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Angel Investor Decision Making
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Critical factors in the investment decision
In a recent survey, angel investors and venture capitalists were asked to rank the most important factors when valuing a company prior to investment. These factors were ranked from 1 (most important) to 7 (least important). The following chart illustrates these differences:

Angel Investors

Venture Capitalists

Factors

Points

Rank

Points

Rank

Quality Management

7.1

1

5.4

1

Growth Potential

4.7

2

4.2

4

Proprietary Product

4.4

3

4.4

3

Market Size

4.3

4

4.6

2

Barriers to Entry

4.2

5

4.1

7

Competition

4.0

6

4.2

4

Return on Investment

3.9

7

4.2

4

Table 1: How Angel Investors and Venture Capitalists Value Potential Companies

Taken from Brian E. Hill and Dee Powers’ Attracting Capital from Angels: How Their Money and Their Experience Can Help You Build a Successful Company, 2002.

The results and what it means to the entrepreneur
Even though both groups of investors ranked the factors differently, the table above (Table 1) illustrates that both angels and venture capitalists mostly rely on the top four mentioned aspects (quality management, growth potential, product, and size of the market) when deciding on an investment. In addition, quality management had a higher average point score by angels than venture capitalists (7.1 versus 5.4). This distinction can be attributed to that fact that most angels tend to invest in a company’s early stages. Perhaps that is why they feel the management team is more important when compared to venture capitalists.

In order to successfully raise angel capital, entrepreneurs need to demonstrate the quality of their management team, focus on the potential growth of their company, define their market, prove that the size of their market is large, and that their unique product or service fills a need in the current market.

Due diligence differences
The same survey also revealed time differences in conducting due diligence. On average, most angel investors claim that it takes them approximately 67 days to close a deal whereas venture capitalists take an average of 80 days. This two week difference between both groups of investors can be accounted for different reasons.  One rationale is because VCs have to perform a more extended, careful analysis on their potential investments since they invest more money in a given company and have to answer to their partners who supplied the money to their firm. Their method of due diligence takes on a more complex and formalized approach (have hired staff or human capital) in order to ensure the success of their investments. As a result, their role is more of a wise money manager rather than as individuals who have to decide on investments on their own.

Angels, on the other hand, do not have the supportive staff (lawyers, accountants, technical experts) as venture capitalists do, so they are often left to conduct due diligence of a company themselves.  Since they invest less money into businesses, their due diligence processes much quicker than VCs. They also do not have to rely on paid consultants as VCs do, which results in a more prompt and timely evaluation of a potential company. When angels invest as a group, they are able to spread their due diligence tasks among all organization members, further expediting the process of evaluation.  

Due diligence in angel groups
One of the benefits of establishing angel investor groups is that the entire organization can be actively involved in an investment, including all angel members who conducted a due diligence process of a potential company. The angel network of investors can divide amongst themselves the different due diligence duties, greatly removing the weight of responsibilities and time from an individual investor. In the same respect, each angel member can receive the benefit of all the other angels’ experience and perspectives.

Angels who invest in groups usually look for investments where at least one member of the group has industry expertise. This allows a better understanding when evaluating the risk versus reward of an investment. This will also enable the angel group to provide more valuable experience to a young company after the close of a deal.

As mentioned, angels do not have the luxury of having a team of resources as VCs do in conducting a timely due diligence process. Here are some ways in which angel investors assess a company:

  1. Web research- The internet is a valuable resource in obtaining information about the company and company founders. Certain websites and online membership programs can provide such information, including if the company has been sanctioned, has changed its name several times, etc. They can even provide financial and criminal information about the founders.
  2. The industry- It is important for the investors to find out the existing customer needs in the market or trends in a given industry and if the potential invested company is compatible with market and consumer needs.
  3. Distribution strategy- This is the approach whereby investors can envision the success of the entrepreneur’s company. It also involves manufacturers and distributors who support modern distribution strategies that will make it easy for customers to shop for and purchase their products.
  4. Competition- The knowledge and awareness of any industry competitors, a prediction of their performance, and if they have a competitive edge on entering the market with more superior technologies.
  5. The philosophy of each company- An investor must understand the mission of each company and be compatible with their values and beliefs.
  6. Meet with entrepreneurs- It is important for angel investors to personally meet the entrepreneurs, prepare and ask questions about their company, and to see if they demonstrate the qualities they are looking for in an investment.
  7. Meet with management and staff- By meeting with management and staff, investors can find out if they are high-quality experienced people, can provide a full-time commitment to the company, share similar interests, are coachable, and easy to listen to.
  8. Rely on references. Many angels consider this the most important aspect of due diligence. Third party validation can be acquired from other investors, customers, suppliers, bankers, previous employers, competitors, etc.

An angel’s due diligence plays a vital role in potential investments. By examining market and industry trends, the competitive outlook for a company, and the profiles of the founders and management team, the angel investor can assure the deal is legitimate and establish a foundation for future investment and growth. In addition, due diligence can address potentially significant areas of concern before any litigation can occur.

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