Does Angel Funding Help Startups?

In this guest article Scott Shane (who wrote “Fool’s Gold? The Truth Behind Angel Investing in America”) reviews recent research from the Harvard Business School into the benefits of Business Angel funding for businesses. For a potential or actual Business Angel, it makes for a very interesting read. (Originally published here by American Express Open and Scott Shane).

If you are thinking of raising capital from a business angel, you probably want to know if getting that funding will help your business.  More specifically, you are likely interested in learning whether angel financing will benefit you enough to justify trading equity in your company for the investment.

Unfortunately, academic research doesn’t provide an answer.  No study indicates how much of your company you should give up to obtain angel backing.

A recent Harvard Business School working paper by William Kerr, Josh Lerner and Antoinette Schoar examines whether getting angel funding benefits start-ups. While the study provides suggestive evidence that it does, it can’t rule out the alternative that it doesn’t.

The authors looked at companies that sought funding from two angel groups – Tech Coast Angels and Common Angels – between 2001 and 2006.  Focusing on those ventures that just met and just missed the groups’ funding criteria (to avoid having their results being biased by dogs and stars among potential investments), the authors find that getting angel money increases the odds that the ventures survive until 2010, but not the odds that they get additional financing from a source other than the angel group.

(They also show that getting angel money affects subsequent web traffic, but since web traffic isn’t a goal of most entrepreneurs, and no one knows what dimensions of firm performance web traffic is correlated with, I leave this measure aside.)

The authors conclude that “the results of this study… suggest that angel investments improve entrepreneurial success.”  Perhaps, but I’m not so sure.

First, getting angel money doesn’t help the startups get subsequent financing, so how does getting angel financing help?  The authors say that “’softer’ features, such as their mentoring or business contacts, may help new ventures the most.”  Maybe, but there’s no direct evidence that the financed groups received more mentoring or had access to more contacts than those who weren’t funded.

Second, survival is a strange measure of performance for angel backed companies. Few, if any, angels make investments in companies with the hope that they will merely stay in existence.  They are hoping that the companies in which they put their money are going to go public or be acquired.  The ventures funded by angels might be more likely to survive than those not funded not because they are performing any better, but simply because the angels’ money allows them die slower, increasing their chances of being the “living dead” – companies that aren’t going anywhere but haven’t yet run out of cash and failed.

(If the authors had found that getting angel funding was related to a measure of “successful exit” that combined having an initial public offering with being acquired in a transaction where investors made money, I would be more convinced.)

Third, Tech Coast Angels and Common Angels are among the most successful angel groups, having a relatively high share of positive exits among their portfolio companies.  There’s no way to know whether getting money from more average angel groups will increase a new venture’s odds of survival.

In short, while the authors wrote a very interesting academic article, we still don’t know if getting angel money improves the performance of startups.

(Originally published here by American Express Open and Scott Shane).

This Post Has 3 Comments

  1. This is an interesting article but made me wonder where our investing Non-Executive Director service fits in with these angel investing activities? Most start-up and early stage companies in my experience need a high calibre successful Non Exec or two even more than they need funds (although they might well not be aware of this) – with our investing Non Exec service they get both investment and a “wise owl”.

    Is therefore an investing Non Exec not likely to be more beneficial to a young company than an Angel investor – what do you think?
    Chris Spencer-Phillips.
    MD First Flight

  2. Whether angel investing is good or bad for you, this is probably the best time ever to get angel funding for a number of reasons, but most of all the EIS (Enterprise Investment Scheme) currently in place in the UK!

    More detail on the government’s site:

    Andries Smit
    MD LEAP in Life Business Builders

  3. My view is that while EIS is a nice “cherry on the cake”, the most important reason for investing is the return obtained. There are other taxes that more than obliterate the benefit of EIS (assuming you keep within the rules).

    What would be nice is a simple tax system!

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