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Angels in America, and elsewhere

3 February 2012
by Patrick Love

Click to see the book on OECD iLibrary

The OECD has just published a report that “aims to provide some qualitative and quantitative information on the angel market”. However, if you’re looking for advice on selling yours, you’ll be disappointed. Financing High-Growth Firms: The role of angel investors is actually about investors who finance new ventures at the start-up phase and sometimes help them with operational expertise and contacts as well. These “business angels” borrow their name from their counterparts in the theatre, people who put up money to pay for new shows.

They fill an important gap by providing external seed capital and early-stage equity, and in many countries they’re far more important than the better-known venture capitalists. The sums they invest are much smaller, around $25,000 to $500,000 compared with $3 to 5 million for venture capital, but it’s vital given how hard it is for new businesses and young entrepreneurs to get loans.

With hindsight, we’d all have invested in Google, Apple, Microsoft and the like, but these were among hundreds of start-ups with little or no collateral and practically no assets other than a good idea, optimism and clever geeks. Yet you can see why banks would be reluctant to lend them money, especially in the present financial environment, and given what’s known as “moral hazard” – in this case the (not unrealistic) fear that the money would end up subsidising a drug and booze-fuelled lifestyle rather than the next Facebook.

Financing High-Growth Firms mentions that angel investors tend to be experienced entrepreneurs and business people who put money in sectors they know well and favour local start-ups, but it would be interesting to see how the angels decide to invest in one project rather than another. I remember reading an interview with a man who’d done well on the stock exchange by putting his money into companies whose products he appreciated and whose market seemed likely to expand, but that’s easier than spotting the potential of something that scarcely exists outside the mind of its inventor. (And even then, there’s no guarantee – do you know anybody who still uses a typewriter?)

Analysis is complicated by the fact that terminology is often vague, with angels, informal investors (founders, family, friends) and informal venture capital used interchangeably. As well as that, individual angel investors usually keep information about their investments private, despite increasing professionalisation and the formation of groups and networks of investors.

Some governments are supporting these groups, and also intervening via other programmes and policies to encourage angel investment, including from tax incentives to co-investment funds.

However, the report points out that there has been little formal evaluation of these policies and programmes to date and policies that worked in one country may not necessarily work the same way, or be as successful, elsewhere.

Useful links

OECD work on innovation

OECD work on new sources of growth

OECD symposium on the New Geography of Innovation and the Impact of the Economic Crisis

OECD Centre for Entrepreneurship, SMEs and local development

One Response
  1. Morgan Thomas permalink
    February 4, 2012

    Moral hazard refers to a situation where one party is tempted to take on excessive risk because they can assume that any losses incurred will be covered by someone else. Insurance often poses a problem of moral hazard. Fannie Mae exposed itself to excessive risk because it felt it could count on the federal government to cover it — even though the latter wasn’t statutorily obliged to. The whole concept of “too big to fail” that pervades the financial system today carries with it an indefinably large component of moral hazard.

    And Woody Allen still uses a typewriter.

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