We concluded last time that early-stage investors back the jockeys and not the horses. But that is not everything we need to know about how angel investing decisions are made. Luckily, one source for more ideas is Angels or Sharks? The Role of Personal Characteristics in Angel Investment Decisions, which focuses on the personal characteristics (race, gender, age) of the entrepreneurs being backed. If you are studious, download the paper here.
A paper that doesn’t rely on AngelList data! Instead, authors Thomas J. Boulton, Thomas Shohfi, and Pengcheng Zhu do the work so that we don’t have to: they watched the first eight seasons of ABC’s Shark Tank!
You might know everything you know about angel investing from Shark Tank. (That’s a good start, but you might want to check out VentureSouth’s “Myths of Angel Investing” too…) Angel investing on Shark Tank differs considerably from hometown angel investing at VentureSouth. Nonetheless, the dataset of 1,089 entrepreneurs, 707 ventures, and 14 angel investors on Shark Tank’s earlier seasons gives some interesting insights into how (some) angel investors make decisions.
What does watching every episode of Shark Tank reveal?
- Some academics go the extra mile for a good paper!
- Angels are more likely to fund younger and “better” businesses (higher profit margins and businesses with patents held or pending) (p.2)
- Older entrepreneurs are less likely to receive offers, as are potentially black entrepreneurs (p.2), who are also likely to get lower valuations.
- Generally, younger, female, and black entrepreneurs request lower valuations; Asians and “entrepreneurs from top universities” request higher valuations (p.2) (but do not receive them) (p.23)
- Gender does not seem to matter (p.3).
- “Homophily” is important (p.3) – investors fund people “like them” – with, for example, black investors more likely to make offers to black entrepreneurs, and black founders more likely to take deals from black investors.
First, let’s tackle some objections to using Shark Tank data: presenters are highly selected (including for characteristics like entertainment value) and therefore probably not representative of early-stage companies generally; the investors are equally unusual (celebrities and ultra-HNW individuals with net worths estimated between $70M and $3.4BN) and not typical angel investors; and, more subtly, Shark Tank activity is public so perhaps the impacts of biases and preferences are lessened compared to what happens usually in private? All true, but at least the data makes a change from survey responses and anecdotes.
With these caveats in mind (and which, of course, the authors try to control for and/or examine), what are we to make of these experimental results?
There are some in here that aren’t a surprise. In all walks of life, people like to interact with people “like them”, so the homophily discussion is not a shock. (It may still, of course, be a problem.) The mixed evidence of bias against women might be surprising, if you didn’t read the prior articles we discussed here and here, or any of the previous angel investing literature (see the discussion of prior literature being mixed on p.7). In this case, female Shark Tank contestants request lower valuations (p.18 and table 3 p.37) but are not less likely to receive an offer or a “discount” offer (tables 4-6). If true, this would have significant implications for efforts to equalize funding for female entrepreneurs.
While these primary hypothesis questions combine both the expected and the unexpected, there are several “asides” in the paper that reinforce accepted wisdom in angel investing. As three quick examples:
- A shared geography also increases the likelihood that an offer is made (p.21). Even sharks like to invest close to home.
- Valuations are higher when multiple angel investors compete to make an investment (p.2). Getting a competitive situation going helps maximize value during negotiations
- Ventures pitched by a single entrepreneur are less likely to receive an offer, which is consistent with angel investors having concerns with respect to key man risk. (p.19). Indeed, a company with just one founder does not get into screening at VentureSouth, as there’s too much risk of 100% of the team leaving.
Fun paper. We’ll leave you, as usual, with extra interesting nuggets and observations from the scholars:
- The average firm has $0.26 of sales per dollar of requested valuation (p.14) – so ~4x LTM revenue is the Shark Tank valuation benchmark but…The price-to-sales ratio of approximately 4 is lower than Sievers et al. (2013) who report multiples as high as 13. (p.14) Not much help answering the perennial question of “how do you value early stage companies?”!
- Troy Carter has a 75% bid rate (p.35). I hear you – I want to invest in everything too!