November 15, 2023

Do angel groups provide better investment returns?

The Seedfunders Podcast
The Seedfunders Podcast
Do angel groups provide better investment returns?

Show Notes

Key Insights

  • Returns are better with angel groups because: Smaller investment amounts means getting into more deals, better due dilligence, more expertise and the opportunity for follow on investment
  • The Kauffman Foundation published: Returns To Angel Investors In Groups which found a 2.6x return in 3 years – or 27% IRR
  • An update to the report found a 22% IRR, though this study only had 250 participants compared to 1,000 in the first study
  • The time spent on due diligence is a big lever to success. 40 hours of more of due diligence produce a failure rate 45% vs 65% with less due diligence
  • The overall multiple in low diligence is 1.1x vs 5.5x with high due diligence
  • Industry experience had a similar impact on success.
  • The final key to early stage investing success was high participation by the group after the investment
  • Investors who put smaller amounts into more deals saw higher returns overall

It’s SeedFunders podcast, episode 4. My name is Joe Hamilton, partner with SeedFunders. I’m joined by the founder, Dave Chitester. Welcome, sir.

Thanks Joe.

Last week was a lot of great info. We talked about the advantages of joining an Angel group, and very compelling. Obviously, as people dig into investing it is about the returns. Let’s spend a little time this episode looking at those returns. Let’s dive into why returns tend to be better with Angel groups.

Well, as I said last week, there are multiple reasons. First of all, the additional due diligence or the extent of due diligence that Angel groups can do. The smaller amounts that investors can invest, which spreads the risk, which allows for more potential returns by having more investments. The industry expertise of an Angel group versus an individual is a huge factor in success. And the ability to participate in portfolio companies after the investment is another factor that really results in higher returns.

That sounds all reasonable. Any studies that verify this.

Yes, there are studies. Perhaps, what’s often called the seminal study on the topic was published by the Kauffman Foundation. It was called Returns to Angel Investors in Groups, of all things. In spite professors Robert Wiltbank and Warren Boeker, basically this study said that Angel investors in over 1000 exits, they analyzed 1000 exits of Angel investors and found that the average return was 2.6x in three and a half years. That equates to a 27% internal rate of return, quantified by over 1000 exits that Angel investment groups had done. Ten years later, they updated that study. Professor Wiltbank updated it, and presented to the Angel Capital Association, a report called Tracking Angel Returns. He found similar results. Basically, a 2.5x in four and a half years, which again is up 22% internal rate of return. Pretty amazing statistics done by the professors.

Twenty-two percent is great, but that’s less than 27%. Why the drop?

On one hand it does, but Paul Clark of VentureSouth in his article, Tracking Angel Returns – the data, says there are a couple of reasons. First of all, there is a difference in methodology. For example, the second study only had 250 exits where the first study had 1000. There could be some significant difference there. He also points out however that Angel investments themselves had changed in that decade. Basically, the Angel investors are investing larger sizes, later stages and higher valuations. That all indicates that there is less risk in these investments, because the Angel groups are moving downstream a little bit. There’s less risk, accordingly, you could expect lower returns. But even at 22% per year, compare that to what, 7% long term in stocks in a regular stock market. That’s a significantly higher increase. Then there’s long term stocks. As Mr. Clark points out, and I’ll quote him he says, “No one in the Angel investment world is panicking.”

You mentioned a number of factors that lead to these higher returns. Did the professors Wilbank or Boeker get into quantifying any of these individually?

Yes, they certainly did. There are three important ones. I think the three most important things that they quantified; one – as I mentioned – is the impact of time spent on due diligence. I’m an engineer. So, I’m a numbers guy. I’m going to talk about some numbers here. Using the mean of 20 hours of due diligence, they quantified low due diligence which is like 10 hours or less, and high due diligence, 40 hours or more. What they found out in deals, where low due diligence was done, the failure rate – and by failure they mean less than 1x or you don’t even get your money back. The failure rate was 65% when low due diligence was conducted. High due diligence on the other hand, more than 40 hours, produced a failure rate of 45%. Now that’s still a big number, but it’s a whole lot less than 65%. Basically, you have less than half the failures versus almost two thirds failures just to buy the amount of due diligence that you’re doing. More importantly, they quantify the success. By success, we’re talking 5x or higher on a deal. Five times your investment or higher. In low due diligence, that 5x or higher return was about 8% of the deals. Eight percent, if you do low due diligence. The high due diligence area above 40 hours produced 26% returns of 5x or higher. If you think about that, and say 20 deals, in low due diligence on 20 deals you can have one to two, one and a half chances of a high exit. On 20 deals at a 26%, you’re talking about five of your 20 deals are going to give five extra higher, strictly due to the amount of due diligence that’s done. Angel groups do that due diligence. They do the 40 hours or more. Individuals typically don’t have the time. They see a deal, they find a recommendation and they’ll invest. So, huge advantage there quantified in the amount of due diligence done. Overall, the professors found that the overall multiple in low due diligence for all deals was 1.1x, just barely getting your money back. For high due diligence, they found the overall multiple was 5.9x. Again, the conclusion, the return is five times higher when you do high due diligence. The Angel groups do that due diligence. Individuals just really don’t have the time to do that much due diligence. Obviously, the returns for Angel groups are significantly higher strictly due to the amount of due diligence that’s performed.

Wow, that’s powerful and compelling insight around due diligence. Did the professors offer any similar insights about other factors?

Yes, as I said there are two other factors that they analyzed that I think are important. One is, they analyzed the industry experience. Basically, the companies that they invested in – that these Angel groups invested in – how much industry experience do the Angel groups have in that particular industry? First, what they found out was again, there was a significant relationship to the returns. For returns of less than 1x again, not even getting your money back, there was a 58% failure rate when there was low expertise. When the Angel group or the individual Angels or Angel groups I mean had low expertise, there was a 58% failure rate, but there was a 42% only 42% again, significant but significantly lower than 58% when there was high expertise in the area. Again, the amount of expertise the group has basically has a direct relationship to the number of failures. It’s not as significant as the due diligence we just talked about, but it’s still very large. Basically, when it comes to the upper side of things like the 5x and higher, the chances of a high return of 5x or higher with low expertise in an area was about 10%. So, one out of 10, five extra higher. With a high expertise in an area, that jumps to 20%. Twice as much chance of getting a high X return when the investors have a high expertise. Angel groups typically have that expertise. They invest in deals that some – one or more of their members have the expertise. That makes a huge difference in the returns.

Due diligence, expertise, what’s the third key factor?

The third factor is the ability to participate with the portfolio company after the investing. The groups that basically invest – and let’s talk about two areas that they studied. One they called low participation. They called that one to two times per year. One to two times per year showed that the return on those investments was 1.3x – very little return. It’s positive, but still 1.3x. High participation which they defined as one to two times per month, not per year. One to two times per month produced returns of 3.7x. Again, this is three times higher a return when there is participation by the group after the investment. These investors want to succeed. The point is the Angel investment groups, they do more due diligence, they have more expertise and they have more time to participate with portfolio companies. All three of those factors has a significant return on the actual money that’s made from these investments.

While we have our academic hats on, any other studies we should consider beyond those two professors.

Yes, the Angel Capital Association has a number of things on more data that people can research. Just look at the Angel Capital Association, there are a number of reports. I’m just going to talk about one more. Matthew Le Merle with Fifth Era in San Francisco published a report called Capturing the Expected Returns of Angel Investors in Groups. Again, very pertinent to our topic here. He did this with the assistance of the Keiretsu Forum. The Keiretsu Forum has 2000 members, three continents, 40 chapters. It’s a very large Angel investment group. Using the data with the Keiretsu Forum and others, he summarized things as follows. He said, “Returns to Angel investing in groups is as high as the mid 20s,” the internal rate of return. As we saw from the previous study, returns could be basically in the mid 20s as percent per year. That is arrived at over a three to five-year period.  You can expect that in a three to five-year period. This surprised me, the failure rate and at just no capital return is actually lower than Venture Capital’s. Angel investment groups’ failure rate is lower than the failure rate of venture capitalists. It’s funny, because he says that’s because Angels work hard to avoid losses. Because they’re investing their own money. Venture capitalists – not to say that they are not as diligent, but they are investing other people’s money. They’re doing larger deals, but Angel investors are working harder to avoid losses, because they are investing their own money. It shows basically, with a failure rate that is actually lower than venture capitalists. Also, he said that the majority of return is from a small number of highly successful outcomes. Again, what we talked about, is it 8% out of the number of investments or is it 26%? It’s basically, those bringing all the return, because there are going to be a lot of failures in the 40% range of failures, 42%. Basically, he concludes that if you put less in more deals, and diversify, that’s the way to go. Again, that’s the advantage of joining a group versus individual. You could put less money in more deals and spread your risk and increase your return.

Great, there have been a lot of numbers flying around this episode. The full transcript is available on Just click podcasts and find the episode you’re interested in. You can listen and read along. Dave, any final thoughts.

Well, as always if any of our listeners have any questions on anything we talk about here, send me an email and I can direct you to the right resources or give you the advice. I do respond personally to every single email. So, don’t be afraid to email me and I will get back to you. Thank you.

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