Other myths

Here are a couple more misconceptions and myths.

I don’t have time to be an angel investor. False. Members of our group attend a 2-hour meeting 10 times a year. (Obviously many do more than that serving on diligence teams or reviewing their findings, being active mentors, advisers, or board members to portfolio companies , etc. – but none is required.) Investors in our funds like the VentureSouth Angel Fund II as entirely passive – no time commitment required.

This is just for men. False. Nationally, around 25% of angel investors are women. Some funds, like our coinvestment partner The Jump Fund, are women-led and focused on female entrepreneurs. Every VentureSouth group has a strong showing from female members, and all meetings are open to spouses. All are welcome.

What else have we missed?

Myth #8: There aren’t enough unicorns in the southeast

This “myth” is true – there aren’t many unicorns in the south east, and none in the Carolinas. There are also virtually no IPOs in the south east – perhaps six in North Carolina and one in South Carolina each year.

Certainly if your investment thesis is to find the next unicorn, Greenville SC is not the best place to do it. But that is not what we are looking for.

We do have a couple of companies where an IPO is a reported goal or a feasible exit. Proterra, for example, just raised $140MM from VCs and has incredible momentum – and an IPO is an obvious possibility.

But those are the exceptions not the goals. As I outlined in “Stand-up comedian entrepreneurs in America,” we aim for companies whose goal is be acquired for $20 million to $50 million (and perhaps more if things go very well). If we can turn an investment at a $2 million pre-money valuation into a $20 million exit, investors are very pleased with their 10x return.

This is absolutely feasible in the southeast. The Carolinas are good at business formation: for example, NC is ranked #8 and SC #14 for startup formation by the Kauffman Foundation, and entrepreneurs (and everyone!) are moving to the Carolinas from everywhere else. We pride ourselves on a tradition of lighter regulation (SC ranks #14 for lightness of small business regulation according to Pacific Research) – though perhaps more than we deserve (NC ranks in the worst half). So there are plenty of candidates and a business climate supportive of growth.

And on exits the regime is also good. “Small cap” M&A (deals of, say, $25 million or less) generally doesn’t make headlines, but it happens often. According to Watermark Advisors’s December 2016 “Watermark Wire” report, the median deal size in South Carolina in 2016 was $31 million and in North Carolina, $27 million – that is, most deals are done at values of $30 million or less.

And there are a lot of them. Watermark tracked $900 million-worth of M&A where information was disclosed. By number of deals these were around 25% of the volume, so the total acquisition activity in SC alone could be $3 billion a year. For North Carolina, it was multiples of that.

This is the exit process for our companies. Acquisitions for $35 million, undisclosed amounts of similar sizes in private transactions that do not make TechCrunch headlines but do generate positive investment returns.

Myth #7: It takes too long to reach exits

This is too often, unfortunately, true. Startup companies take a long time to mature into middle market businesses that large companies are interested in acquiring. Everything takes longer in a startup – from building up a base of engage clients to replacing your laptop when it breaks down.

VentureSouth has several portfolio companies in its portfolio that are past the “3-5 years” that is our target “hold period.” Other nearby funds are still working on companies they invested in during the early 2000s. (This is not necessarily bad. The “home run” multiples in the angel returns studies take a long time to come to fruition!) But no-one has infinite patience, and we have to prove that returns can occur before the investments are inherited by our children.

And we have done that. The average investment time for the successful exits from the VentureSouth portfolio is 1.6 years. Our shortest was 3x our investment in 3 months (a 2800% IRR). So if you set out to invest in companies with a 3-5 year plan and the capacity for an “early exit,” get management and investors aligned towards that, and give companies the tools, processes, and advice to execute them, you can get capital returns in a reasonable time frame.

Myth #6: It costs too much to be an investor

Finding deals yourself; conducting your own diligence; negotiating a deal; paying attorneys to create a suite of transaction documents; paying accountants for tax returns each year; chasing management teams to provide the information to monitor your investments; finding ways to assist your companies to grow; and figuring out how to get your investment back again. The cost of that in terms of time and capital is high. So, yes, it can be expensive to be an angel investor.

In VentureSouth, we do all this centrally, and define the price for it. The time commitment from members then becomes a couple of hours a month for meetings (for active members) or zero (for passive fund investors). The cost is the annual membership fee or fund management fee (for the deal flow, diligence, negotiation, and administration) and carried interest (for monitoring, assistance, and exit). You can learn more about our costs here, here, and here.

Doing this for over 200 people leads to significant economies of scale, as you can guess. (One deal for 60 people is obviously much less cost than 60 separate deals would be.)

Is it expensive? It depends on your perspective. Consider our most recent fund, the VentureSouth Angel Fund II. The management fee is 2% of capital per year – not dissimilar from an actively managed ETF expense ratio, and identical to the typical private equity or venture capital fund’s management fee. (The “2” in the “2/20” structure.) The carry is 10% - half the usual “20%”.  

Then factor on top the value from being part of a group - the networking from being part of a group of business and community leaders, the intellectual challenge of evaluating companies, the satisfaction from helping entrepreneurs realize their dreams, education opportunities, and free food at meetings – and the membership fee seems pretty reasonable.

Myth #5: Angel investing is for philanthropy or fun, not making money

Angel investing is about making money. VentureSouth itself is a private business (a SC LLC), not a government entity and not funded with public dollars. (Venture Carolina is a separate 501c3 non-profit that provides education for entrepreneurs and investors, funded by private donations.)

We get paid primarily from carried interest – that is, we take a share of the capital gains investors make from good investments. (A much smaller share than the IRS already takes incidentally; and aside from Trump coming after us “paper pushers…getting away with murder”.) We don’t get paid if investments lose money.

But aside from business structure and incentives, members know that the primary focus of our groups is attractive financial returns. Our motto is “Make Money. Have Fun. Do Good” – in that order.

Is that true more widely? Do angel investors make money from angel investing, or is their activity simply (even if inadvertently) philanthropic?

Certainly returns on deals vary; they vary over time, geography, investment strategy, and level of good luck. But there are studies that suggest that, done properly, angel investing is a legitimate “asset class” capable of generating positive returns. Our series of posts last year (starting here, then with more analysis here, here, here, and here) we outlined the overall conclusion that angel investing as an overall asset class beats public market investing by 3x.

Investors in our groups have made money investing locally too: overall, the 11 investment rounds that we have exited successfully have generated a 60% annual rate of return.

Myth #4: You need to be an expert

Nope. Most people (nearly two-thirds) that join VentureSouth tell us that they are becoming angel investors for the first time.

This is not deliberate: we are not seeking out people that do not know what angel investing is. Finding them, educating them, and then helping them navigate how to be an effective angel is not the most efficient operational model!

But it is necessary, because in the Carolinas there is not a long history of angel investment. In New York, it’s hard to move without bumping into an angel investor; in Anderson, it’s quite a bit easier. Our operating model is to find people that could be interested in becoming an angel investor, and then give them the tools they need to decide.

These tools include:

Educational events. Taking a look at our events page will give you a flavor of the educational events available to members. We start with a new member orientation session and instruction packet, to help new members understand the basics. We have online webinars and in-person educational sessions on specific topics pertinent to angel investing – from “intro to deal terms,” to “valuations of early stage companies,” to “executing exits” – covering the whole range from investing to realization. We also provide access to the Angel Capital Association’s suite of educational topics. If we had a bigger budget, we would love to do more of these activities.

In house expertise. The VentureSouth team do this, and nothing else, full time – and we are beginning to know what we’re doing. We unashamedly steal the best practices from across the US – in part thanks to Matt’s presence on the ACA’s board of directors.

Established processes. We screen, evaluate, and invest in a standardized way. This month’s deal is compared to all the others we have considered, so a new member can quickly and easily “calibrate” this opportunity against earlier ones – even if they hadn’t seen those ones.

Support from our sponsors. Banking services, legal documents, accounting and tax returns – headaches that a startup entrepreneur (or us!) cannot afford the time or capital to learn about on their own. Thanks to Wells Fargo, Nelson Mullins, Bauknight Pietras & Stormer, and many others, we have the resources to tackle all the technicalities of angel investing; new angels are in safe hands.

Myth #3: It takes a long time to build a portfolio

It simply does not take a long time to build a portfolio of angel investments. When we published the first article, there were 13 investment opportunities available to our members, so you could create a pretty well-diversified portfolio immediately in theory.

This wasn’t an unusual position. Currently (mid-March) we have 12 open rounds available, of which five are new since the first article – a combination of new investment opportunities that have successfully navigated our diligence process and follow-on rounds in existing portfolio companies.

VentureSouth members invested in 15 companies last year (8 new ones and 7 follow-on rounds). Our Palmetto Angel Fund fully invested its capital in 2½ years, and the successor VentureSouth Angel Fund II has already called and fully invested 25% of its capital, only six months into its investment period.

Of course, investing individually or as part of a single angel group limits your deal flow and extends the time it takes to create a portfolio. But larger groups can tackle the workload of diligencing and monitoring a diverse portfolio. We aren’t quite as prolific as Tech Coast Angels (the #1 angel group in the US), who have invested in an average of 20 deals per year since 1997, but for the last few years we have not been far behind.


Myth #2: You need to invest a lot of money

Following the math in the original article, you can create a portfolio of investments as a VentureSouth member for $50,000 (10x $5,000 investments) to $100,000 (20x $5,000 investments). The minimum commitment to our previous sidecar index fund, the Palmetto Angel Fund, was $25,000; it invested in 18 companies.

In general, advocates of angel investing say your angel portfolio should be at most 5% of your investable assets – this is a risky asset class after all. $50k of investment translates to $1 million of investable assets – approximately the accredited investor definition.

So you don’t need millions of dollars to be an angel investor. The returns from angel investing are probably not going to change your overall portfolio return substantially (it’s hard for 5% of your portfolio to change its overall direction), but they could be a nice bonus that is not correlated with the rest of your portfolio.

And you don’t necessarily need to invest using "unused" cash. Many of our investors use a small proportion of their retirement accounts to fund their angel investments. If you just made this year’s IRA contribution and weren’t enthusiastic about more public equities at the “new normal” of 20x P/E, perhaps a self-directed IRA commitment to a VentureSouth sidecar fund might be an alternative this year?

Myth #1: Not many people can be angel investors

Anyone can invest in early stage companies. (You can invest as an “unaccredited investor” in certain situations or platforms, subject to limits on how much you invest and rules on how many other unaccredited investors are investing with you. But for simplicity, we’re only talking about accredited angel investors.)

To be an angel that invests in multiple companies with management teams you don’t already know, you really need to be an accredited investor. That does not mean you need to sit an exam and receive “an accreditation.” It simply means you have a certain level of net worth or annual income.

These levels are defined by the Securities and Exchange Commission, at $1 million of net worth (excluding your primary residence) or annual income over $200,000 for individuals (for the last two years and expected this year) or $300,000 for couples.

(There are potential changes to this definition, to allow people with “expertise” (e.g. CFAs) to be angels even if they don’t hit the thresholds, or to index-link the thresholds, but this doesn’t really change the overall point.)

So how many people are there that could be angel investors? The national Angel Capital Association estimates over four million people in the US are accredited by wealth. An estimate by Deloitte put the figure for millionaire households (a pretty good proxy) in South Carolina at around 110,000 in 2010 and 190,000 by 2015, and for North Carolina around 287,000 in 2010 climbing to 431,000 by 2015.

(Here is the pdf of that study. The study was from 2011, and, given the economic growth and inward migration to the southeast since, the total is probably nearer the 2015 estimates.)

How many actually are angel investors? The ACA again provides a national estimate of 300,000 people making an “angel investment” in the last two years, similar to the number of angel investors calculated by the University of New Hampshire’s Center for Venture Research of 304,950 in 2015.

Data for the Carolinas specifically is not available (as far as I know). Assuming angels are spread proportionally by overall population (an obviously wrong assumption), there would be around 14,000 active angels in the Carolinas. Assuming the ratio of millionaire households according to the Deloitte survey (so roughly 621,000 millionaire households in the Carolinas of a total 15.5 million millionaire households) multiplied by 300,000 active angels gives around 12,000 active angels in the Carolinas. I would guess it is a good bit lower in reality.

Whatever the exact figures, there are a good number of people making angel investments in the Carolinas, and many multiples more who could be.

Myths of Angel Investing: This Month's Posts

In my last two Upstate Business Journal articles (here and here), I’ve tried to debunk a few myths and clear up a few misconceptions about angel investing.

There are a few areas that word count limits my ability to explain and cite sources, so over the course of the next few posts this month I’m going to expand on the eight topics, to explore where the misconceptions come from and provide a bit more detail on my clarifications. Hope they prove useful.

Don’t have time to read those articles? No problem: the myths are:

  1. Not many people can be angel investors
  2. You need to invest a lot of money
  3. It takes a long time to build a portfolio
  4. You need to be an expert
  5. Angel investing is for philanthropy or fund, not making money
  6. It costs too much to be an investor
  7. It takes too long to reach exits
  8. There aren’t enough unicorns in the southeast