Angel investing provides capital to start-up businesses, often when banks and venture capitalists won’t. Impact investing seeks to solve social or environmental problems while generating financial returns. When the two types of investments meet, heavenly things can happen.
“The intersection of angel investing and impact investing is very fertile territory,” says Tom Balderston, managing principal of SustainVC, with offices in Philadelphia; Concord, Mass.; and Durham, N.C. “There are some registered investment advisors who are on the forefront. There are others who are coming along slowly, because they’re starting to get pressure from their clients and they figure they’d better learn about it.”
Impact and traditional angel investing are similar in most ways. The distinction is that the impact version of angel investing focuses on social or environmental causes and formally measures the outcome.
SustainVC manages the Patient Capital Collaborative series of funds, which invest in companies that apply for funding through Investors’ Circle, the nation’s oldest early-stage impact investing network. Balderston, who serves on the board of Investors’ Circle, says the organization includes both successful entrepreneurs and wealth inheritors who want to make a difference with their resources.
Like regular angel groups, Investors’ Circle sponsors events where entrepreneurs pitch for funding. But companies presenting to Investors’ Circle are also evaluated through the B Impact Assessment platform for measuring and benchmarking impact, which features the Global Impact Investing Ratings System (GIIRS) survey. GIIRS assesses the social and environmental impact of companies and funds with a ratings and analytics approach similar to Morningstar’s investment rankings.
Impact angels also seek strong performance because profitability is likely the best route to sustainability. “Only sustainable and growing businesses can expect to make a difference in the world. We look for opportunities where entrepreneurs can harness the power of the market to make positive change,” says Balderston.
BigBelly Solar is one of the opportunities Balderston has discovered. The Newton, Mass.-based maker of solar-powered waste and recycling stations has “grown nicely” since Balderston first provided financing as one of the early angel investors. The company has deployed thousands of its compactors worldwide.
Boston Heart Diagnostics, which provides blood tests that assess the risk of cardiovascular disease, is one of the Patient Capital Collaborative funds’ success stories. This business just made the Forbes 2014 Most Promising Companies list.
In 2012, over 268,000 angel investors put almost $23 billion into more than 67,000 start-ups in the U.S., according to the Center for Venture Research at the University of New Hampshire. The center says investments for the first half of 2013 increased 5.2% over the first half of 2012. Nationwide, angel activity is increasing, with more high-value deals closed in 2013 than during the previous year, according to the Halo Report, published by the Angel Resource Institute, Silicon Valley Bank and CB Insights.
While exact numbers are hard to come by, experts say more of these billions are flowing to impact-oriented investments. Investors’ Circle, for example, is one of the 10 most active U.S. angel groups, according to the Halo Report.
Investors’ Circle experienced a 390% increase in investment in 2012 over the previous year. Between 2012 and April 2014, members invested nearly $24 million. Since its founding in 1992, Investors’ Circle has provided more than $180 million, plus $4 billion in follow-on investments, to over 275 enterprises working to improve education, health, communities and the environment.
Fiendish Risks, Celestial Rewards
Studies show that successful angels can earn an average 250% return on their investments. The savviest angels can grow their investments 10 times or more. But the odds of losing all one’s capital are 30% to 40%. Moreover, 70% to 80% of investments fail to reach their projected returns.
Because all angel investing, whether impact or regular, is high risk, experts recommend an angel portfolio consisting of 10 to 15 carefully vetted investments selected over time. Angels typically allocate $10,000 to $100,000 per company. Most angels limit the size of their portfolios to 5% to 10% of total assets.
Lack of liquidity is another risk with investments in start-up private companies. Angels must generally wait for a return until a company gets acquired or goes public. The average time to exit is five to seven years.
Despite the risks, the rewards that motivate impact angels include helping to launch the next generation of innovators, having a more personal connection to their investments and supporting their local communities.
“The majority of impact angel investors have a background in being entrepreneurs themselves. They are very similar to regular [angel investors]. They just have a little bit more of a philanthropic motive,” says Elizabeth Kraus, a former higher-education software entrepreneur and managing director of the Impact Angel Group, a Boulder, Colo.-based network of about 45 investors that became a formal membership organization in August 2013.
“A lot of impact angel investors want to have an active role in the companies they invest in,” says Kraus. These former entrepreneurs often seek to contribute their time, talent and networks. They can provide guidance to fledgling businesses to help achieve financial and impact goals by shaping early choices regarding customers, strategic partnerships and revenue models.
Kraus says most of the impact angels that she knows also want more of a direct connection with their investments. “They’re investing in a person, rather than in a prospectus. They get to experience the passion and enthusiasm of the entrepreneur,” she says.
Rebuilding hometown economies is another motivation for impact angel investors. “We’re hearing from clients that they want their money out of Wall Street, into their local communities, and in particular into the food sector,” says Eric Becker, chief investment officer of Norwich, Vt.-based Clean Yield, a registered investment advisory firm that works exclusively with social investors.
While the bulk of its clients’ assets remain invested in socially screened stock and bond portfolios, Clean Yield helps clients target their impact investing dollars primarily in growth-stage food, agriculture and clean energy companies in New England. For early-stage impact investing, especially in the technology and health care sectors, Becker says he relies on outside funds, like those of the Patient Capital Collaborative. He says that staying focused locally is one of his firm’s risk-management strategies. “We can get to know people and keep tabs on the companies we invest in more easily.”
Becker says his firm has many clients who were uneasy about their investments well before 2008. “The financial crisis only confirmed their concerns about the long-term viability of the economic model that’s represented by Wall Street—sort of fast money and disconnected from the real economy. They perceive much more safety in the companies that they know and respect in their local communities.”
Where Angels Dare To Tread
Experienced angel investors often claim that the composition of the company’s founders is the key to successful start-ups. “Team, team, team” is perhaps the most popular truism in the angel community. More than having a brilliant product or service, the entrepreneurs must be able to persevere and change course when necessary to turn dreams into dollars. Entrepreneurs may need even more talent to achieve financial and impact goals simultaneously.
The Impact Angel Group uses its own impact metrics, partially based on the B Impact Assessment criteria, to evaluate the overall investment. But the quality of the founders is so critical to a start-up’s success that they also use an assessment tool from Denver-based Pairin to evaluate the entrepreneurs themselves. Pairin, an early-stage company in which the Impact Angel Group invested, provides pre-employment screening to determine whether a person is a good fit for a prospective type of job.
In addition to a strong management team, the Impact Angel Group looks for Colorado-based companies that have an ability to scale, execute and exit; a clear and sizable market for the product or service; legally defensible intellectual property; some degree of traction, as demonstrated by customer contracts, strategic partnerships and revenues; the capacity to grow the Colorado economy; and the potential to have a substantial, positive impact on a social or environmental issue.
“Early-stage investing is really a pretty risky area, especially on a direct basis,” says Balderston. Experts caution that investors new to the space are better off joining one of the hundreds of angel groups around the country, investing in a syndicate or buying into a fund.
Investors’ Circle is the largest nationwide group specializing in impact-oriented investing. Toniic is a well-known global network of impact investors.
Angel group membership gives new investors the chance to learn the ropes from more experienced angels and to get help with the often onerous due diligence process. The amount of time spent on due diligence positively correlates with increased returns to investors, according to a 2007 study funded by the Ewing Marion Kauffman Foundation and the Angel Capital Education Foundation (now the Angel Resource Institute).
When choosing an impact-focused angel group, it’s important to join one whose members agree, or at least agree to disagree, on the definition of “impact.” The Impact Angel Group, for example, filters opportunities based on their ability to generate a positive financial return. The group provides their investors with the results of the impact assessment, but leaves it to individual members to determine whether a particular company is impactful enough to warrant investment.
“There’s business-model impact, like producing a vaccine, for instance,” says Kraus. “But there’s also impact in the way that that the business is supporting the local community, the way that they’re treating their employees, the way that they’re understanding where the pieces of their product are coming from.”
“Impact is a very complicated subject,” says Sheila Lamont, an attorney who works with Kraus and serves as deal flow manager for the Impact Angel Group.
“Some of our members joined with a very personal view of impact investing and initially expressed concerns that investments being screened didn’t seem to fit into that framework since they weren’t curing cancer or addressing problems of world hunger. But after a great deal of group discussion and more time looking at our companies in screening, they acknowledged that impact can be multi-faceted.”
For one thing, Lamont says the downturn in the economy has led some members to focus more on job creation. “It’s not their sole criteria for impact, but it’s one of them. People want to know if the company will create a fair amount of jobs, not just employ five or six people,” she says.
New ventures generated almost two-thirds of the new jobs in the U.S. over the past two decades. During the first half of 2013, angel investments created 111,500 additional jobs, or 3.9 jobs per angel investment, according to the Center for Venture Research.
Besides joining an impact angel group, clients can find promising impact-oriented start-ups through accelerators or incubators that vet businesses, then select a small number to groom for pitching before potential investors. Boulder-based Unreasonable Institute and Chicago-based Impact Engine are accelerators that serve for-profit social and environmental entrepreneurs.
Many angel groups also syndicate deals. In a syndicate, a lead investor usually structures the deal, negotiates terms with the founders and works with the attorneys to get the appropriate documentation in place.
For investors who don’t want to participate directly or through a group, there are always funds. Properly constructed and professionally managed portfolios of angel investments can generate an IRR of 25% to 30% over three to five years, according to industry experts. Besides the Patient Capital Collaborative, funds that invest in early-stage impact ventures include Boulder-based Greenmont Capital Partners, San Francisco-based Pacific Community Ventures, Vancouver-based Renewal Funds and Toronto-based Investeco Capital.
Devil’s In The Details
Angel investments are some of the riskiest, least transparent and most illiquid assets in which affluent clients can invest. Yet they’re also among the best performing, with returns comparable to those of venture capital investments. Several studies show that angel investments have median returns of 18% to 38% or more.
Some say wealth advisors aren’t eager to be part of impact angel investing because they’re concerned about the potential liability for recommending or giving an opinion on anything so risky. Some advisors may also be deterred because they believe it’s difficult to earn fees on angel investments. Advisors may also lack the expertise to evaluate early-stage investments for either financial or impact returns, or both.
But those involved in impact angel investing say there are many clients in the niche that would appreciate help from financial advisors. Some predict that early-stage companies will soon be pitching to advisors on behalf of clients who want their advisors to source deals and handle the vetting process, leaving the final decision to invest up to the clients.
One reason for advisors to consider joining angel groups is the ability to get help with due diligence on potential startup investments that clients bring to advisors. If a group of experienced angels believes the investment is a dud—that it won’t provide a reasonable financial return or solve a significant social or environmental concern—the advisor doesn’t have to be the one to disappoint the client.
Balderston says that several wealth managers and family offices interested in impact angel investing have recently contacted both Investors’ Circle and Patient Capital Collaborative. “The impetus is coming from the clients as far as I can tell. They’re urging their wealth managers to find opportunities like this,” he says.