Startup Funding Outlook: The Angels Are Coming!

Last Updated Sep 20, 2011 7:39 PM EDT

Attention, entrepreneurs: The planets have aligned for the right startups to find their angels between now and the end of the year. An incentivized and increasingly sophisticated angel community is making a greater number of investments and with a high degree of urgency.

The reasons why are varied, but significant:

1. Angel investors are taking advantage of federal and state tax breaks on small business investments. The Wall Street Journal's Eleanor Laise points out, "...under a law enacted late last year, investors won't have to pay capital gains tax on certain small-business stock they acquire before the start of next year."

So the clock is ticking. There are certain requirements though, such as holding the stock for more than five years. Check the SBA Site for more information on the Small Business Jobs Act of 2010.

In addition to federal tax incentives, 18 states currently have angel investment tax credit programs. The incentives vary from 100% in Hawaii to 10% in New Jersey. States offering 50% or more include Kansas, Louisiana, Oregon, Arizona, Virginia, and West Virginia. The full report is available at Angel Capital Association.

2. The proliferation of angel networks. In the past year alone, the number of angel groups has grown to 340, an increase of 13%, according to research conducted by the Angel Capital Education Foundation. You can find an angel network by visiting the website Angel Capital Education, where they are listed by region.

3. It's easier than ever to find investors. In the past, individual angel investors and companies seeking capital have had a difficult time finding each other. This no longer needs to be an obstacle with the proliferation of websites like AngelList, an online network that unites investors with potential investments. It's similar to a dating site, with investors and startups searching for the perfect match-up. Equally important, the site identifies and profiles an ever-growing list of critical "connectors" -- influential folks who play an invaluable role in connecting angels and startups. The site also shows the deals the connectors have helped make happen and where to find all the key players.

4. Innovations in portfolio management. A small segment of financial advisors are embracing a new investment approach called Hybrid Portfolio Theory (HPT). It is a new paradigm. It splits an investment portfolio into two components. The majority of a portfolio represents 75-90% of total assets usually consisting of short-term high liquidity, lower-yielding instruments.

The remainder representing anywhere from 10-25% is called Positive Asymmetric Outcomes (PAO). According to Venture Populist, a PAO is defined:

...by its ability to generate high double digit or multiples of return on investment, as can be achieved by successful investments in venture capital, private equity, direct (angel) private investment in start-up, small business, private manufacturing business, private real estate, private debt, franchises, operating cash-flow businesses, as well as, publicly traded emerging growth companies and leveraged option strategies or highly-specialized investment strategies such as managed futures.
These portfolio managers are competitively distancing their practice from the vast majority of investment firms by offering a distinctive value proposition. As a result, they are creating a new crop of angel investors and this trend is expected to continue.

Currently, there are more than 300,000 active angel investors in the United States. However, the potential pool is much larger since there are millions of wealthy individuals with the discretionary net worth to make angel investments.

Angel investors collectively invest around $25 billion per year in North America. That is as much as all venture capital funds combined. The average investment is anywhere from $25,000 to $250,000. And the majority of the startups they fund have no revenue at the time of the initial investment.

The use of the term "angel" to describe investors hails from the Broadway and London Theatres, where it was used as a term of endearment for the affluent individuals who invested funds in productions. The word, like the process itself, has since evolved to define those who invest their private capital in startup companies that have the potential for rapid growth. Considering the industry's prosperity in the past decade, we can expect further advances in its sophistication as well as its increasing role in funding emerging companies. For investors and entrepreneurs alike, it's show time.

Read more: