In a Down Economy, Angel Investors Change Course

[qi:110] The grim economy has led not only to a drop in consumer spending and the foreclosure of more than a million homes, but to changes in the way angel capital is deployed. Angels, by definition, invest their own money in startups, so downturns in the stock market and falling home values can mean they have less to invest and are more gun-shy about investing it.

While data for the first half of 2008 isn’t in yet, most angel investors with whom I’ve spoken tell me that rather than run from the lousy market, they’re adapting to it by doing more follow-on investments, syndicating deals amongst multiple angels and, in some cases, investing greater amounts of money into a single startup so it can pay the bills during the dry spell for early-stage capital that they see lying ahead.

“Two trends we’ve seen are: We’re investing in deals we’re already in, and [we’re] keeping them alive longer because conditions are not ripe for an exit,” said John May, founder of Washington D.C.-based Active Angel Investors. “We’re also giving more runway to portfolio companies. When times are tight, we want to overfund.”

In order to get more investors involved in the deals they’re doing — and further spread the risk — May says his group is investing with angel groups and in companies outside of the Washington D.C. area. Angels typically avoid investing in companies located far away from them because helping an early-stage venture requires a lot of hands-on assistance.

There are about 258,200 angel investors in the U.S., and in 2007 they invested $26 billion in 57,120 deals, according to data from the Center for Venture Research at the University of New Hampshire. Jeffrey Sohl, head of the CVR, said he expects the amount invested in the first half of this year to be flat over the same period in 2007, but the number of angels to continue to rise (it rose by 10 percent from 2006 to 2007). “Since their net worth may be down, angels have less to invest, so we’re seeing that instead of one angel putting $100,000 into a deal, four or five angels might put in $25,000 to $20,000 apiece,” he explained.

In times like these, some angels look to other forms of investment altogether, but the heads of organized angel groups say that’s not common. Knox Massey, who runs Atlanta Technology Angels, said that just one or two of the more than 50 angels there have started started looking at, for example, distressed property.

One reason might be that many angels in organized groups are former entrepreneurs who don’t merely invest for a return, but also to stay involved with growing companies. That being said, members of angel investment organizations represent only about 20 percent of the total angels out there, according to Sohl. Some angels might be pulling back during the downturn, but an overall rise in formal angel groups with more disciplined-than-usual investment strategies could serve to keep investment dollars at even levels. None of the groups I spoke with said they’d seen above-average churn in membership over the past 6-12 months; in fact, many indicated that they have wait lists for new members.

There are also three trends taking place that are working in angel investors’ favor: The cost of starting many types of companies is lower, ventures firms have stopped doing a lot of seed and early-stage investment as their funds have gotten larger, and the tough economic climate is pushing valuations down — which means angels can get more of a company for less money. According to data provided by Angelsoft, a company that manages angel deal flow, average valuations have dropped to $2.3 million from $3 million in 2006.

“Angels aren’t quite as profligate with their cash as they might have been when their home was worth $10 million, but for many angels who view investing in startups as a serious exercise, this is a good time to put their money to work,” says David Rose, the head of New York City Angels and CEO of Angelsoft. Let’s hope it stays that way.

This was originally published on BusinessWeek.com.

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