ANGEL INVESTMENTS: A FINANCING OPTION FOR ECONOMIC
TRANSFORMATION IN NIGERIA
BY
Appah, Ebimobowei - (Corresponding author)
Department of Accounting,
Faculty of Business Education,
Isaac Jasper Boro College of Education,
Sagbama, Bayelsa State, Nigeria
Email: appahebimobowei@yahoo.com
&
Okoli, Margaret Nnenna, (Phd)
Department of financial management,
School of Management, Federal University of Technology,
Owerri, Nigeria
E-mail: ndimegnne@yahoo.com
ABSTRACT
The study on Angle Investment as a financial option for economic transformation is a high networth private equity investors who invests her capital in start-up companies in exchange for
equity share of the business. The study seeks to evaluate individual investors who have the desire
and sufficient high-net-worth to enable them to invest part of their net worth into high risk. The
empirical evaluation revealed many important things to know about angel and these includes
many angels are in most of cases former business entrepreneurs themselves. Angel bring both
capital and mentoring to the start-up company. The business angel see themselves as playing
important roles in the assemble of human society by serving and making returns on their
investment while taking a high risk. Angel gives access to networks and new potential customers.
The study also revealed that Angel Investment are extremely difficult to measure the size of the
market or number of investment by Business Angel. Some recommendations on the study own
view of their impact were, amongst others, their provision of experience with handling
unforeseeable events and their strategies for avoiding their own prior mistakes. This is consistent
with Macht (2006). Therefore, it is widely acknowledged that business angels play a vital role in
the development and growth of new ventures, in terms of both the financial capital they invest as
well as offering their business skills and personal networks they have acquired throughout their
professional lives (Mason 2006; Kelly 2007).
Keywords: Angel Investment, Finance, Economic Growth, Economic Transformation
INTRODUCTION
Chemmanur and Chen (2006) stated that the angel is a pure supplier of capital; he
cannot affect the probability of project success through his effort. Further, angel
financing is abundant, so that the angel invests in all projects which yield him a
positive NPV. Business angel is a high net-worth individual who invests his or her
own money in start-up companies in exchange for an equity share of the
businesses. Business angels may be defined as: ‘High net-worth, non-institutional,
private equity investors; That is, individuals who have the desire and sufficiently
high net-worth to enable them to invest part of their net worth into high risk – high
return entrepreneurial ventures in return for a share of voting control, income and
ultimately capital gain” (Callahan and Mazzarol, 2003). Also Shane (2009)
defines an angel investor as a person who provides capital to a private business,
owned and operated by someone else who is not a friend or family member. Acting
as informal venture capitalists, angels invest billions of dollars in thousands of
fledgling companies annually. Some important things to know about angels
include: Many angels are in most of the cases former business entrepreneurs
themselves. They bring both capital and mentoring/coaching to the start-up
company. They make investments in order to gain a return on their money, to
participate in the entrepreneurial process, and often to “give back” to their
communities by catalyzing economic growth (Drakulevski, Veshoska, Gjrov and
Trajkovska, 2011). There is evidence that the business angels may see themselves
as playing important roles in the assembly of human, social and physical capital, in
addition to the more obvious financial capital resources supplied (Ardichvili,
Cardozo, Tune and Reinach, 2000). The angel plays a personal role, serving as
friend, mentor and confidant (Sapienza and De Clercq 2000). Angels make a return
on their investment when the entrepreneur successfully grows the business and
exits it, generally through a sale or merger. It is estimated that angels invested:
$26 billion in 57,000 start-up businesses in 2007 in the United States and around
€3 billion in 2007 in Europe Angels tend to invest in companies that are located
near them regionally. Angels tend to invest early and take a higher risk. Angels
invest in different sectors. Angels are generally more flexible and reactive than
other investors. Angels give access to networks and new potential customers.
Angels acts as an ambassador for the business, increasing the credibility and the
chances to rise follow-on funding.
According to Avdeitchikova et al., (2008), Business Angel research is
characterized by a lack of a uniform definition Nonetheless, the key features that
delineate Business Angels (BAS) from other types of investors remain robust
(Mason and Harrison, 2008). These include the description of Business Angels or
angel investors as wealthy individuals who offer risk capital to unlisted firms in
which they have no family connection. Contrary to institutional venture capitalists
(VCs) who raise the capital to be invested from others, business angels invest their
own money and at their own account. While some authors such as (Ramadani,
2009; Wong et al., 2009) use the terms “informal venture capital” and “Business
Angel” interchangeably, others (e.g. Szerb et al., 2007; Riding, 2008) segment the
informal market into BAs (narrow definition of the informal VC) and love money
investors (family and friends). Although less researched than VC, there are a
number of empirical studies on BAs from a wide range of countries in particular
the USA and the UK (Politis, 2008; Lahti, 2011). Empirical evidence, however, is
scattered across various contexts with different levels of detail (Kelley, 2007;
Politis, 2008).
Previous empirical studies have revealed a fairly robust description of the “typical”
BAS, who is a middle aged male often with a college or university degree that
invests a relatively large amount of his personal wealth in entrepreneurial firms
(see Morrisette, 2007; Politis, 2008; Ramadani, 2009 for reviews). Most BAs have
an enterprise background stemming from previous entrepreneurial or management
experience (see Morrisette, 2007 and Politis, 2008 for reviews; Lahti, 2011b).
Another generality among BAs is their involvement with the investee (Mason and
Harrison, 2008) as most of them do not only provide the entrepreneurial firms with
equity but also with non-financial support.
LITERATURE REVIEW
CONCEPTUAL ISSUES
In order to find potential investment candidates, BAs rely on a network of business
associates and friends (Kelley, 2007). The bulk of angel investments are made
informally and in secrecy, making it extremely difficult to measure the size of the
market and/or the number of BAs (Mason, 2009). Since the mid- to late-1990s,
however, there are tendencies to formalization by creating BANs (Ibrahim, 2008).
Among the reasons for forming a BAN are a steadier stream of deal flow,
increased opportunities for interactions with other BAs and VCs and the
advantages from the pooling of resources such as the chance to fund larger deals
(Ibrahim, 2008). Business Angels primarily focus on start-ups and early stage
firms. A study in the USA indicates that a majority of angel-backed firms have not
earned revenues when they receive funding from Business Angels (Wong, 2002).
Consequently, angel-backed ventures receive financing earlier in the lifecycle than
VC-financed companies. Such early stages involve high informational risks (see
below) for potential investors, so that “angels are more willing to finance firms
with greater uncertainty about the prospects of success than venture capitalists”
(Wong et al. 2009) and are often the only financing source available at this stage.
For an optimal benefit of their enterprise background, Morrisette, 2007; Ramadani,
2009; Lahti, 2011b) and in industries they are familiar with (Wong et al., 2009).
Most BAs focus on high-tech industries for investment (Månsson and Landström,
2006) and provide investees – compared to VCs – with relatively smaller amounts
of funding (Wong et al., 2009).
In order to mitigate risks, angels typically form syndicates and co-invest with
others rather than alone (Kelley, 2007; Wong et al., 2009; Lahti, 2011b). Evidence
from the US shows that companies that receive funding from BAs typically seek
lower amounts of capital coupled with higher revenue and profit projections.
Freear, Sohl and Wetzel (2002) noted that in the literature of the informal venture
capital there has developed in the last few years a taxonomy of angels, sometimes
resulting in unfortunate terminology. We have seen virgin angels, latent angels,
wealth-maximizing angels, street-walking angels, entrepreneur angels, income-
seeking angels, corporate angels, archangels, and corporate and institutional
archangels.
Mason and Harrison (2002), Paul, Whittam and Johnston (2003) reported that
there is considerable evidence, particularly amongst the business angel community,
that investors are frustrated by the low quality of the investment opportunities that
they see and so are unable to invest as frequently or as much as they would like.
Moreover, the existence of business angel networks, whose objective is to improve
the efficiency of the market by „introducing‟ investors to entrepreneurs seeking
finance, and vice versa, has not improved the ability of investors to invest because
many of the businesses that they have put in front of investors are not been
investment ready (Mason and Harrison, 2002; Westphal, 2008).
Research into business angels in Australia suggests that they are predominately
male, middle aged and are either highly educated or have only a basic education.
Such individuals have an average annual income of $180,000 and a personal net
worth of around $2 million. These angels invest an average of $200,000 in new
business ventures and already hold 10 to 14 percent of their capital in
entrepreneurial ventures. International research suggests that business angels are
experienced investors, who have reasonable financial skills and are confident in
their ability to evaluate the merits and risks of prospective investments (Mason and
Harrison, 2002). Business angels have diverse backgrounds, sources of personal
wealth and different levels of financial sophistication. While some are active
investors, most invest in only one or two ventures each year, and prefer to focus on
start-up ventures in areas where the angel has personal experience as an
entrepreneur. In addition to providing financial capital, the angel investor also
provides access to networks of friends, family and business contacts for the new
venture. Most business angels invest ‘close to home’ and insist on personal
knowledge of the entrepreneur and usually invest in companies in industries with
which they are familiar (Wiltbank & Sarasvathy 2002).
Ardichvili et al. (2002) studied the different types of resources that angel investors
can contribute to their investee companies and identified five main categories:
human, social, physical, organisational and financial capital. Human capital is
embedded in human beings and consists of their skills, knowledge and abilities
(Erikson & Nerdrum, 2001; Ardichvili et al., 2002). Business angels certainly
bring human capital to the investee company by contributing their own knowledge,
experience and skills. In addition to that, BAs can increase the human capital of the
investee company’s employees who can learn from them. Social capital constitutes
the resources that are and can be obtained through social relationship networks
(Sørheim, 2005). BAs increase the social capital of the company by providing their
own networks of contacts and by thus growing the venture’s contact base. One
example of this increase is the introduction of other investors to the company,
which enhances both the relationships that the business has with external financiers
and the chances of further funding. Physical resources are tangible assets like
machines or factories, whereas organisational capital is knowledge embedded in
the organisational culture, databases, manuals or patents. Apart from educating
employees, BAs can also make the business learn from their own experience and
thus increase organisational capital. Financial capital consists of equity and debt
and it is the one resource that initiates the relationship with business angels
(Cassar, 2003). Consequently, BAs are capable of adding value through their
knowledge of and access to resources, their skills to negotiate for resources, and/or
their abilities to develop resources (Ardichvili et al., 2002).
Theories and Empirical Review
Theoretical Underpinning
Investment refers to any vehicle into which funds can be placed with the
expectation that it will generate positive income and/or preserve or increase its
value. Investment takes the form of addition to real and financial assets in an
economy. This presented addition is occasioned by the profit maximization
principle presented by Okafor (1983). Angel Investment would be identified with a
behavior that is consistent with the various theories investment such as Markowtz
efficient market hypothesis, the slow growth theory, the Kaldor’s mode of
economic theory. Markowitz efficient market hypothesis, fifty percent principle,
Greater tool theory, Odd lot theory, Loss-Aversion theory, Rational Expectation
theory, Short interest theory and the Bottom line theory among others.
This Markowitz efficient behavior applied by Angel Investors is usually associated
with five cardinal returns such as:
a) Saving/premium-investment (intermediation) decisions are based on the
parameters of risk and returns (Ezirim and Muogholu, 2002).
b) Preference for more returns on investment to fewer returns.
It can easily be observed that Markowitz efficient market hypothesis is basically a
theory of return and risk, which phenomena are the building blocks of modern
portfolio theory. In their investment and intermediation activities, insurance
companies construct portfolios in the process of creating and holding different
types of both real and financial assets. The portfolio behavior of insurance
companies is targeted at creating optimum amounts and varieties of assets, and
hence optimum returns on investment, at a given level of risk. The effect would be
to minimize the level of risk possible at any given level of expected return. Such
portfolio behavior is in line with what has been described as efficient portfolio
behavior, (Ezirim, 2007).
The Solow Growth Model
The Solow growth modelis the neoclassical growth model is the work hours of
research on economic growth and often, the basis of more recent refinements. The
theory started by positing that planned investment must make up for the amount of
income funneled out of the income circle by saving. The Slow growth theory posits
that the rate of savings determine the capital stock and, hence output and always
raise income and investment of the productive sector but may reduce consumption.
The Kaldor’s Model of Economic Growth
The Kaldor model is an attempt to make savings – income ratio a variable in the
economic growth process. It is based on the classical saving function which
implies that savings generated by Angel Investors equals the ratio of profit
contributed to the national income or national output.
The interpretative value of this model, according to Kaldor, is the
conceptualization or treating of investment or the ratio of investment to output
(I/Y) as an independent variable. An increase in the level of investment would
raise the level of demand, prices and income (Jhingan, 1997).
EMPIRICAL EVIDENCE
Prior research on business angels has increased rapidly in recent years and we can
today find studies from a wide range of countries, including the US (Freear, Sohl,
and Wetzel 1997), Canada (Duxbury, Haines, and Riding 1996), the UK (Van
Osnabrugge 1998; Kelly 2000; Paul, Whittam, and Johnston 2003), Germany
(Stedler and Peters 2003), Japan (Kutsuna and Harada 2004), Singapore (Hindle
and Lee 2002), Australia (Hindle and Wenban 1999), and the Nordic countries
(Reitan and Sørheim 2000; Sørheim and Landstro¨m 2001). Compared with the
very earliest studies in the field. In particular, research has revealed that the typical
business angel is a middle aged male who invests a relatively large amount of his
personal wealth, most often in young and technology-oriented firms (Reitan and
Sørheim 2000; Hindle and Lee 2002; Stedler and Peters 2003). The working
relationship between the business angel and the entrepreneur can in most cases be
characterized as fairly active. The most common form of business angel
involvement seems to be by way of working on the board of directors and by
providing consultancy services to the firm when required (Mason, Harrison, and
Chaloner 1991; Landstro¨m 1993; Mason and Harrison 1996; Freear, Sohl, and
Wetzel 1997; Tashiro 1999; Hindle and Lee 2002). Extant research has also
pointed out that business angels tend to work closely with their portfolio firms as a
means of both promoting and protecting their interests. Even if business angels are
a very heterogeneous population (e.g. Stevenson and Coveney 1996) there seem to
be some defensible generalities among many of them.
Several studies have pointed out that business angels have a genuine
entrepreneurial career background, in which they often have made their fortunes
through a cash-out of their own previous ventures. In the early US study of
business angels conducted by Wetzel (1981) he reported that 78% had previous
start-up experience Bruton et al 2010. Brettel (2003) report a similar figure in his
study of German business angels where 75% of the investors had previously
started up their own companies. He also noted that about two thirds of them have
been involved in starting up two or more companies. However, the most
impressive results in terms of prior entrepreneurial experience come from studies
in the Nordic countries. In a Swedish study Landstro¨m (1993) reported that as
many as 96% of the business angels had previous start-up experience, while Suomi
and Lumme (1994) in a study from Finland reported a similar figure of 95%.
Furthermore, in a study of Norwegian business angels, Reitan and Sørheim (2000)
stated that even if ‘only’ 46% of the surveyed business angels had prior start-up
experience most of them had management experience from new ventures or in
relation to company ownership.
Tashiro (1999) in his study of 20 Japanese
business angels noted that they often provided business advice to the businesses in
which they invested.
This support was usually in the area of management, but some also provided more
specific advice regarding technology, human resources or finance. In a study of 27
serial business angels in the US, Ardichvili et al. (2002) report that the investors
provide a wide range of non-financial resources to their portfolio firms. These
activities include shaping the business concept or business model of the new
venture, finding and recruiting the management team and key personnel, finding
additional sources of capital and helping to establish social networks. In addition,
the investors were highly involved in the governance of the new firm. Paul,
Whittam, and Johnston (2003) surveyed business angels in Scotland. Among their
140 usable responses they found that the main non-financial value added benefits
were provision of business contacts, enhancing the management skills in the new
venture, and helping with raising additional funds. Sætre (2003) in a study of 20
Norwegian business angels reports that these investors provided access to industry
insights which greatly augmented the firms’ ability to make strategic choices, and
that the access to their high level industry networks facilitated the enactment of
these strategies. Some investors also made demands for information and reports
concerning the development of the business to keep up with the day-to-day running
of the business. Brettel (2003) in a study of 40 German business angels reports that
the most important contributions made by these investors were the use of their
personal networks, their involvement in coaching the entrepreneur and their
provision of financial know-how. Other contributions included their provision of
marketing know-how, management experience and their knowledge of the
industry, helping with strategy development, and searching for and choosing
executive personnel. Amatucci and Sohl (2004) made an in-depth study of four
women entrepreneurs in the US who obtained business angel financing. In their
study they report that the business angels served as mentors and were also deeply
involved in both strategic and operational activities. In another in-depth study of
four business angels in Norway by Sørheim (2005) he recognized the value added
contribution of business angels reported in the literature but also demonstrated that
experienced business angels may play a value adding key role as facilitators for
further finance. This ability was primarily and strongly affected by their previous
track record as developers of entrepreneurial firms.
This link to further finance is evident also in Madill, Haines, and Riding (2005)
who in a study of Canadian technology based firms who had received investments
from business angels report that these investors helped the firms to become
‘investment ready’ for future rounds of investment from venture capital firms. This
was realized through active involvement in value added activities such as
providing
networking
opportunities,
hands-on
assistance
(legal
advice,
accountancy advice, and provision of resources) and business and marketing
intelligence. This active involvement by business angels gave credibility to the
firms in which they had invested and increased their attractiveness to institutional
venture capitalists.
CONCLUDING REMARKS
This paper contributes to literature and research on business angels in two
important ways. First, it provides a systematic overview of previous literature and
research on business angels. Second, the paper presents set roles that business
angels have been reported to perform together with links to theoretical perspectives
that explain why these roles have the potential to contribute to the sustainable
entrepreneurship development in Nigeria. There is now a growing recognition that
improving the access of entrepreneurs to finance is not exclusively a supply-side
issue. The impact of an increase in the supply of early stage venture capital will be
limited because many of the businesses that come forward are not investment
ready. The consequences are, first, that investors are unable to make as many
investments. Business Angels are involved in their investee companies in many
different roles and provide a significant impact upon these companies, especially in
relation to success, survival, efficiency and profile of the investee. Some
recommendations on the study own view of their impact were, amongst others,
their provision of experience with handling unforeseeable events and their
strategies for avoiding their own prior mistakes. This is consistent with Macht
(2006). Therefore, it is widely acknowledged that business angels play a vital role
in the development and growth of new ventures, in terms of both the financial
capital they invest as well as offering their business skills and personal networks
they have acquired throughout their professional lives (Mason 2006; Kelly 2007).
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