October 17, 2006
The Puzzling Behavior of Angel Investors
Posted by Darian Ibrahim

Thanks to my hosts for the opportunity to visit, and to Gordon for the warm welcome.  Like Gordon and Vic, one of my primary interests is the emerging field of “law and entrepreneurship.”  However this field is defined, it must include entrepreneurial finance.  Much important work has been done on venture capital, but relatively little has been done on angel investing. 

Who are angel investors?  They’re high net worth individuals, often ex-entrepreneurs, who invest in early stage start-up companies.  The term “angel” originally referred to wealthy investors in early 1900s Broadway shows.  Today, angels typically invest in start-ups within their fields of expertise and geographic area.  Angels are said to provide more capital, and perhaps significantly more capital, to start-up businesses than do venture capitalists.  If this is true, then why do angels receive scant attention from academics?  The most likely explanation is that angels are difficult to study, given their informal nature and penchant for secrecy (to avoid being inundated with funding requests).  Nonetheless, the available information we do have – some of it empirical but much of it of the conventional wisdom/anecdotal variety – suggests that angel investing differs dramatically from venture capital investing.  Most notably, angels take common stock, while venture capitalists take preferred, and angels do not bargain for protective provisions or board seats, while venture capitalists do.

My first project in this area will explore the reasons for these radically different investment strategies. I hope to explain why angels may opt for relatively unfavorable terms compared to venture capitalists, despite enjoying similar bargaining power over entrepreneurs.  Some attribute this to a lack of sophistication, but the likely explanation strikes me as much more complex…

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