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Angel Investing: a Case Study of the Processes, Risk, And ANGEL INVESTING: A CASE STUDY OF THE PROCESSES, RISK, AND INTERNAL RATE OF RETURN by Geoffroy T. Roach A Dissertation Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Business Administration UNIVERSITY OF PHOENIX December 2008 © 2008 by GEOFFROY T. ROACH ALL RIGHTS RESERVED ANGEL INVESTING: A CASE STUDY OF THE PROCESSES, RISK, AND INTERNAL RATE OF RETURN by Geoffroy T. Roach December 2008 Approved: Mark S. Allen, Ph.D., MBA, Mentor Alexander Hapka, Ph.D., Committee Member Eugene Lee, Ph.D., Committee Member Accepted and Signed: Mark S. Allen Nov 19, 2008 Accepted and Signed: Alexander Hapka Nov 19, 2008 Accepted and Signed: Eugene Lee Nov 19, 2008 __________________ Dawn Iwamoto, Ed.D. Date Dean, School of Advanced Studies University of Phoenix ABSTRACT One of the most difficult components in starting and growing a new enterprise is acquiring capital and other resources. Funding for many new enterprises comes from a large, yet relatively unidentified, group called angel investors. This case study is one of the few to examine the returns from angel investing and one of the first to examine the dynamics of angel investing groups. Computing internal rate of return for angel investments for Keiretsu Forum, an angel group, for the years 2000-2006 revealed that the investments generated higher returns than could have been obtained from the broader equity market as measured by popular index funds. Perhaps more important, this study also indicated that the processes developed by and regularly used by the angel group are effective at identifying potential failed deals and are not so restrictive as to bypass potential winners. This research also showed that networks of angel groups are beginning to develop and this development not only contradicts the established notion that angels only invest locally but also reveals that the amount of capital that may be raised from angels in these networks of groups can be greater than previously thought. The information that can be generated from the angel group processes is increasing and the speed and cost by which that information can be developed and shared is decreasing. These results point to an area for future research that may indicate a change in the investment ecosystem and potential changes in the relationships between angels and venture capital firms. This information and the ability to raise capital for early stage enterprises quickly and effectively may help make more capital available ultimately driving the creation of new enterprises and economic growth. iv ACKNOWLEDGMENTS This research would have been impossible without the members and staff at Keiretsu Forum. The vision and dedication of Randy Williams, the CEO and founder of Keiretsu, created the environment that made this work possible. Sonja Markova, Vice President of Keiretsu, was indispensable in her wealth of knowledge about the investments, the members, and the entrepreneurs. Krupa Patel, Neda Mehran, Heinz Blennemann, Mathrew LeMerle, and Colin Wiel from Keiretsu played a significant role in gathering the data and validating the methods used in the work. The Keiretsu members in the San Francisco Bay Area, San Diego, and Seattle chapters also helped shaped this study with their interest and feedback. Many other people in the investment and finance fields provided feedback and the motivation to finish this work. William Sharpe provided early direction and Mark Garmin helped shape the ideas around the investment processes. Rob Wiltbank helped navigate previous research into the angel world. Carol Sands and Laura Roden provided the sanity checks that helped keep the research on track. Lew Petrinovich and Mary Lynn Wilson provided the editing and pointers to help make the writing comprehensible. Mark Allen, Alex Hapka, and Eugene Lee are a great committee and provided the insight and direction needed in the University of Phoenix environment. Completing a study and program like this could not have been done without the support of colleagues and friends. The staff and board of directors at San Jose Jazz provided much needed support and help. Friends like Arturo Riera, Bruce Labadie, Lucie Paye, Madelyn Crawford, Barbara Christmann, Vera Gert, Gary Duyanen, Jan De Carli, Dennis Broughton, Robert Griffin, Harley Christensen, Kim Stoermer, Kelly Eastmoor, v and so many others helped. Matt Kesner, Randy Smith, John Schermer, Bill Hazzard, Jack Conway, Brian Brockhouse, and Roy Kaufmann, the members of Octobop, the jazz octet, provided much needed relief from the pressure of the doctoral program. Last, but certainly not least, are the thanks due Colleen Hansen who provided the real spark and encouragement to finish. vi TABLE OF CONTENTS LIST OF TABLES................................................................................................ x CHAPTER 1: INTRODUCTION......................................................................... 1 Background of the Problem .................................................................................. 2 Statement of the Problem...................................................................................... 4 Purpose of the Study ............................................................................................. 5 Significance of the Problem.................................................................................. 7 Nature of the Study ............................................................................................... 8 Research Questions............................................................................................. 11 Theoretical Framework....................................................................................... 13 Definition of Terms............................................................................................. 16 Assumptions........................................................................................................ 20 Scope, Limitations, and Delimitations................................................................ 22 Summary............................................................................................................. 24 CHAPTER 2: REVIEW OF THE LITERATURE ............................................. 25 Research History................................................................................................. 27 Investing and Entrepreneurship ................................................................... 28 Diversification, Portfolio Theory, and Investment Returns......................... 31 Agency Theory ............................................................................................ 35 Capital Structure and Liquidity ................................................................... 36 Behavioral Finance ...................................................................................... 39 Funding Models for Early-Stage Ventures.................................................. 40 Current Findings ................................................................................................. 42 vii Angel Investing............................................................................................ 42 Characteristics of Angel Investors............................................................... 45 The Investment Process ............................................................................... 51 Risk Management ........................................................................................ 54 Venture Capital Investing vs. Angel Investing............................................ 58 Emergence of Angel Investment Groups..................................................... 67 Angel Investing Outside the United States.................................................. 71 Barriers in Angel Investing.......................................................................... 73 Returns from Angel Investing ..................................................................... 74 Conclusions......................................................................................................... 76 Summary............................................................................................................. 77 CHAPTER 3: METHOD .................................................................................... 79 Research Design.................................................................................................. 79 Appropriateness of Design.................................................................................. 81 Research Questions............................................................................................. 81 Population ........................................................................................................... 81 Informed Consent and Confidentiality................................................................ 82 Sampling Frame.................................................................................................. 83 Geographic Location........................................................................................... 84 Instrumentation ................................................................................................... 84 Data Collection ................................................................................................... 84 Data Analysis...................................................................................................... 85 Validity and Reliability......................................................................................
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