Tracking Angel Returns - piling in?

In a follow up to this post, we need to explain why the 22% annualized rate of return for angels in groups is possible – and doesn’t get “competed away” when everyone finds out about it and piles in. My theory is that it’s very hard to “pile in” to early stage investments.

1)      If you’re an individual, you probably aren’t even allowed to invest in early stage companies – so large “retail” investors likely can’t impact the asset class. (This may change as equity crowdfunding kicks in – but I doubt it, at least for a while.)

2)      If you’re an institutional investor, how do you deploy $100 million into early stage capital? There is basically no cost-effective or logistically feasible way – even though, in total, angels invest $25 billion in early stage companies each year.

3)      If you’re in California, how do you evaluate and invest in early stage companies in North Carolina? You don’t. Angel investing is a local activity: 93% of VentureSouth’s deployed capital has been here in the Carolinas. Even despite technology, angel investing remains an in-person and localized pursuit.

It’s likely impossible for one unified market to generate 20%+ returns consistently over time. But hundreds of illiquid, hard-to-access, opaque, and highly-localized markets could keep generating, on average, such results.

At VentureSouth, this our target – a portfolio return of 20% net to investors – and we are on track to get there.

Tracking Angel Returns - data biases?

IRRs of 20%+ sound unlikely. If angels were really doing that, wouldn’t they have followed hedge fund managers to Puerto Rico or the Caymans?

Maybe - although a 3x return on a $10,000 investment, which is the median investment made by an investor in VentureSouth groups, might not get you all the way there.

But it does seem unlikely that the returns are truly this good. This isn’t because angels are (or aren’t) “beating the market.” The efficient market hypothesis says beating the market is impossible, as prices reflect known information (all public, or all including inside information, depending on your strength). On this, EMH is definitely correct – which is why Buffett is winning his hedge fund bet so easily. But angels aren’t beating the market – they’re investing in a different market.

Still, if 22% was a consistent return, everyone would pile into that asset class, drive up deal valuations, and therefore eliminate the “excess returns.” (Or invest in more “marginal” (or nutty) companies and therefore bring the median return down.) So can it be true?

There are two approaches here: either the 22% is wrong, or we need to explain why it can be true. This post tries the first; a follow-up post with tackle the latter.

So let’s try to knock some holes in the 22%. There are likely several sources of exaggeration, because the data is (generally) provided voluntarily. Two are:

  • Self-selection bias: in general, people only report information if they think it’s notable (which would suggest greater reporting of big wins or big losses, less reporting of 0.5x-2x returns) and much prefer to report their winners than their losers.
  • Survivor(ship) bias: similarly, it’s likely that angel groups or funds that did poorly weren’t around to report their data, while successful and sustainable groups did.

How much of an impact do these biases have? In a 2012 study of hedge funds, funds that did not report to commercial databases had alpha (outperformance vs. the market) 60% lower than funds that did report – from a “truncated left tail” in the returns distribution. Commercial databases of hedge funds likely miss the worst performers. That is true for mutual funds and VC and PE (though perhaps less so as public pension fund investors have to report their data – good or bad); and it likely applies to angel too.

The authors of the angel studies are obviously aware of these biases, and try to control for, or at least analyze, them. Their tests suggested angels reported honestly (the data for syndicated deals was generally consistent between the different syndicate respondents, for example); sampling through groups makes it more likely the “failures” are included; and comparing “high response” groups with “low response” groups showed very little difference between the returns declared, suggesting “low response” groups were not just supplying their best results. 

And it may also be that as positive results take longer to achieve the “achieved” returns underestimate the eventual return – this “locked up” capital bias possibly offsetting the others. (It’s the opposite of “instant history bias.”)

So, yes, 22% is probably not exactly right. The lack of data relative to hedge funds, PE or VC makes definitive conclusion impossible. My view is that 22% is probably a touch high to be the median result, but I don’t think they are much lower than that – which is why I’m an investor in the Palmetto Angel Fund (VentureSouth's first “index fund”) and will be in the next one too.

Tracking Angels Returns - the right benchmark

Continue the “tracking angel returnsseries… Another objection might be that the S&P 500’s performance over the last 15 years is not the appropriate benchmark against which to judge angels' returns. Fair enough – I just used that for simplicity. Here are some alternatives.

Different time frames: The original Wiltbank study was over the 20 years to 2007. The same time period for the S&P (1987-2007) has a total annualized return (including reinvestment of dividends) of 6.3%. Not much difference vs the 7% in the original.

Different index: S&P 500 obviously has different companies (the largest of the large caps – you need a $5.3bn market cap to be in the S&P 500 today), so it’s not obvious to compare with angel investment returns. Fair enough. Choose any public index over the similar period, and I’ll wager it looks pretty similar. The S&P 600 small caps, for example has a 10 year return of 6%; the NASDAQ returned 0-11% IRR depending on your timing since 2000 (ignoring dividends: I couldn’t easily find NASDAQ total returns, but assuming dividends don’t add more to NASDAQ returns than the S&P I think we’re on solid ground…).

Different timing: If you compared the return from when the S&P bottomed at 676.53 in March 2009 to its current value, you’d have enjoyed annualized returns of closer to 19% including dividends. The NASDAQ enjoyed an IRR of 11% from the trough in September 2002. Well, yes, if you can consistently “time” the market you can outperform the averages – but if you can do that you’re in a very small minority…

Correlation? We don’t have enough granularity to determine whether angel investment returns follow those from public markets – whether timing matters. Perhaps they do and therefore if you timed your angel investments well you could beat the “22% market index”? The general belief is that angel returns are not correlated with the economy or public market indexes, and that timing doesn’t matter in angel investing.

So here’s a request: can anyone supply a public market benchmark that makes the returns look poor?

Tracking Angel Returns - inflation, taxes, and fees

Last week’s UBJ article tried to cover a complex subject – investment returns for angel investing compared to other uses of capital – in a short word limit, so didn’t do justice to some of the nuances. As promised, we’ll cover a few of them in posts over the next few days.

First: what about inflation? All data given was “nominal” – that is, actual data with no adjustments for inflation. Inflation obviously hurts returns: if you deduct 2% per year from the 7% annualized return for the S&P 500, for example, you get a 5% “real” return; 2% subtracted from 22% IRR for angel investments giving a 20% real return is again harmful. But now the relative real return looks even better for angels: 22%/7% = 3x vs. S&P nominal returns; 20%/5% is now 4x for real returns. (I used 2% just for example; choose your own “deflator.”)

Second: what about taxes? Here too, angel investments are generally helped by tax laws. Most angel returns are (lower rate) capital gains; most public market returns are too, but not always, if you have a quick sale or you pay (higher rate) ordinary income on dividends. In early stages, too, investments might pass through their losses to investors if they’re an LLC – which can be helpful to offset other income.

Governments sometimes encourage investment in early stage companies with other favorable laws. Some federal benefits (like QSBS capital gains exclusions) and local tax law – like the SC angel investor tax credit that can reduce your SC income tax liability by up to 35% of the amount you invest in SC-based startups – can have a materially positive impact on post-tax returns too.  (We’re not tax advisors – consult your tax advisor to learn more and judge if those paragraphs were accurate!)

Thirdly: what about fees? Here, public markets catch up a bit. Fees on a basic S&P 500 index tracker might cost you a few basis points (expense ratio of 0.16% on the Vanguard VFINX, for example), or perhaps 0.5% for more complicated trackers (small caps, particular investment strategies), plus another 1% for actively managed funds or the work of a money manager.

Fees for angel investments on your own can be “zero” plus cash expenses in diligence costs, tax preparations, state filings, etc., which can be significant; plus time and effort.

Angels in groups charge different fees depending on how they are organized. Professionally-managed groups like ours charge fees because of the greater input into decision-making, administration, and portfolio management. Fees might include annual membership dues, ad hoc levies, or “asset” or “management fees”. For now, let’s use the fee structure for the VentureSouth Angel Fund II of 2% management fee and 15% carried interest, which we expect to reduce gross returns by 3-4%.

So net of fees and taxes, and (not) adjusting for inflation, a reasonable comparison might be 4.5% for S&P 500 and 16% for angel investing – still at the 3-4x out-performance in the original article.

Tracking Angel Returns - the data

I had the pleasure of writing Matt’s regular Upstate Business Journal article this month. You can see the glossy original here. We’ve reproduced it below and included links so that interested readers can follow the source data. We’ll also have some follow up posts on this blog over the next couple of weeks to dive more deeply into areas that we didn’t have the word count to cover.

What about inflation? What about fees? S&P 500 is the wrong benchmark – and what about other alternative asset classes? You can’t beat the market!? We would love to hear your thoughts on this data - and objections to our interpretations of it.


How much money do angel investors make investing in early stage companies? Is it a genuine “asset class” with generally predictable returns or just a potentially expensive hobby?

When UCAN investors in Greenville and SCAN investors across South Carolina invest in a startup company, we have a specific return goal: to make a 50% or better annualized rate of return (or IRR), which translates to ten times our investment in five years (or four times in three years, etc.). We know that early stage investing is highly risky: startup often fail and take their investors’ capital with them. Factoring in the inevitable losses, we target a “portfolio return” of 20% IRR.

This compares to the annualized return (including dividends) of the S&P 500 over the last 15 years of around 7%. Do angels really enjoy rates of return three times better than public markets?

When you read about the fortunes of early private investors in Twitter or Uber, or founders like Mark Zuckerberg and Elon Musk, you see that sometimes they do. But those cases are news precisely because they are atypical. So what does returns do “regular” angel investors expect, and what do they actually achieve?

Matthew Le Merle’s study, Capturing the Expected Returns of Angel Investors in Groups, released last December, answers the first question. From surveys of angel groups, Le Merle found that 55% of investors expect returns above 20% IRR, and the rest expect 10-20% IRR – better than public markets on average. This resonates with surveys of our members that show they are targeting returns of 20%+ IRR.

Do angels achieve those goals? There is almost no public data on angel investment returns, as angels are private individuals with no reason to share their successes or failures, and gathering data from the 70,000 angel investments made each year would be a Herculean task. However, there are some clues. The most comprehensive data available on angel returns suggests that – in groups and on average across a diversified portfolio – angels have achieved rates of return over 20% IRR. The seminal study, Returns to Angel Investors in Groups, published in 2007 by Professors Robert Wiltbank and Warren Boeker, surveyed angel investors and over 1,000 exits, finding an average 2.6x return in 3.5 years, or 27% IRR. Other studies demonstrate similar results.

Why is this relevant now? Last week, Professor Wiltbank published an updated study, Tracking Angel Returns, to the Angel Capital Association, on whose board our partner Matt Dunbar serves. The study added another 250 investments, and found a similar result – 2.5x return over 4.5 years, or 22% IRR. If you’re a skeptic, you might consider that evidence of a decline in angel investment returns. One blog reacted with concern about “the internal rate of return dropping five points, down from 27 percent in 2007 to 22 percent in 2016.” That seems a bit of a leap, given the smaller sample size, changes in methodology, and other differences between the two studies.

Still, there is evidence that angel investments themselves have changed over the last decade – generally, and on the west coast particularly, moving to larger sizes, later stages, and higher valuations – so a slightly lower return is not surprising. But even the “lower” 22% IRR is three times the 7% of the S&P 500, so no-one in the angel investment world is panicking!

Wiltbank’s data reinforced other lessons for early stage investors. First, individual investments are very risky. Nearly 70% of investments in the new study returned less than the invested capital: picking one or two angel investments is not likely a winning strategy. Attractive returns come from portfolios of diverse investments – a basic expectation from portfolio theory. If you plan to be an angel investor, you should either dedicate the time, diligence, and resources to invest in 10 or more companies, or find a vehicle that does it for you – like the Palmetto Angel “sidecar fund” that is VentureSouth’s “index fund” of angel investments.

Secondly, patience is key. People lose money by trading on emotion – buying or selling based on fear or gut reactions. If you “lock in” losses by selling, you cannot achieve those target portfolio returns. Angel investments are typically protected from that downside because they are illiquid – the shares cannot be sold easily unless the company is sold, so losses are not locked in when the company faces challenges. On the other hand, angel capital is locked away for several years – five years is our guidance, although we aim for, and have realized, several earlier exits; but if you expect capital back in a year, you will be disappointed.

So how much money do angels make investing in early stage companies? With diligence, diversification and patience, 20% annual returns are still attainable. Although the UCAN and SCAN portfolios are still relatively young, we have already generated several returns above 50% IRR – and we anticipate our portfolio will compare favorably to the angel studies over time. And finally remember angel investors join our groups to “make money, have fun and do good”. Make money from diverse investments; have fun interacting with other members and innovative and exciting ideas; and do good advising our entrepreneurs and growing our local community’s economy. The total return on that is measured in more than just dollars.