Angel Investors Make Money, Data Shows 2.5X Greater Returns (2023)

Editor's note:Dr. Robert Wiltbank, is a professor at Willamette University, where he and Wade Brooks run an angel fund run by second-year MBA students. He serves on the board of directors of the Angel Resource Institute and is a partner at Montlake Capital (an advanced stage growth capital fund) and Revenue Capital Management (a fee-based lender). He is co-author of two books and numerous scientific articles.

I started studying angel investment returns about 10 years ago because I had a problem I couldn't solve: the investment world seemed convinced that angel investors were idiots. Conventional wisdom held that they made ill-advised investments in very fledgling companies, most of which were doomed to fail. And while they were on the verge of success, savvy "professional" investors simply stepped in, swiped them and reaped the real benefits. Furthermore, the Angels faced a selection problem: all the best entrepreneurs and opportunities would naturally gravitate towards the best VC funds, leaving only the "waste" to the Angel investors.

What then? Are angel investors just ignorant philanthropists or legitimate business investors?

Through research supported by the Kauffman Foundation, NESTA (a UK-based corporate foundation), the University of Washington and the University of Willamette, I have compiled the largest existing dataset on investor financial returns. I didn't seem so naive or incompetent. Although they are not professional investors, most angels are very successful in their own right, mostly as a result of their own ventures. His first-hand knowledge of creating new businesses and new markets seemed very relevant to successfully investing in other entrepreneurs working to do the same.

The best estimate of angel investors' total return from this data is 2.5 times their investment, although the probability of a positive return on each investment is less than 50%. This is absolutely competitive with VC returns.

interested inAndy Rachleff's article suggesting that angel investors don't make moneyit was extensive. The play is thought-provoking and has some really good points. First, everyone must understand that angel investing is a high risk investment; it really is a "home run" game like formal venture capital investments. Second, even with angel investing, an investment portfolio is a great approach. Third, whenever you make risky investments it is a great principle to limit your bet size and make sure you don't invest too much of your wealth in aggressive positions. Valuable lessons from Andy's personal experience investing in venture capital firms in Silicon Valley.

Fortunately, there is now good data on angel returns in Silicon Valley and nationally, and while more research is needed, the data suggests that angel investors can, and often do, make money. Of course, there are more and less capable angel investors, just as there are formal venture capitalists, but as a group they are definitely not ignorant philanthropists. They seem to be generating reliable returns as business investors.

With these data, we don't need to derive from the experience of venture capitalists. Says Andy, "When the average VC fund is barely making money and initial investments are even less attractive opportunities than what VCs are chasing, then the typical angelic returns must be dire." They just aren't. Assumptions like this are problematic because early-stage risky investing does not take place in an efficient market. Angel investors generally act differently than venture capitalists, and the fact that venture capitalists have abandoned the initial investment does not necessarily mean that they have done so because the initial investments are inherently less attractive. (A plausible alternative explanation for why VCs abandoned early-stage investments is a consequence of fund size growth, NOT a reduction in the number of attractive early-stage opportunities.)

Let's take a look at the actual data. (If you're really interested in data, you can read two reports detailing data collection efforts in the US and UK, and a more detailed description of the distribution of results:Kauffman Foundation Return of Angels StudyjInvestment firm Angel von NESTA🇧🇷 In addition to these two professional reports, you can read moreformal academic workon how entrepreneurial experience affects the return of angel investors.]

The common multiple of the data presented in the graph is 2.5 times the angel investment (i.e. $100,000 invested would generate $250,000). It is based on over 1,200 angel investor investments collected separately in North America and England over a 15-year period. It's not very concentrated geographically, either in the 1998-2000 bubble or in any sector. The distribution of returns for the different US and UK samples are nearly identical, a useful check on the robustness of the original North American data. Data does not include “book value” estimates. (If you want more details on these things, you can check out the full reports.)

Here are some important things to keep in mind:

1. With any UNA investment, an angel investor is more likely to lose their money, i.e. earn less than a 1X return. It's risky. However, once investors had a portfolio of at least six investments, their average return exceeded 1x. Irving Ebert of the Ottawa Angels ran an excellent Monte Carlo simulation on this data and found that executing about 50 trades is roughly equivalent to overall 95th percentile performance. It is clear that most traders will fall somewhere in between. Angel investors should probably try to make at least a dozen investments, but this is just a general rule of thumb. This is crucial: every investment must be madeas if it were your onlyoneThe bar cannot be lowered so that you can build a bad portfolio faster.
2. Cash production is heavily focused on winners; 90% of all cash returns are produced by 10% of the outflows. This is essentially the same concentration as venture capital. The second biggest "bucket" of cash returns is in the high volume but low multiple group, the 1X to 5X category. However, it is important to note that this is not soexactlythe same as formal venture capital. These returns happened everywhere geographically (NOT across the Bay Area or Boston), they happened across industries, and most importantly, without accompanying VC investment. In fact, venture capitalists ended up investing in only one in three companies, and the companies they invested in producedlowerReturns than those venture capitalists didn't invest in.
3. When you add it all up, these angel investors (in the US and UK) generated a gross multiple of 2.5 times their investment over an average time of about four years. This return is absolutely competitive with formal venture capital returns. Since the margin of error around these estimates is greater than the risk source and risk expert data, I'm not going to claim that the Angels "outperform" formal venture capitalists. But the assumption that they are cheating themselves out of making money with angel investments is simply not supported by the data.

Angel investors seem to bring more diversity to strategies when investing and building companies compared to formal venture capital. Their entrepreneurial background (85 percent of them are "paid" entrepreneurs) and the fact that they invest their own money takes a step back from the notion that they are just "hacked" VCs. They differ from formal venture capitalists. Some investors focus on capital efficiency, others on shooting for the moon with all the capital they can get. Some actively pursue VC participation, while others consciously avoid VC participation. Many other approaches are constantly being developed.

But before we stray too far from hard data, this is what the Angel Resource Institute (ARI) has been building over the past year or two.HALO report, a quarterly report on angel investor activity in the US. The data on valuations, activity levels, geographic and industry distribution is very interesting and will also provide a quarterly indicator of angel investment returns over time. In the first half of this year, valuations were not high at around $2.7 million before the money, and round sizes are hovering around $550,000 in a variety of sectors. Again, the image seems more representative of angels as legitimate commercial investors. It's also worth noting that angel investing is more widespread across the country than formal venture capital; it's not very concentrated in the Bay Area.

To keep things in perspective, it's important to remember that most companies, even large ones, don't do this.It ismake venture capital investments. Nearly a third of IPOs come from venture capital-backed companies. While this is really impressive considering that VCs invest in less than 1% of startups, it still means that two out of three IPOs come from companies that never had VCs. Angel investors, like savvy entrepreneurs, don't necessarily see the growth of formal venture capital investments as a measure of success.

Nobody celebrates a loan, but for some reason some people like to celebrate a risky investment. Best case: Equity (Angel or VC) is a great assetwith a part of the financial obligation🇧🇷 Worst case scenario: an albatross around the neck...with a part of the financial obligation.

Like angel investors, venture capitalists want their money back multiplied by 50 if they can get it. The idea that angels are dumb while venture capitalists have cornered the market by building big companies is simply not borne out by the data. Now let's get back to the business of selling more product and less inventory!