If the venture capital industry’s best days are behind it, as suggested previously, it is only natural to assume that angel investing is in similar straits. But is that necessarily the case?
It is true that both segments, which invest in start-up and young companies, have thrived during a time when interest rates have been artificially depressed and risk-seeking has been actively encouraged. Strength in technology shares–which have, as a group, outpaced the broader equity market since the post-crisis bull market began in March 2009–has also lent support in an environment where high tech continues to dominate the start-up landscape. Boosted by the tailwind of a solid long-term track record, VC and angel investing have, until recently at least, attracted considerable interest.
Citing data from the Center for Venture Research at the University of New Hampshire, the Harvard Business Review reported that aggregate U.S. angel investments in 2014 were $24.1 billion, with more than 73,000 ventures receiving funding. The total number of active investors was 316,000.
A frostier environment
That said, the backdrop has become less friendly. In December, the Federal Reserve raised interest rates for the first time in seven years, and as of this writing, it is expected to enact multiple increases over the next 12 months. While things could change, such developments undoubtedly sour the investment outlook. Aside from the fact that higher fixed-income yields will likely be seen as an attractive option for some investors, many of the businesses that have benefited from accommodative policies, including young companies with limited resources at their disposal, will find the going getting tougher as conditions tighten.
Indeed, the year is only just underway, and markets are already discounting this prospect. The S&P 500 index is down almost 6% year-to-date and the technology-laden NASDAQ Composite index has lost 7.25%. While the relationship between private and publicly-traded markets is not necessarily linear, the fact that investors are in the mood to sell–most notably, last year’s technology high-flyers–will almost certainly play some role in tempering expectations in the VC and angel markets.
However, there are reasons to believe that the former could be more affected than the latter. For one thing, the venture capital space has historically catered to larger investors, who are more heavily influenced by broad asset class trends and industry expectations than angel investing counterparts. Although the latter group no longer appears confined to “friends and family” and high net worth individuals–most of whom generally don’t view investing through an institutional prism–risk-return preferences tend to be more flexible.
Fallout from pre-IPO woes
Moreover, the boom in the growth-stage private market–most notably, the $1 billion-plus technology “unicorn” segment–has helped to draw some VCs into the fold, potentially representing a significant differentiator between the two early-stage investing sectors. As discussed in “Venture Capital Industry: the Next Trouble Spot?”
many are holding on to investments–some of which are larger than in the past–for longer than they used to, heightening the risk that they could, so to speak, be left holding the baby.
Moreover, the fact that this sector has become larger, more concentrated and more institutionally-oriented in the wake of its successes has likely created opportunities for those who invest in smaller firms and start-ups based outside of VC strongholds such as San Francisco. According to International Business Times, 80% of the funds that flowed into the venture capital industry in 2014 went to five states, with California receiving 56 percent of the total. Start-ups outside of those areas are naturally seeking other options.
A frostier monetary policy environment may well broaden the range of opportunities available to angel investors. Certain sources of financing, including commercial and consumer lending, will likely become less available, make it harder than it already is for entrepreneurs to raise money. Within days of the Fed’s December move, regulators expressed concerns about bank lending to risky sectors. Last year’s dramatic sell-off in high-yield bond markets, sparked by distress in the energy sector amid a sharp decline in oil prices, have only added to lender caution.
An expanding roster of angel networks and online crowdfunding platforms has also made things easier for those who invest at the earliest stage. The Angel Capital Association reported that the number of angel groups — which enable investors to share research and pool capital — has quadrupled since 1999. According to Crowdfund Insider, business and entrepreneurship funding volumes, including equity and other forms of financing, rose to $6.68 billion in 2014, a 357% increase from a year earlier.
Certainly, if angel investors begin to be weighed down by pressures affecting other areas, or if economic and financial conditions deteriorate to the point where it calls the broader outlook into question, then it is likely this segment may experience a retrenchment similar to what is being seen elsewhere. Barring that, it remains a sector with interesting prospects.