Angel Exits Study

According to Nelson Gray, business angel investor, special projects advisor for LINC Scotland and European Business Angel of the Year in 2008, “the overall impression when talking to Angels around the world is that they have become frustrated with the lack of successful exits or liquidity events, resulting in them not receiving the return on their investments they hoped for.” This concern can be linked to broader criticisms of the UK angel community for focusing too much on the art of making investments, and research for documenting investment activity, and ignoring returns, which, it is claimed, discourages investment (Jeff Lynn: TechCrunch: 5/8/10).

Exits are the most critical part of the investment process. First, they reward entrepreneurs for the risks they have taken and facilitate repeat entrepreneurship. Second, a lack of exits constrains the re-investment process which is the biggest barrier to the growth of angel investing. Third, with the growing number of co-investment funds investing alongside business angels the lack of exits is now also an issue for the public sector. Fourth, exits enable angel groups to demonstrate their ability to make a financial return to attract new members and retain existing ones.  However, previous research indicates that the exit is not considered in the investment decision.  The UK angel community has typically operated on the basis that, in the words of one prominent angel group gatekeeper, “good investments will always find exits”. However, this approach to investing is no longer effective – if it ever was. Achieving exits is now the biggest challenge for angel investors, not just in the UK but around the world.

However, the body of academic research on business angels that has been developed over the past 20-30 years is unable to inform the investment community on best practices. Although studies have been undertaken of deal flow, investment decision making, deal structuring and post-investment relationships, and there are a few studies of investment returns, the literature has virtually nothing to say on exit strategies.

The overall objective of the research is therefore to provide greater understanding of how business angels can create and realise value in their investee businesses. Specifically, what mistakes lead to failed investments? And what practices are associated with high returns?

The study has developed two themes. First, it examines the changing organisation of the angel market from one that is largely invisible and fragmented, dominated  by individual angels who wish to remain anonymous, to one in which organised angel groups are gaining prominence. These groups typically appoint a manager – termed a gatekeeper – who, in some cases, is a member of the group but in other cases is an external appointment to manage the investment process.

This is an important development for two main reasons. First, our understanding of how business angels make their investment decisions is based on studies of individual angels. We don’t know whether angel group gatekeepers operate in the same way. Do they screen investment opportunities in the same way as individual angels? Is the investment decision based on the same criteria? This has obvious implications for entrepreneurs approaching angel groups for finance. Second, what is the effect on the shift from solo angels to angel groups on the types of investments being made? It is already clear that angel groups make bigger investments than solo angels and are more likely to make follow-on investments. Does this mean that the angel market is following the same path as venture capital funds by shifting to larger, and later stage, investments.

These – and other – issues are examined in the project’s first Working Paper which looks at the nature and transformation of the angel market in Scotland. The emergence of angel groups has progressed further in Scotland than anywhere else in the world, outside of the USA. The study is based on interviews with 19 gatekeepers. It covers the formation and organisation of the groups, investment activity and outcomes, investment decision-making criteria and exit strategies.

The study has also interviewed over 30 individual angels to examine their investment decision-making criteria, exits and exit strategies.

The investment decision-making of both gatekeepers and individual angels has used the technique of verbal protocol analysis. This asks respondents to ‘think out loud’ as they perform a task, in this case considering a real investment proposal. This material will be written up in a second Working Paper which compares how gatekeepers and solo angels make investment decisions.

A third Working Paper will look specifically at exit strategies, looking specifically at whether the exit is considered when angels are appraising investment opportunities, and whether angels and gatekeepers have pro-active strategies for achieving exits.

, a PhD student from Portugal, is also associated with this research. His research is focusing on two themes. First, he is investigating the investment criteria of angels and gatekeepers using several methodologies (ranking, verbal protocol, conjoint analysis) to examine the extent to which findings are related to methodology. Second, he is developing a typology of business angels to examine whether such groups have similar approaches to investment decision-making.