Angel investors, often characterised as wealthy individuals with an entrepreneurial past, have surpassed VCs and become the biggest financier of early stage capital.

By Martim Gois

According to the European Business Angel Network (EBAN), angel investment accounted for €6.1 billion, or 71% of a total €8.6 billion European early stage investment market in 2015. A lion’s share of those investments was made via angel groups, where many individual angel investors invest together. Hence, these organised angel groups are the number one financier of startups in Europe (a similar trend is visible in the US, too).

I learned this a year ago when I started thinking about my Masters Thesis in Finance at Aalto University, Helsinki. Founding a startup myself during my studies and bootstrapping it into a sustainable business aroused my interest over the value of the most prominent, professional startup investors: How do angel groups affect their portfolio firms? Are they just superior selectors pre-investment, or do they actively enhance their portfolio firm value post-investment? What is the realised impact of angel groups on firm performance? To my amazement, despite their economic magnitude, there is a complete lack of studies relating to the realised impact of angel groups.

To set this murky record straight, I went on to study the realised impact of angel groups on firm performance and analyse the impact using a comprehensive set of outcome metrics covering everything from innovation to commercialization, profitability and productivity. In the thesis, I measured the impact over a three-year period after the first angel group investment in 2006–2011. The data is hand-collected and comprises a one-to-one matched sample of 75 angel group financed and 75 control firms, all Finnish.

The methodology follows most sophisticated VC impact studies and consists of endogeneity-adjusted fixed effects regressions performed over the matched sample. Now any potential angel group influence due to superior selection pre-investment can be disentangled from their causal influence post investment. Besides selection bias, other common impact study biases like survey, substitution and survival bias are avoided.

While digging into the study, another surprising fact came across: The venture capital literature is unaware of recent startup literature like the ones of Eric Ries or Steve Blank, or even nowadays widespread terms like product/market fit. Hence, to gain more current and meaningful interpretations, I decompose the influence of angel groups and examine whether differences in firm stage, business model driver and market readiness affect the magnitude of the realised impact.

Stage is divided between early (less than two years old) and later (two years old or older) stage startups; business model between driver between hardware- (value proposition involves a hardware component to it) and software-driven (only software) startups; and market readiness between product/market fit (increase in sales/assets ratio from one year to another) and non-product/market fit (no increase) startups.

Four key findings interest entrepreneurs and investors alike.

1.Innovativeness pays off pre-investment

Innovativeness increases the odds of angel group financing. The findings confirm angel groups select more innovative startups: angel invested firms have 77% higher pre-investment intangible assets growth, 90% more patents (pending) and 40% more trademarks (pending). Further, innovativeness was the only variable with an identifiable selection effect. This highlights the difficulty in ‘picking winners’ and confirms an investor bias towards proved value like existing IP rights in the selection process.

2. Post investment, angel groups add value to existing innovation, not new innovation

After the investment, angel groups add only value to the protection of existing innovation, not the development of new innovation. Angel groups increase startup patenting and trademarking by 80% and 30%, respectively, yet the latter is only weakly significant. However, angel groups have a significant and negative impact towards new innovation, starting two years after the investment. These findings suggest angel groups value IP protection and prefer shifting resources to other activities than the development of new innovation. To comprehend the specific drop after two years in more detail, other outcome variables must be studied.

3. Later stage and software startups profit from angel group investment, early stage and hardware startups don’t

Angel groups do have a causal positive impact on firm sales growth. However, these value-adding effects are not immediate. Instead, they come with a two-year delay, only during the third year after the investment. Once the effects of timing are removed, and the impact is measured over the three-year period as a whole, the realised impact of angel groups on sales growth is only significant for the subsamples of later stage, software-driven and product/market fit firms. Angel groups contribute directly to an annual sales growth increase of 34%, 36% and 38% for later-stage, software-driven and product/market fit firms, respectively. No significant angel group value adding effects are found for early stage, hardware-driven and non-product/market fit startups in terms of sales growth.

These results suggest angel groups’ ability to reduce agency risk and information asymmetries is limited and dependent on firm readiness and business model driver. In low risk environments like older, market ready or less asset intensive software ventures, where experimentation is cheap, business fundamentals are flexibly changed and scaling is quick, angel groups can add value. For higher risk environments like younger and non-market ready firms, as well as hardware firms with more complex and time-consuming development processes, there is no identifiable significant value adding effect.

4. Product/market fit matters most

The causal relationship between angel groups and startups is strongest with product/market fit firms. For startups that have product/market fit before the investment, angel groups increase directly annual sales growth by 38% throughout the holding period. In contrary, for startups that have no product/market fit pre-investment, the results imply angel groups influence their performance only after achieving market fit: the significant negative contribution towards new innovation after year two coupled with a significant positive contribution to sales growth at year three suggests angels shift resources from innovation to commercialization, supposedly only after achieving market readiness. Alternatively, this shift in resources can be interpreted as impatient investor behaviour regardless of market readiness.

Nevertheless, the findings prove angel groups are better at scaling proven business concepts that have already achieved product/market fit, rather than helping startups develop underlying business fundamentals. However, identifying product/market fit pre-investment is hard — there is no identifiable selection effect for it. Thus, angel groups invest mostly in startups still struggling with business fundamentals like product development, wait until they achieve product/market fit — which happens on average around 2–3 years post investment — and then maximize value by exploiting existing innovation via commercialization and the protection of IP.

The findings of the study do confirm angel groups not only select more innovative firms, but also help build the firms they invest in, however, under some key constrains favoring later stage, software-driven and product/market fit startups. It especially validates the importance of product/market fit for early stage venture development. For angel groups and investors, to profit most from their investments, the study stresses the importance of more nuanced selection criteria and active involvement with the development of business fundamentals. For startups, to profit most from their investors, the results highlight the importance of bootstrapping until product/market fit and only after it seeking finance for scaling.

In the end, entrepreneurs need to work their art themselves — angel groups just accelerate the art to the hands of the masses.



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