November 11, 2009

Suppose you’ve started a business that needs $100,000 of external financing to get off the ground.  Because none of your friends or family has the money to make the investment, you’re looking for an accredited angel investor. 

That investor is going to be very, very hard to find.  Statistically, very few people are in a position to make these kinds of investments.

Let me give you some numbers to show you how rare this source of financing is.  Because only a small number of new companies are successful enough to generate a reasonable return on an investor’s capital, most accredited angel investors realize that they need a diversified portfolio. Therefore, most investors will only invest a small portion – sophisticated angels say no more than 10 percent – of their net worth in start-ups.  So  a person who can invest $100,000 in start-ups needs a net worth of at least $1 million.

But investors also need to invest in multiple start-ups to be properly diversified.  Another rule of thumb among angels is that you need to invest in at least ten start-ups to be properly diversified.  So to invest $100,000 in a single new business and be properly diversified, a person needs a $10 million net worth.

The problem is that very few people have that kind of money.  Even before the current financial crisis – the 2004 IRS Statistics of Income data are the most recent available – only 126,000 Americans had that kind of net worth. 

Moreover, most of these people aren’t interested in financing start-ups.  According to a survey of a representative sample of adult Americans by business demographer Paul Reynolds, approximately 10.5 percent of people with this kind of net worth have made an informal investment in a start-up in the previous three years.  So if we apply that number, we are left with about 12,600 people worth $10 million or more who make informal investments.

Unfortunately, if you aren’t a friend or family member of the investor, that person isn’t likely invest in your business.  Three quarters of the informal investments by accredited investors go to friends and family.  Now we are down to about 3,000 people in the entire country that you can target for the money that you need.

Now it’s possible to also go to an organized angel group to raise the money that you need.  There are perhaps 250 of those groups in the country.  So between individuals and angel groups, you have about 3,250 targets for the $100,000 you need.

So what do these numbers mean if you are seeking financing for your business?  First, if you need $100,000 in capital, you might want to think in terms of 10 people who can each provide $10,000, rather than one person who can give you $100,000.  In my book Fool’s Gold: The Truth Behind Angel Investing in America, I point out $10,000 is the size of the typical (median) angel investment in the U.S. Moreover, because a person needs a net worth of only $1 million to make a $10,000 investment of this type, there are far more people you can go after for the money you need. (The IRS statistics of income shows that there are 2.2 million people who have a net worth in excess of $1.5 million.)

Second, you might want to think about redesigning your business model to demand less capital.  While $100,000 might not seem like a lot of external capital to raise, there are relatively few people who can provide this amount of financing.  In addition, the number of potential angels increases very fast as the amount of capital you need decreases.  So cutting in half the size of your ask more than doubles the number of potential angels.

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About the Author:  Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America; Illusions of Entrepreneurship: The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By; Finding Fertile Ground: Identifying Extraordinary Opportunities for New Ventures; Technology Strategy for Managers and Entrepreneurs; and From Ice Cream to the Internet: Using Franchising to Drive the Growth and Profits of Your Company.

Join the conversation ( 3 )

• Adam Hoeksema 1 year 5 months and 1 days ago

  

  According to a report distributed by the Angel Capital Education Foundation between 96 and 99% of angel investment applicants are denied funding.
  
  For this reason, I have written an extensive guide titled, "I Was Denied Angel Investor: Now What?" This will provide you a step-by-step guide to help your business survive and thrive even after being denied angel investor funding.
  
  Access this report now, for free at www.theexecutiveplan.com. Best of luck!

• Anita Campbell 2 years 3 months and 1 days ago

  

  Paul -- Yeah ... reality! Too bad we have to deal with it. :-)
  
  So to sum up the message here: seek out smaller investments, from more people. And you're more likely to get funding. Or go a bit slower, and try to get by with less capital.
  
  
  
  

• PAUL ROSENFELD 2 years 3 months and 1 days ago

  

  Man are you a wet rag! Just what us entrepreneurs need who are trying to raise angel capital - reality! LOL. Appreciate the fine logic and well-reasoned argument. As a CEO trying to do just what you outline, I agree it's a challenge. But to be a Founder of a start-up is to already self-select into a group of highly confident, highly aggressive folks who look at the same data as everyone else and see opportunity.
  
  Of course the main strategy you leave out is: standout from the crowd of other entrepreneurs. Be smarter, more differentiated, with a better mgt team, in a hotter space, with better timing, and a better product with lower costs and more customers. Be more aggressive, more scrappy, more thoughtful, more responsive and better poised than the next shmuck looking for money.
  
  :-)
  
  Taken together with your prescriptions these three strategies should suffice for funding! How's that for optimisim??
  Paul
  
  p.s. don't go seeking too many investors - kiss of death for the Founders.