial Returns: Angel Investments vs. Other Asset Classes

Few years ago, the Ewing Marion Kauffman Foundation and the Angel Capital Education Foundation conducted the largest study on the financial returns of angel investors in North America and released a report in 2007, showing that angel investors participating in organized angel groups achieved an average 27% internal rate of return (IRR) on their angel investments.

Overall, this set of angel investors affiliated with angel groups experienced exits that generated 2.6 times their invested capital in 3.5 years from investment to exit. This return compares favorably to that of other private equity investments, including those of early-stage venture capital. Seven percent of exits generated returns above 10 times their initial investment.

New Series: Asset Allocation Strategies for Angel Investors

You see, angel investing is a high-risk, high-payoff activity. To help investors tap into the potential lucrative returns without risking more than what they can stomach, we’ve prepared a new series on asset allocation strategies, which studies what veteran angel investors recommend in respect to personal asset allocation and effective portfolio building.

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Quick Notes

• Venture capital investing is up 41% in the 1st quarter this year vs. a year ago
• Number of startup acquisitions is at an all time high
• Quantity and quality of acquisitions are good
• 14 to 15 IPOs in 1st quarter, compared to 18 IPOs in the last 2 years
• Quality of IPOs – some good; some aren’t
• Briefly discussed corporate VCs

William R. Kerr

Startup businesses need more than just cash in their kitty to achieve success and business longevity, according to a Harvard Business School paper into entrepreneurial funding.

While it is important that seed businesses receive the necessary funding to get their operations up and running, sometimes the psychological support they receive is just as important as the financial leg up.

Only an archangel can make this happen!

Angels vs. VCs and Friends & Family

Where a venture capitalist may swill some cash around in their managed fund and occasionally flick some in the general direction of promising startups, angel investors give new businesses their proverbial set of wings – give yourselves a pat on your cherubic backs for that one!

Angels are oftentimes seen to provide the same type of support that friends and family might.

But just like the merciless honesty we expect to receive from friends and family, angel investors don’t back a venture they don’t believe in – and this point of distinction appears to make all of the difference.

Angel-Backed Companies Less Likely to Kick the Bucket

The Harvard report penned by William R. Kerr, Josh Lerner, and Antoinette Schoar tables evidence that angel-funded firms are less likely to kick the bucket than firms that rely on other forms of initial financing.

This is good news for you angels out there who have invested your hard-earned cash in a venture and look forward to continued pay days!

While venture capitalists might be intent to keep flogging the dead horse that still promises to win a race, angel investors are proven to seek out companies that are committed to the growth of more than just their bank accounts.

According to Kerr, Lerner and Schoar, the improvements that can be seen within businesses funded by sophisticated angel investors can be logged at between 30% and 50% – more than the improvements noted in businesses using other types of initial financing.

Kerr, Lerner and Schoar go on to say that these statistics can be attributed to:

• the use of networking that is initiated by most angel investors;
• the dedicated due diligence they put into researching each new venture before signing on the dotted line;
• the personal assessment undertaken to weigh up the chances of recovering their outgoings; and
• the way that angel firms survive and thrive by upping the ante on diversifying their portfolio and maintaining a personalised approach to their business backing.

It is okay to initiate a “Give me an A, N, G, E, L” cheer here punters!

More Than Money

The concept comes back to the nature vs. nurture school of thought.

Josh Lerner

Does a new baby require only milk to satisfy her growth and development needs?

Unlikely.

Just like an infant, startup businesses are usually seeking added value from an angel financier.

Adding value means helping out and being there when the
company needs you (e.g. providing helpful advice and critical connections), not stepping on the founder’s toes when your help isn’t needed.

The overall vibe of the Kerr, Lerner and Schoar report is that angel investors should embrace the fact that they are expected to give more to their investments than just the funds.

Take Away

You’re all acutely aware of the fact that the success of your investments is balanced greatly on the success of those you invest in, so take away some key points of thought from the Kerr, Lerner and Schoar paper.

• Due diligence, due diligence, due diligence – Look beyond the business plan and executive summary. Intensively evaluate every member on the startup team. Listen carefully as they present their ideas to you. Do they believe in themselves as much as they expect you to?
• Document, document, document – The Kerr, Lerner and Schoar report details information about how much effort Tech Coast Angels put into maintaining their database of companies not funded by them, but should be! Food for thought…
• Score it – Take a ballot on a new venture detailing your interest level in a pitch delivered by a startup, your overall confidence in the facts and figures that back them up, and your belief in their commitment to drop their egos and put in the hard yards to make success happen.

The Center for Venture Research at UNH has released a report [PDF] on the angel investor market in 2009. The report indicates that angels haven’t significantly decreased investment activity. But they’re committing fewer dollars due to lower valuations and a cautious approach to investing.

The report also highlights the significant changes in the critical seed and startup stage investment landscape.

• Total investments in 2009 were US$17.6 billion, a decrease of 8.3% over 2008.
• A total of 57,225 entrepreneurial ventures received angel funding in 2009, a reserved 3.1% increase from 2008.
• The number of active investors in 2009 was 259,480 individuals, virtually unchanged from 2008.
• A decline in deal size of 11.1% from 2008 (as a result of the small decline in total dollars and the increase in number of investments).
• Mergers and acquisitions represented 54% of the angel exits.
• Bankruptcies accounted for 40% of the exits in 2009.
• 250,000 new jobs created due to angel investments, or 4.4 jobs per angel investment. This represents approximately 5% of new jobs in the US in 2009.

Stage

• Seed and startup investments accounted for 35% of 2009 angel investments, a decrease of 10% from 2008.
• Post-seed/startup investing represented 62% of investments, an increase from 2008, indicating angels’ increased interests in the early and expansion stage.
• New, first sequence, investments represented 47% of 2009 angel activity, a significant decline from the last 2 years.

Sectors

As a percentage of total investments in 2009.

• Software (19%)
• Healthcare Services/Medical Devices and Equipment (17%)
• Industrial/Energy (17% — significant increase from 2008, reflecting a growing appetite for green technologies)
• Retail (9%)
• Biotech (8%)

Women

• Women angels represented 11.3% of the angel market.
• Women-owned ventures accounted for 21% of the entrepreneurs that are seeking angel capital.
• 9.4% of these women entrepreneurs received angel investment in 2009.
• Both the number of women seeking angel capital and the percentage that receives angel investments are low compared to the overall market.
• These data indicate that when women do seek angel capital they lag behind the market yield rate by 5%.

Why are some investors more successful than others? What makes them different from the average ones?

Successful investors understand risks and they use risks to their advantage. For this reason, we started a 2-part series on risks, and on improving the odds of turning someone else’s ideas into profits.

The 4 primary types of risks are:

• Financial
• Market
• People / Execution
• Product / Technology / Technical

We’ve looked at Financial and Market risks in Part 1. Here, we’ll look at People and Product.

People / Execution Risk

Time and time again investors all around the world place significant weight on the founding team. You’d want to have the right talents. You’d want to know that the team has what it takes to execute their oh-so-brilliant plan. You’d want to bet on the jockey not on the horse.

According to Harvard Business School’s working paper, “Performance Persistence in Entrepreneurship”:

All else equal, a venture-capital-backed entrepreneur who starts a company that goes public has a 30 percent chance of succeeding in his or her next venture. First-time entrepreneurs, on the other hand, have only an 18 percent chance of succeeding, and entrepreneurs who previously failed have a 20 percent chance of succeeding.

Bet on an A-team. In an A-team, at least one of the founding members has a history of success. Head over to Startup Team That Adds the Steam and Doing Due Diligence on Startup Team to find out what an A-team looks like.

Note, though, we’re not suggesting you should automatically reject inexperienced entrepreneurs. After all, angels are more likely than VCs to back first-time entrepreneurs. Ultimately, you need to ask yourself whether you believe in the team or their products.

Naval Ravikant of VentureHacks once said, “The team matters more in enterprise deals, traction matters more in consumer deals.” So, a consumer Internet startup that has traction run by an inexperienced team might be just as good.

Some evaluation questions include:

• Can the team execute?
• Does the team have a track record of success?
• Do they have business acumen?
• Do they have the domain expertise?
• Do they have operational experience to make it a success?

Product / Technology / Technical Risk

The product or technology is the central basis of a startup’s value proposition. No product, no business. A mighty cool product without applications is still mighty useless. You can be looking at a solar-powered torch so sleekly designed that it’ll put Apple to shame. But if the torch only works when the sun is out, shining brightly in the sky, then the torch hardly solves anything. Who needs a torch when you can see clearly under the sun?

If you think the technology is cool but not quite sure about its application, consult with independent experts who get the technology. Ask them to validate and assess the risks before making any investment decision.

If you’re looking at a unique product / technology that actually solves problems, conduct searches on patent applications and make sure the product hasn’t infringed existing patents on the market.

If there’s possibility of infringement but you’re convinced of the technology’s potential, talk with an experienced lawyer to see if there are any workarounds. Otherwise, you may want to simply pass on the opportunity and save yourself some sleepless nights.

Some evaluation questions include:

• Does the product solve a real problem?
• Is the product unique?
• Is it patented or protected by IP?
• If not, does it have first-mover advantage?
• Can the product operate freely on the market?

Final Thoughts

Higher risks yield higher returns. Understand the risks involved and weight them against potential rewards. Learn to adore risks and use risks to your advantage.

For Jason Cohen, an angel investor and the founder of Smart Bear Software, he wants the entrepreneur to list the known risks so he can evaluate them. He wants to see that she’s honest, that she has both eyes open. And he wants to know how she’s addressing and reducing risks.

If the entrepreneur claims that risks are minimal because she’s “in control” or “in the know,” it’s likely that she isn’t even aware of the risks. Cohen doesn’t invest in such entrepreneurs.

Keep these in mind when you’re evaluating a potential investment.

And think ahead. Take calculated risks. That’s how you can improve the odds of profiting from promising startups.

Times have changed.

Now, not only are women running businesses, they are starting them. And they aren’t sticking with cosmetics or flowers or anything else traditionally “female.”

Ning was co-founded by a woman. So was Flickr, which was bought by Yahoo in 2005 for US$30 million.

Research Findings

Research from venture capital firm Illuminate Ventures presents a compelling case for funding female entrepreneurs. Some of the notable findings are:

• Efficiency, efficiency, efficiency:  The high-tech companies women build are more capital-efficient than the norm. The average venture-backed company run by a woman had achieved comparable early-year revenues, using an average of one-third less committed capital.
• Fewer Failures: Despite often being capital-constrained, women-owned businesses are more likely to survive the transition from raw start-up to established company than the average.
• Growing Influence in Tech:  Women-owned or led firms are the fastest growing sector of new venture creation in the U.S., growing at five times the rate of all new firms between 1997 and 2006 – now representing nearly 50% of all privately held businesses.
• Diversity Improves Performance: Organizations that are the most inclusive of women in top management achieve 35% higher ROE and 34% better total return to shareholders versus their peers – and research shows gender diversity to be particularly valuable where innovation is key.

Looks like, giving women a shot isn’t that bad of an idea. In fact, far from it. It can bring about social progress. And it can restart our economy in the process. Sounds like, it’s worth a bet.

Yet, the Center for Venture Research has found that, in the first half of 2009, 22% of businesses looking for angel investors were owned by women. But only 6% of them were able to establish a relationship with an angel investor.

What’s Missing

Thanks to Facebook, Twitter, and a bounty of blogs, wikis, and everything else that comes with Web 2.0, people are organizing and connecting in ways unknown 5 years ago. Women in the technology sector are on the forefront of these advances.

Women in Technology International (WITI) is a trade association that connects and supports female technology professionals. WITI’s membership numbers 140,000, half of whom either own or hold an executive role in a technology company, according to the association’s 2010 demographics.

This spring, Women Who Tech will hold its Third Annual Telesummit for Women in Technology. These virtual symposiums broadcast panel discussions via podcasts, which makes them free resources that are available on demand.

Earlier in February, Women 2.0 held its 2-day “Will it Launch?” workshop in San Francisco to help women polish their startup ideas.

Apparently, the business resources are in place. What’s missing is your investment to transform business plans into businesses.

BUT, barriers to entry is low and there are heaps of other issues to consider. With all ‘em challenges and all ‘em developers itching to try their luck, how do you identify startups that have good potential?

Let’s take a look at the kind of startups VCs are backing and the things they said about the space. This will at least give you some clues as to what criteria should be met, which could save you some time in the screening process should you decide to back an iPhone startup.

I. Target

The key is to look for iPhone startups whose goal is to build scalable businesses, not individual developers who are just hoping to hit the jackpot.

II. Exit

Investors typically make money upon exits (e.g. M&A, IPO). They expect the startups to have an exit within 10 years.

For KPCB, it invests in companies that have the potential to become standalone, public companies. Successful investors aim big and look for homeruns.

III. Focus

KPCB has its hearts for location based services, social networking, mCommerce (including advertising and payments), communication, and entertainment.

For aggregate data, ChubbyBrain offered a breakdown of companies per industry that have received angel and VC funding. Industries that appear relatively hot within the iPhone ecosystem include: social network, gaming & entertainment, diversified application development, information provider, and monitoring & security.

IV. Multi-Platform

iFund manager Matt Murphy told mocoNews that they’re not betting solely on the iPhone platform. “Over time, most companies [in the fund] will eventually diversify to other platforms.” This is important as portfolio companies can leverage the popularity of other platforms like Android.

Case in point: Most recently iFund-backed GOGII has released its textPlus app for Android.

V. Business model

How do the companies make money? “Majority of apps right now are moving towards, or are pursuing a free ad-subsidized model, or a model using virtual goods with some apps being a paid download or monthly recurring charge,” said Murphy. “90 percent will be monetized by advertising, virtual goods, or some form of affiliate fees or commerce.”

A word about micro-payments: With the golden price point being US$0.99, your investee will need to sell a whole lot to ensure you get the great ROI. Is the market for the app there and is it big enough?

And take note of the freemium model. Mobile knowledge portal MSearchGroove (MSG) cited studies from Pinch Media which showed that iPhone app usage drops significantly after 90 days as novelty wears off. The iPhone startups you’re evaluating must be quick and meticulous in releasing apps. Fredrick and Rainey note that a clear and compelling upgrade path is a must.

While [the freemium model] works in some sectors, overall, the gap between free and paying customers is widening. This is happening because buyers can be very fickle. As their attention spans shorten, their brand loyalty diminishes as well.

In the mobile space, for instance, a game or app that’s hot today can easily be forgotten tomorrow. Users have little or no incentive to upgrade, so they just move on to the next trendy, free offering. Providers must innovate at an incredibly rapid pace in order to keep pace with market demand. But they can’t be careless – offerings must be thoroughly tested before they go public, since most people won’t give something a second chance if they’re unhappy the first time. And these providers must have a clear and compelling upgrade path to entice a larger percentage of paying customers.

Of course, you’d want to do your due diligence and look at other factors like the startup team, the company’s competitive edge, piracy concerns and go-to-market issues before opening the checkbook. But now that you’ve gained a clearer picture of what a fundable iPhone startup looks like, it’ll help you filter out a good chunk that obviously don’t fit the bill and give you an easier time to find that special company that hasn’t reached the VC stage. You might come across it in 3 to 5 days or 3 to 5 months, or you might never find one that steals your heart.

Just to give it some context, iPhone startups received between US$15,000 and US$15.5 million from VCs and angels as of June 2009, according to ChubbyBrain’s aggregate statistics. For the initiated, there’s plenty of room for individual angels and angel groups to play.

Image: pinkykeos

Mobile platforms are where a significant portion of the computing world is headed, and the iPhone and iPhone OS have been significantly responsible for that shift.

As of June 2009, ChubbyBrain found that over US$100 million in total VC/angel investment has been injected in 17 iPhone startups in the span of less than 2 years.

In their own words:

We identified $102.49 million in total VC/angel investment divided amongst 17 iPhone application startups (as of June 29, 2009). Perhaps this $100M+ number isn’t surprising given conversation that the iPhone may be bigger than the PC, but over $100 million in the span of less than two years for iPhone predicated startups is noteworthy.

VC firm Kleiner Perkins Caulfield & Byers (KPCB) alone accounted for US$50 million worth of investments; that’s half of the US$100 million iFund initially launched in March 2008.

(KPCB’s iFund is a US$100 million investment initiative that funds startups building apps for iPhone and the phoneless iPod Touch.)

3 months later in September, iFund manager Matt Murphy told Bloomberg, “It’s pretty clear we’ll go beyond $100 million,” and the firm will increase the size of the fund due to the popularity of Apple’s device.

The size of the customer base is “stunningly larger that most of us expected,” Murphy said. “Is it going to be 100 million a year from now, 200 million two years from now? I think so. Everybody still wants an iPhone.”

Not everyone’s bullish. This month, New York Times reported venture investors’ losing interest in startups that build iPhone apps. The publication quoted David Pakman of Venrock, “That was a very exciting place to look at; the growth numbers were off the charts, but I think we all understand now that it’s very hard to build big businesses here.”

In 2010, people are expected to buy 2 to 3 times as many Android-based phones as iPhones, “ripping apart the hegemony of the Apple ecosystem,” Peter Fenton of Benchmark Capital told New York Times.

Google’s Android is making news, no doubt. But if you’ve already set your mind in backing iPhone startups then you might want to take a look at the prospects and study how the big boys select their winners. This might give you some insights into the screening process and save you some time while you’re at it.

Smartphone / iPhone

In 2009, smartphones only represent 14% of total handsets sold worldwide. Nonetheless, Gartner is optimistic about the potential of smartphones and predicted that sales will grow 38% by 2013.

In 3Q09, “smartphone sales surpassed 41 million units, a 12.8 per cent increase from the same period last year.” Carolina Milanesi, research director at Gartner said, “Smartphones continued to represent the fastest-growing segment of the mobile-devices market and we remain confident about the potential for smartphones in the fourth quarter of 2009 and in 2010.”

Even though iPhones only account for a small slice of global smartphone sales, Apple maintained its third position in the global rankings, with its worldwide smartphone share increased from 12.9% in 3Q08 to 17% in 3Q09.

“Its [average selling price] is holding steady and sales in the fourth quarter should be even stronger as Apple starts selling in China,” according to Gartner.

iPod Touch

iPod Touch is also garnering some seriously ink of late. Broadpoint AmTech analyst Brian Marshall estimated “iPod Touch sales soared more than 100%, to 7.2 million, in the final quarter of 2009.”

Peter Farago, VP of mobile app analytics company Flurry, “believes it won’t be just a one-quarter blip.” He continued, “What we know for sure is that a huge new batch of iPod touch users was injected into the system.”

Wired’s Charlie Sorrel puts it into context –

iTunes Store downloads for the iPod Touch leapt almost 1000% on December 25th. That indicates that a lot of kids found iPod Touches under the tree this year.

There are now clearly added temptations in the iTunes Store, with a full line up of music, games, movies, TV shows and pretty much everything else teenagers used to head to the mall to spend their allowances on, and this alone would explain the spike.

“Teens and pre-teens tend to download far more apps than older iPod and iPhone owners,” Gagan Biyani of MobileCrunch quoted Farago. “The iPod touch has clearly become a major player for Apple in terms of app sales.”

App Store

And who’d question Apple’s global cult following? It’s got a user base that’s anxiously awaiting new applications; users are using the apps 30 times more compared to other devices.

Murphy said in an interview with mocoNews, “Steve Jobs quoted 60 million downloads in the first 30 days. That means 10 million iPhone users are outselling the entire U.S. market of 250 million mobile devices.”

App Store hit its one billionth download in April 2009. mocoNews’ Tricia Duryee estimated “about 100 apps are being downloaded every second-that’s 6,000 every minute, 360,000 every hour and 8.6 million a day.”

4 months later in September, Bloomberg reported “more than 85,000 applications are available through Apple’s App Store,” and 2 billion programs have been downloaded.

Just few days ago, Apple hit 3 billion downloads after “App Store saw a 51% increase in downloads from November to December.” Biyani shared his observations:

App Store downloads are 13 times greater than the Android Market. Additionally, the fact that the already-mature App Store saw a 50% monthly growth rate versus the Android Market’s 20% is impressive. One would think that the App Store growth would plateau at some point, but it doesn’t show any signs of leveling off just yet.

True, device sales and download numbers don’t automatically translate into app sales, but it’s likely that they’d trend alongside app sales, as Biyani pointed out.

Yes, the stats look good and the numbers are encouraging. But this is far from a comprehensive analysis, nor does it meant to be. You should do further research to assess future prospects before writing a check. The 2-part series simply aims to provide you with some quick pointers to help you screen more effectively should you decide to invest in the iPhone and iPod Touch platform.

Next, we’ll look at the type of companies VCs are backing and what they dig. Turns out, there’s a place for Android.

Credit: ezioman

They’re young. They’re brash. They expect an immediate payoff, have no respect for their elders, and think technology can replace good, old-fashioned elbow grease.

And work Saturday? ROTFLOL (translation: Rolling on the floor, laughing out loud.)

They’re Generation Y. At least that’s the stereotype.

But angels might want to withhold judgment on these brash young hotshots. They might be worth knowing after all: Turns out, Gen Y entrepreneurs are more likely to succeed in a recession.

The Kids Are All Right

That’s the findings of one “study.” The American Express (AMEX) OPEN Small Business Monitor surveyed small businesses and found 80% of young entrepreneurs, ages 18-28, have a more positive outlook on prospects in the recovering economy.

In its annual 30 under 30 look at upcoming superstars, Inc. calls these young guns a “dynamic group of self-starters that has managed to raise money, launch new products, build new technologies, and tap into underserved markets.”

Old Guys Are All Right Too

But in his brilliantly opinionated article, Vivek Wadhwa finds that when it comes to founding successful startups, old guys rule. Companies with an “old guy” at the helm are far more likely to survive and thrive than companies run by founders who just started growing facial hair.

“The old guy,” which he defines as someone who is 40 years old or more and has at least 2 kids, have been around the block; they’re motivated to get out of their middle-class life and they know a thing or two about running a business.

Heavenly Match

So angels, look beyond generational perceptions, and misperceptions, to see the very real advantages Gen Y and Old Guys can each bring to the table.

As a young South Caroline entrepreneur points out — young guns are more flexible and innovative to make a profit but old guys are more capable of dealing with the ebbs and flows of business.

Experienced angel and Gen Y entrepreneur – could be a match made in heaven.

The research on female angels isn’t one to please the feminist. According to the Center for Venture Research, one third of respondents to a research study [pdf] believe women investors are at a disadvantage because their sources of wealth are more often inherited than earned. Such individuals, then, might not have the professional experience or credibility of investors who created their own wealth.

The Social Science Research Network has also found evidence that female angels have lower levels of confidence compared to men. Also, women tend to be more risk adverse by nature, which can lead to missed opportunities in riskier deals.

The Future Can Be Bright for Female Investors

While findings throughout the industry support the assumptions that women are indeed the weaker sex when it comes to investing, it doesn’t mean that the future isn’t bright for female angels. It simply means they need to get a little money, nerve, and experience to play in the game.

As Dr. Hardaway so eloquently expressed, “I’ve been in about 50 real estate deals and about fifteen tech deals. I am actually a deal junkie. Most of the men I talk to don’t have my stomach for roller coaster rides. But guess what? I’m a woman. They are SMALL deals. I’ve never lost everything, and I have had a fabulous time. I will obviously do this until I completely lose my senses.”