Ben Romano, Xconomy
Desney Tan is a decorated computer scientist and principal researcher at Microsoft Research where he works on mobile and wearable devices. He’s done well enough to have “a couple extra dollars to toss around,” he says, and he wanted to take his passion for technology up another notch by investing some of those dollars in early-stage companies. But he didn’t know how to get started
“There’s always been, to some degree, a perceived high barrier to entry for getting in either at the entrepreneur side or the investing side,” says Tan, who has spent most of his career at large companies.
Last year, he attended the Seattle Angel Conference, one of a growing number of programs designed to educate wealthy individuals on the basics of angel investing. Now Tan, 37, is participating again, this time committing $5,000 to a pooled investment fund, plus an additional $500 to cover legal, accounting, and other costs.
“If you look at the investment commitment at this level, it’s actually quite low-cost tuition to really get your toes wet in this space, and to learn from fairly seasoned investors,” Tan says.
After evaluating more than 40 local startup companies, Tan and the other conference participants will select a group of finalists and pick one for an investment of about $150,000 at the fifth Seattle Angel Conference next month. Tan is hooked and plans to stick with angel investing for the foreseeable future. It not only dangles the lure of a future payoff, he says, it also makes him feel like he is helping the whole tech sector in the region grow. “The community gets built as a result of people engaging deeply over a longer period of time,” Tan says.
Recruiting new angel investors and growing the community was what John Sechrest, a software developer and angel investor, had in mind when he organized the Seattle Angel Conference (SAC) in late 2011. Modeled on similar programs in Oregon, SAC has helped introduce nearly 80 investors to angel investing, Sechrest says. The winning company selected at the culmination of each 12-week program receives a relatively modest investment, ranging from $100,000 to $205,000 through the first four SAC programs. But the point is to help would-be investors get comfortable making risky, early bets on local startup companies, while also providing nascent businesses a source of exposure and very early capital.
The United States already has hundreds of angel groups—and many have always worked hard to educate potential investors. What’s new is that a few groups with the explicit intent to educate newcomers have taken root, particularly in the Pacific Northwest. “These are rare,” says Robert Wiltbank, a professor at Willamette University who studies angel investing and is a board member at the Angel Resource Institute. “This is actually kind of a Northwest thing.”
Another new one coming to the Seattle area is the Pipeline Fellowship. Begun three years ago in New York, it is an angel investing boot camp for women that is expanding to Seattle this fall. The aim is to be “a launch pad into angel investing” for women, with a specific focus on women-owned social enterprises, says founder and CEO Natalia Oberti Noguera.
These new efforts are helping to meet a growing demand for education about angel investing, driven by media coverage, awareness of the JOBS Act and crowd-funding platforms like Kickstarter, and shows like Shark Tank, says Marianne Hudson, executive director of the Angel Capital Association, a national trade group with 12,000 members.
“More people are thinking, ‘Hey, I could be an angel,’ and realizing they need to get a good grounding in being a good investor, or they’re going to lose their money,” she says.
That good grounding may be particularly needed in Seattle, which has a reputation for punching below its weight-class when it comes to entrepreneurship and angel investing. New data from the Kauffman Foundation on entrepreneurial activity found just 220 entrepreneurs per 100,000 people in the Seattle-Tacoma-Bellevue area, despite the presence of major technology companies like Microsoft and Amazon, and the region’s depth of technology talent. That’s a lower rate per capita than all of the 15 largest U.S. metropolitan statistical areas, except Chicago (200 entrepreneurs per 100,000 people) and Philadelphia (180 per 100,000). San Francisco led the pack with 570 entrepreneurs per 100,000 people. In addition, Northwest-based angel groups accounted for only 7.7 percent of 2013 deals nationwide tracked in the latest report on angel investing trends from the Angel Resource Institute, CB Insights, and Silicon Valley Bank. Most of the deals—18.6 percent—are done by California groups.
One common explanation for the perceived dearth of angel investors in Seattle is that many people here followed a more conservative path to wealth, such as working at a big, established tech company such as Microsoft or Amazon.
“Most of the Microsoft and Amazon millionaires didn’t start Microsoft and Amazon and weren’t there when it was a young company,” says Michael “Luni” Libes, a serial technology entrepreneur and angel investor. “They’re wealthy now, but they’re not entrepreneurs, and so their first thought isn’t to turn around to be angels and feed the next generation of entrepreneurs.”
In contrast, Wiltbank points out, the typical angel investor is someone who has built and sold a business.
“They cashed-out as entrepreneurs,” he says. “Cashed-out entrepreneurs know that you actually can make money doing entrepreneurship. Rich people who’ve never done entrepreneurship are much more skeptical of that fact. … If you’re a multimillionaire from Weyerhaeuser, you’ve spent your whole working life watching startups come and go.”
But with the right encouragement and training, people like John Sechrest believe, more of these millionaires could become enthusiastic angel investors—defined as people who put their own money into start-ups, in contrast to venture capitalists who typically invest others’ money. An active community of early stage, risk-tolerant investors is widely considered a key ingredient to a healthy innovation economy.
Who can be an angel?
An angel investor must be an individual accredited investor, meaning that he or she earns at least $200,000 a year ($300,000 for a married couple), or has a net worth, not including primary residence, of at least $1 million.
There were more than 9.6 million U.S. households with a net worth of at least $1 million in 2013, according to the Spectrem Group, a research firm focused on affluent investors. More than 1.2 million U.S. households have a net worth of $5 million or more. “I think they’re the ones that are more inclined to be angel investors,” says Spectrem Group president George Walper Jr. Only 132,000 households have a net worth of $25 million or more, he adds.
The Center for Venture Research at the University of New Hampshire counted nearly 135,000 individual angel investors active in the first half of 2013, up about 3 percent from the same period in 2012 (PDF).
The pool of potential angel investors looks likely to change, but with several different regulations in play, it’s difficult to say whether the number will shrink or grow.
The Dodd-Frank Wall Street Reform and Consumer Protection Act requires the SEC to review its accredited investor definition every four years, beginning this year. Last summer, the Government Accountability Office studied the current standard, which covered, by its analysis, about 8.5 million U.S. households in 2012 (PDF). It examined potential alternative criteria that would balance investor protection with efficient capital formation. Some suggested alternatives would make adjustments based on investors’ understanding of financial risks or set a minimum threshold of liquid assets.
Also, part of the JOBS Act passed in 2012 allows non-accredited individuals to invest small amounts in private companies, though regulations have yet to be finalized. Washington State also just passed a crowdfunding law allowing companies to raise up to $1 million a year from non-accredited Washington investors, with income limits on how much they could invest.
Once people have met the accredited investor threshold, what prompts them to delve into angel investing?
For Desney Tan it was the combination of having the necessary wealth, an interest in technology and innovation, and the desire to gain new skills and experience. It’s hard to claim that you do innovation “without understanding all the different ways of doing it,” he says.
Another common way in to angel investing is through social relationships.
The majority of new members in the Seattle-based Alliance of Angels, for example, come from referrals. “Existing members had a good experience and tell their friends all the fun they’re having,” says managing director Yi-Jian Ngo.
SAC also taps existing investors’ social networks and local events such as Geeks on a Trail and Open Coffee to connect with new participants—particularly those who might have self-selected out of angel investing because they believe that the buy-in is too high. “I think that there’s a fundamental breaking point for accredited investors,” Sechrest says. “People who are above $5 million can invest in ways that people below $5 million probably shouldn’t.”
SAC’s group-investing model is particularly suited to the latter category, he says. “We’re looking at people at Amazon or Google or Facebook or Microsoft who earn $200,000 and are [accredited] investors on income instead of net worth.”
How to become an angel
So how can you train a wealthy individual to be a savvy angel investor? Many angel groups, such as TiE Angels Group Seattle, don’t make this an emphasis. “TAGS members are typically accredited investors, who are corporate executives, serial entrepreneurs, academicians, community leaders or accomplished individuals who may not need training,” explains group chairman Haresh Ved in an e-mail.
For those who make the attempt, the standard approach is something akin to an apprenticeship.
“The only way that appears to be effective for learning how to be a good angel is to do this with more experienced angels,” Ngo says.
Element 8, a cleantech-focused angel group based in Seattle, provides mentoring, workshops, and collective due diligence sessions led by more experienced members. And the Keiretsu Forum Northwest has hosted a monthly due diligence training class over the last couple of years with over 800 attendees, says Northwest Region president Nathan McDonald.
There is of course an enlightened self-interest at play here. The experienced investors benefit when more of their fellow angel investors can lead deals. But the willingness to teach fits into a broader theme that everyone I talked to for this story underscored: Angel investing is about making money, yes, but it’s also about giving something back. “‘I want to help the next generation of entrepreneurs succeed.’ It’s a very common reason, or motivation,” Ngo says.
But even these efforts leave a clear gap, says entrepreneur and angel investor Libes, who began an incubator called Fledge to help educate social-enterprise entrepreneurs at about the same time that SAC was started. “We have so many programs in the city focused on the entrepreneurs,” he says. “And the angel groups, they have a little bit of training, guest speakers and so forth. But their method has been to drop [new investors] into the deep end of the pool and say ‘Go.’”
SAC was set up to fill that gap. It educates aspiring angels in a more formal way through workshops covering the basics of angel investing, due diligence, and term sheets. That’s followed by three months of weekly due diligence meetings during which participants evaluate dozens of nascent companies in a wide range of industries. Past winning companies include Illumagear, maker of a helmet safety lighting system for construction workers; Piper (previously called Daily Dollar), which offers a cloud service to replace paper receipts; and Booktrope, offering Web-based tools for various aspects of book publishing.
The program is designed with first-time angel investors in mind and offers a minimum investment level that allows them to experiment without feeling over-exposed. The idea is to learn by doing—with a lot of help, says Josh Maher, a SAC organizer who got involved after finding success as a real estate investor. “OK, you want to do an angel investment? Let’s do one,” he says.
Organizers aim for about half of the 20 to 40 people that participate in each program to be first-time angel investors.
The participants are guided through the process of winnowing down a pool of 40 to 50 applicant companies—each of which pays $100 to attend the culminating conference—by more experienced investors, and by newcomer peers with different perspectives. They read through business plans, listen to entrepreneur presentations, and attempt to independently validate everything the companies say about things like market size, competitors, customers, and revenue, says Sechrest, a former economic development director in Corvallis, where he helped set-up the Willamette Angel Conference six years ago, modeled on earlier programs elsewhere in Oregon. When he moved to Seattle in 2011 his goal was to replicate that success.
The process can give participants a new way of looking at businesses, among other things.
Desney Tan has spent most of his technology career at big companies that have their own well-structured ways of doing things like forecasting market potential for a new venture—practices that can be worlds away from the approach angel investors take to evaluating nascent businesses that may still be looking for their first customers.
Working with a diverse team through SAC, Tan says, “has opened my eyes to the range of methodologies one can use to evaluate markets and businesses, and make those projections. They [the other SAC participants] each bring slightly different viewpoints as to how to find big winners.”
The SAC participants narrow the field to six finalist companies who present at the culminating conference. They select a winner to receive the investment, usually in the form of debt that converts to equity when the company raises its next round of capital. (SAC participants learn about deal structuring, too, and smaller groups may also decide to make separate side investments in the finalist companies.)
It’s too early to say what impact SAC is having on the ranks of active angel investors in Seattle.
A “very small minority” of new members in Alliance of Angels last year came from SAC, says Ngo. And representatives of Element 8, TAGS, and Keiretsu Forum Northwest, say they know of no SAC members who have joined their ranks, though some have attended meetings as guests. The existing angels expect it to take time for new angel investors to gain confidence and step up their activities. It can take two to three years for people to find out whether angel investing is right for them, Ngo and others say.
The experience in Oregon suggests that programs like SAC could eventually make a difference, however. Wiltbank, the Willamette professor, says he hasn’t seen any empirical evidence, but has noted new angel investors and more activity in the areas where the conferences on which SAC is modeled have been running for longer.
The model of educating new investors through the course of an actual investment began around 2005, when organizers of Oregon Angel, an education conference and startup pitching event begun in the late 1990s, formed a fund to invest in the winning startup. About a dozen investors in that fund—some of them rookies—made up about a third of the initial investors in the Oregon Angel Fund, a group that now numbers 170 and has $7 million to invest this year, says founder Eric Rosenfeld. Since then, the new investor conferences have been a steady, if small, source of new members in the Oregon Angel Fund.
“Almost every year there’s one or two people that ask to join the Oregon Angel Fund from one of those events, people we haven’t met before,” Rosenfeld says.
If there is one concern with programs like Seattle Angel, it’s that it is conditioning new investors to think that angel investing means making the occasional $5,000 investment. McDonald, whose group has sponsored the similar events in Oregon in the past, applauds efforts to get more individuals involved. But, he adds: “At the end of the day, companies typically need hundreds of thousands of dollars. We need more $25,000, $50,000-plus check writers. … $5,000 a year ultimately doesn’t make much difference in the angel capital marketplace.”
Sechrest agrees, but also sees a role for smaller check-writers like the ones he’s trying to serve with SAC, and his next step is to create a mechanism for them to write small checks more frequently.
Research by Wiltbank and others suggests that angel investors with more companies in their portfolios have better chances of success. Hypothetical investors with $1 million net worth might devote at most 10 percent of their portfolios to angel investments. To spread that $100,000 across a portfolio of say 20 angel deals means individual investments would typically be too small to be worth the effort for even very early stage startups.
That’s why angel investors band together in groups.
Sechrest is now working on Seattle Angel, which would be an umbrella organization including a fund to enable a group of less-wealthy accredited investors to pool their checks and make more, smaller investments. He hopes to have this fund up and running next year, and sees it as another way for the broad population of people with more than $1 million but less than $5 million to make angel investments, and put the skills they may have learned in SAC to work, leading new deals.
“What we’re trying to do with this is increase the bottom end of the angel investing community so we have a strong startup ecosystem,” he says. “To do that… we need to grow more lead investors.”
Seeing success, but taking time
While the impact of efforts like Sechrest’s may take some time to be seen, early-stage investing in Seattle could also get a boost from the region’s recent run of successful initial public offerings. Zulily and Tableau Software went public in 2013 and watched their stocks soar. Zillow did so in 2012. Employees with stock options could become tomorrow’s angel investors, bringing with them the perspective and experience of being inside a company during its high-growth phase.
Libes is among those hoping that the wealth from these companies “will recycle faster than the Microsoft and Amazon wealth.”
Keiretsu’s McDonald adds “there’s money definitely spilling out” from the wealth those companies created. The IPOs have had a clear positive psychological impact on area angel investors, he says.
“Having Mark Vadon make half a billion dollars in one day is pretty sweet,” McDonald says of Zulily’s co-founder, whose 30 percent stake in the company was worth more than $1.2 billion by the end of the first day of trading last November. Venture capital firm Maveron also had a phenomenal return on its early investment in Zulily, he adds.
That said, McDonald hasn’t seen new angel investors showing up to Keiretsu meetings as a result of the IPOs. Not yet, anyway.
“It takes some time to ripple through,” McDonald says. “It’s definitely out there.”
Chris DeVore, a venture capitalist with Founders Co-op (which just raised $10 million for its third investment fund focused on early-stage Pacific Northwest software startups) and managing director of Techstars Seattle, says investors from other sectors are also paying attention.
“I *am* seeing more non-tech investors dip their toe in the water of early-stage tech investing, so that’s a plus, and I’d attribute it to a generally broader awareness and more positive view of the strength of the Seattle tech ecosystem and its ability to create value for investors,” DeVore says in an e-mail.
However, he can’t point to any specific uplift in investing activity or new angel investors either from the recent IPOs or programs like the Seattle Angel Conference. “I know it takes time for these things to play out,” he says.
Time has also been a factor for Desney Tan, the Microsoft researcher participating in the SAC. “The time commitment is perhaps a little larger than expected,” he says. “But the fun and the impact on my world view was also more significant than I was expecting.”
Two things in particular stick out. He has been surprised at the “raw energy” of the startup scene in Seattle, and of the entrepreneurs he’s encountered. He has also come to realize that angel investing can be an intensely personal experience.
“We’re not dealing purely with businesses and numbers here. These are people with dreams,” Tan says. “We’re really … enabling these dreams, and doing it with something that happens to be an investing tool, but it’s greater than that.”