How do angels select deals?

A frequent question from entrepreneurs is: How do angels select deals? Often selection of an appealing investment feels random or biased. In today’s paper, which you can go download here (if you come back), Attracting Early Stage Investors: Evidence from a Randomized Field Experiment authors Shai Bernstein, Arthur Korteweg, and Kevin Laws examine the characteristics that seem most important to investors in early-stage companies.

Bernstein and Korteweg are from business schools in California, and Laws is from AngelList – a nice combination of academia and real-world practitioners. They were also covering new ground in 2014, with the first experiment showing the causes of particular investment selection. 

The experiment was to send 16,981 emails about 21 companies to 4,494 active investors (and really 8,189 emails that were opened by 2,925 investors, as many didn’t open any of the emails) on AngelList during its early years. The emails randomly varied the information shown on three key variables – founding team, traction, and lead investors – and recorded the decisions to “learn more” about the investment opportunities. (This is to address the selection bias of only looking at companies that are actually funded.)

To cut to the chase: investors respond to information about the team, but do not respond to information about traction or lead investors (p.4). The paper confirms experimentally the angel investor cliché that angel investors “back the jockey and not the horse”.

The paper goes on to examine the related questions of “why” information on the team affects investment decisions (investors value execution – “operational capabilities” – more than ideas); and whether focusing on the team actually creates better results (in Section VI: no answer in this paper, though more experienced angels (who presumably have better returns) have the strongest response to team information and lowest reaction to other subjects… suggesting overall “yes it does”). 

Several interesting insights or further conclusions emerge:

• The paper highlights a key theme of “growth” investing – how companies move from “human capital focused” (i.e. back the jockey not the horse in the earliest stage) to “asset” focused, as one of the ways companies create enterprise value is to move from founder personality to established business.
• Given how often early-stage investors are accused of “herd behavior” and basing their investment decisions on who the shallow idea of who the lead investor is, it’s interesting to see the experimental evidence that “notable lead” really isn’t a determinant of whether companies get investors’ attention. This is true of the active investors on AngelList; is it true generally?
• What can entrepreneurs learn from this? Team is key! If you’re going to spend extra time on presentation, emphasize the credibility and skillset – especially operational capabilities – of the founding team.

Overall, nice to know the clichés have some experimental validation!