Even Angels Fear to Tread

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Biz ownersThey’re risk-takers, putting thousands of their own dollars into unproven ideas for the thrill of turning startups into successful businesses.

Called angel investors, these wealthy individuals are the financial saviors who step in after entrepreneurs have raised all the cash they can from friends and family.

The problem is, there aren’t enough of them.

Wealthy individuals who finance startups around the country are cutting back because the deals have gotten less attractive. Several investors said they can make the same or more money without taking nearly so much risk.

The number of active U.S. angel investors declined 11 percent to 125,100 people in the first half of 2010, compared with a year earlier, according to the University of New Hampshire’s Center for Venture Research. Those who remain are becoming more cautious, with the lowest percentage of angel investors funding startups at the idea or concept stage in at least 15 years.

“If we don’t have the acorns, we’re not going to have the trees,” said Jeffrey Sohl, director for the University of New Hampshire’s Center for Venture Research.

Without the money, entrepreneurs like Joel Ackerman are having a tougher time building their businesses and creating jobs. Ackerman, a former UnitedHealth Group executive, needs $2 million to build his startup, River Systems, which is developing software to help senior citizens communicate with their doctors, family and pastors from home.

He’s had more than 20 meetings with angel investors. They say he has a great idea, but they want to wait until there is a product that brings in revenue.

“The traditional role of an angel investor is about dead right now,” Ackerman said, who has nearly used up his retirement savings and taken a second mortgage on his house to fund River Systems. “We have the great potential to create jobs. Once we get the ball rolling, it will happen.”

Many angel investors say they would invest more money into startups, if they had it. The problem is, their money is tied up in earlier investments, some of which have been in their portfolios for more than a decade.

One way for investors to get their money out of a startup is for it to go public on the stock market. But a weak market has mostly cut off that pathway.

“We’re just waiting for some of our investments that we’ve been in for 10 years to come through,” angel investor Steve Wirth said. “We want to see some liquidity events, so that we can plow proceeds back into the community again and again.”

Investors are also concerned about medical device companies. Uncertainty about approval processes at the Food and Drug Administration makes investors nervous.

Andy LaFrence, who invests in clean tech and life sciences companies, said he’s generally not interested in startups that need more than 18 to 24 months to get products for the market. It’s too risky, he said.

“In general, I want to make sure there is a pretty short window to sale,” LaFrence said.

Angel investors say part of the problem is they aren’t getting rewarded enough for the risk in investing in unproven business ideas.

In the past, angels would often get more favorable deal terms than later investors. But that has changed, and later-stage investors can often make as much money or more.

“They spoiled the party for a lot of people,” angel investor Mark Ravich said. “If you’re entering at a later stage, you’re taking less risk and getting a better deal.”

The financial burden on angel investors has also increased. In the past, a promising startup could move on to funding from venture capital firms after it started with raised money from angel investors. However, venture capital firms are shifting toward later-stage companies, requiring angel investors to provide multiple rounds of funding.

“If this is the new normal, there is not enough money to fund things to get further enough along to a (venture capital firm),” said Paula Skjefte, president and CEO of Waterford Consulting. “I would like to believe this is cyclical, but something is going to have to change to make the whole entrepreneur side of the equation a more friendly environment.”

State officials are hoping a tax credit will help sweeten the deal. Qualified investors who put at least $10,000 into Minnesota startups will receive a 25 percent tax credit on their investment.

The credit started last year, bringing in more than $28 million in investment in startups.

“Our program is really helping change the environment here,” said Jeff Nelson, angel tax credit program coordinator. “What our program does, in a sense, is give (investors) a partial exit right away. If you put $1 million in, within months, you’re getting 25 percent of that back.”

At Sartell, Minn.-based software and application distributor W3i, angel investment played a key role in making the business successful and profitable, co-founder Rob Weber said. It was 13 years ago when Weber and his identical twin Ryan started what would become W3i out of their college dorm. The company had nearly leveraged all of its $1 million in assets and without the angel investment, it would have gone out of business, Weber said. Today, W3i employs about 70 people.

Weber has registered as an investor under the state’s angel tax credit program and said he believes Minnesota entrepreneurs who have succeeded should give back. Weber said the credit’s incentive recently encouraged him to double his investment in a local startup.

“I want to see the community get stronger,” 31-year-old Weber said. “I don’t do it because I expect a good return.”

Visiam, which supplies processing technology for municipal solid waste management groups, said the $75,000 it received through the angel tax credit program last year helped the company save three full-time jobs, hire outside consultants and bring its technology to commercialization.

“It allowed a company to stay in business,” said Scott Hughes, chief operating officer.

Other plans are in the works to make it easier to find accredited angel investors, whom the U.S. Securities and Exchange Commission requires to meet requirements such as a net worth of more than $1 million.

The Minnesota Angel Network, a Web portal that will help facilitate discussions between angel investors and entrepreneurs, will launch this summer. Startups will have their business plans critiqued by network’s mentors and must meet certain milestones before entering the portal.

St. Paul, Minn.-based Rain Source Capital, which pools angel investors’ money to create angel funds, said it plans to create 121 U.S. angel funds over the next four years. Each fund would be worth at least $1 million.

That’s not to say it will be any easier for entrepreneurs to raise money, CEO Steve Mercil said.

“What’s changed a lot since the recession is companies have to get to cash flow even quicker. … They have to show some real growth and critical mass to attract capital,” Mercil said. “Gone are the days … where you could just generally prove something and people will start throwing money at you.”

Source: McClatchy-Tribune Information Services.