Why angel investing is essential to social enterprise
Maximillian Martin has published a paper on impact investing that social entrepreneurs should read. Chock full of footnotes I found his section on the limited role of foundations via PRIs and the greater potential role for angel investment to be particularly valuable. This is why I am pushing for Central Ohio to support the Community Investment Network of Central Ohio, a hybrid design that combines the grant-funded development of a pipeline of social enterprise ideas with an angel fund to provide capital to the most viable ideas.
Here is an excerpt from Martin’s report that includes his thoughts on foundations and angel funds in social enterprise investment:
Much of the work to develop the impact investing industry as we know it today has been performed by foundation philanthropy. This is where foundations seem to have comparative advantage. In fact, the program-related investments (PRI) described in the introduction were pioneered by the Ford Foundation in 1968. Along with grants, they are occasionally used today to help social enterprises in the seed or early stage.
However, due to cost and complexity, they are generally passed up. For example, in 2009,only five one-hundredths of one percent of US foundation capital deployed went to equity PRIs. While PRIs have not gained much of a following, they have prompted an important dialogue about earning social returns from giving and investments.
In recent years, private investors have been gravitating toward a more business-like approach to philanthropy, emphasizing positive societal outcomes that can be empirically verified and seeking greater accountability in the charitable sector. Foundations nevertheless continue to play an important role as the impact investing industry matures, especially with respect to disseminating knowledge on best practices and capacity building to get meaningful deal flow started and cut transaction costs. A well-regulated charitable foundation sector is a major asset in getting the impact investment industry off the ground in any jurisdiction.
Deal Flow Generation and Buy and Build: Angel and Early Stage Investors
Impact investing also needs bottom-up innovation and deal flow in order to thrive. This is where angel investors come in with their “buy and build” strategies and expertise. In the US and Europe, angel investors have served as a reliable source of financing for high-growth companies over the past couple of decades. The angel investment sector is continually growing and organizing through groups and networks.
Although venture capital draws the majority of the attention from policy makers, it is angel investment that is the primary supply of external seed and early-stage equity financing in many countries. Angel investors also tend to be less sensitive to market cycles than venture capitalists. Since the financial crisis, VC sources of funds have dropped and the businesses they once supported are in dire need of financing by angel investors who can fill the equity gap between funding by founders and later-stage venture funds.
Angel investors can bring more to the table than just provide money. They are pivotal for the impact investing industry because they can:
- first, bring expertise in assessing deals(angel investors know how to identify good projects and teams and evaluate them);
- second, support a wider range of innovation(angel investors usually invest locally and in a wider range of sectors than venture capital firms, they support a wider range of innovation);
- third, reduce transaction costs(angel investors can connect high-quality entrepreneurs to more investors via groups and networks);
- fourth, they can help build the track-record for impact investments(a lack of track record is often cited as a major barrier for investors and angel investment can help to build such a record);and,
- lastly, they can support the growth of start-ups in their field of expertise(support can be both financial and through business advice).
By providing these critical services, angels can bring more impact investments to a later-stage of financing. Angel investment helps more than just the investee. In the US, estimates suggest that approximately 250,000 new jobs were created in 2009 by firms supported by angel investment, representing 5 percent of new jobs in the country. Additionally, early stage firms with angel financing have an increased probability of survival and improved performance and growth by 30 percent to 50 percent on average.
For these reasons, greater government support to lower risk for angel impact investment seems like an interesting opportunity. Angel impact investing is currently in its formative stage in Europe, with a first dedicated session and training conducted at the 2013 Annual Conference of the European Business Angels Network (EBAN). Angel investment framework conditions vary, so policy makers should take certain factors into account when drafting helpful legislation, such as the level, sophistication, and volume of angel activity in a particular area.
Effective policies in one country may not translate well in another. In fact, in the US and Canada, angel policies are implemented at the regional rather than the national level. Tax incentives are a popular policy tool for angel support but must be monitored and evaluated since they can be difficult to structure. The UK has long-standing angel tax incentive programs that have been shown to have a beneficial effect on the economy. Approximately 24 percent of investments would not have been made without one program in particular, the Enterprise Investment Scheme (EIS). Japan implemented an “income exemption system” in which an angel can deduct from his income the amount of his investment up to a certain limit. In France, the innovation agency OSEO devised a unique funding structure for innovative, early stage companies. The amount of funding is limited to 50 percent of the capital needed so as to draw in other investors. One third of the amount is a grant and two thirds is a loan. This approach has reduced the risk associated with the development and commercialization of novel technology.