As if they are not stretched enough, a small but growing number of active CEOs routinely take a few hours each month to invest in startup businesses. As angel investors, these CEOs use their own money to take an equity stake in early-stage businesses with the expectation that eventually the investment will reap significant returns when the business is sold or has an exit.
The term “angel” comes from the Broadway theater scene where wealthy patrons (“theater angels”) invest in theatrical productions and make a return if the show does well. Today, there are about 250,000 angel investors active in the U.S., according to the Center for Venture Research, who contribute over $19 billion to roughly 55,000 new startups every year.
For this story, Chief Executive interviewed a dozen CEOs about their angel investing (about half were willing to share as long as they weren’t identified). To qualify, the CEOs had to be active executives of an enterprise with at least $25 million in annual revenues and 150 employees—with a personal portfolio of at least three angel investments. The CEOs had to put their own wealth at risk.
Based on our admittedly unscientific sample, the average angel CEO is male, 43 years old, invests in one or two startups a year, manages an angel portfolio of four startups at any one time and invests $25,000-$75,000 in the average transaction. The typical valuation of startups is $1-2 million. Most CEO angels prefer high-tech startups. With nine years being the average time between early-stage investment and exit, only a few have actually broken even, much less made real money.
All CEO angels interviewed for this story qualify as accredited investors, according to SEC regulations. An accredited angel investor must meet at least one of three criteria: assets of at least $1 million (not including the value of the primary residence), annual income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of at least the same income level in the current year. While fewer than two percent of Americans can meet these requirements, Chief Executive subscribers almost universally qualify.
While a few CEO angels treat their angel investments as an integral part of their investment portfolio, a majority say they do it for reasons that can’t easily be captured on a straight P&L basis. A commonality among CEOs in this category is that they were entrepreneurs themselves and had a major liquidity event. A frequent theme among these CEOs is that they want to stay in the startup game by giving back. They get a buzz from mentoring younger entrepreneurs, being the first to learn about disruptive products and services; and if they make money down the road, well, that’s even better.
Unspoken is the remote possibility that the angel CEOs might land on the ground floor of the next Google, Facebook or PayPal, when the multiples can be life-changing—even for high-wealth investors. Brian Cohen, chairman of the New York Angels, is the first investor in Pinterest—currently the brightest star in the startup constellation. Cohen may well multiply his initial investment by a factor of 1,000 when Pinterest goes public or is acquired. Of course, it’s now four years post-investment and Cohen has yet to see a dime. Uncertainty is the nature of angel investing. (Full disclosure: Brian Cohen and I are the authors of the forthcoming book What Every Angel Investor Wants You to Know: An Insider Reveals How to Get Smart Funding for Your Million Dollar Idea.)
David Perla, co-founder and co-CEO of Pangea3, the largest legal-process outsourcing provider worldwide, with more than 1,000 employees globally, is a typical angel CEO. Perla, 43, funds an average of two startups per year, investing about $50,000 per transaction. In valuation, the startups tend to be in the $2 million to $4 million range. While he takes a definite interest in the startups, he makes it clear to the founders that his first responsibility is to Pangea3 and they can’t expect him to be on call for routine coaching. “Managing founder expectations is key,” he says.
Perla describes the funds he sets aside for angel investing as discretionary. “This money is not part of my kids’ college fund or my own retirement planning,” he says. “If you take losing money personally, stay away from angel investing.” Diversification is the key to success in any investing program; and with just four startups in the typical CEO angel’s portfolio, meaningful diversification is impossible. Perla suggests that CEOs who want to maximize their odds should consider participating in a VC fund.
“Assume you are going to lose all your money,” agrees Manuel Henriquez, founder and CEO of NYSE-listed Hercules Technology Growth Capital, a specialty financing company that provides debt financing to pre-IPO, venture-backed companies. “Treat success as a complete surprise. The law of small numbers will likely lead to a complete loss on your investments,” he says. “I’m happy to come back at the end of the day at net zero.”
CEOs considering making an angel investment should answer one central question: What’s in it for me? If the answer focuses on what you will receive, you should buy an index fund, suggests New York Angels chairman Cohen. “On the other hand, CEOs who are willing to give first and receive second will be rewarded by organizational wisdom and market insights that will improve their game as CEOs to the organizations they lead,” he adds.
Jacqueline Corbelli, co-founder and CEO of BrightLine, a provider of interactive television solutions for entertainment and advertising, invests in a handful of opportunities every year, typically hearing two dozen pitches before selecting one in which to invest. Corbelli is typical of CEO angels in that she invests less for the monetary return than the charge she gets from ideas that offer new ways to transform an industry through digital technology.
“The marketplace is struggling with the opportunity to jump to a whole new level by utilizing digital technologies,” Corbelli says. “I’ve watched businesses get transformed when they make a deliberate and focused effort to leverage technologies. I look for people who get that and I want to invest in them,” she says. While she does due diligence on the startups, she recognizes that, given the early-stage nature of the businesses, due diligence really comes down to the CEO angel’s instincts. “I want to invest in people who are smarter than me in the area they are investing in,” she says.
Hercules Technology Growth Capital’s Henriquez is a CEO angel investor because he likes being involved with bright young people dedicated to changing the world. “True fishermen cast their lines not because they want the fish, but because they like fishing,” he says. “It’s fascinating to help spawn new technologies, to challenge the status quo; it’s what this country is all about and angel investing allows me to be a small part of it.”
Top Four Reasons for Donning Angel Wings
- Mentor and learn from the brightest entrepreneurs
- Gain early access to disruptive products and technologies
- Improve your own game through fostering startups to market success
- The possibility of getting in on the ground floor of the next Google or PayPal