Start-up investment: Fallen angels

"The fact is that angel investing is a pretty miserable space to be in. It's not that lucrative and the vast majority of companies fail. Right now, the only angels that are investing are people with really deep pockets who are industry insiders."

Richard Robinson has been an internet entrepreneur and investor in start-ups in China since 1996. Despite his dim outlook, during that time Robinson has helped six companies raise angel funding and is part of the Beijing chapter of AngelVest, one of the first institutionalized angel groups in China. His main frustration is that angels in Asia need inside knowledge of a specific sector and connections in order to be successful - as well as celebrity power to be able to promote their companies.

Angel investment isn't only a problematic space to look at for the investors themselves, though. In 2010, $28 billion was committed to venture capital deals in the US, compared to $19 billion in angel-stage rounds. In China, $7 billion was invested in venture capital over the same period, compared to less than $1 billion in angel rounds. The disparity between the two markets demonstrates how the tremendous demand from Chinese entrepreneurs for start-up capital clearly isn't being met.

Many Chinese entrepreneurs succeed in raising $15,000-100,000 from personal contacts - Robinson refers to them as the three Fs: "friends, family and fools" - but it's in the next price bracket, $100,000-160,000, that willing investors are lacking.

A handful of venture capitalists have lowered their ticket sizes to reach into this space, while some angel investors have done the opposite, but competition for capital is fierce. As a result, numerous Asian entrepreneurs - mainly in China and India, but also in Southeast Asia, where there's an active angel scene emerging from Singapore - have opted to boot-strap their own companies, prove their concept and then go to an angel, rather than the other way around. However, it is a luxury few local start-ups can afford.

Devils at work

Once entrepreneurs do succeed in raising capital, they can be vulnerable to usurious terms and protections imposed by unscrupulous investors. By selling excessively large stakes in their companies for small amounts of equity, many founders endanger the long-term sustainability of their businesses.

"Typically in an angel round you'd be giving up 10-30% of the company, but I've heard of angels who are not very aptly named as angels - they're more like devils - grabbing more than 30% of the company," Robinson tells AVCJ."If you're getting close to 50% or even control from an angel round, then you're just crushing it for the founders later to be able to raise subsequent rounds."

Some believe that Asian entrepreneurs also have it harder than their US contemporaries when it comes to gaining a market for their products. Jordan Green, chairman of the Australian Association of Angel Investors, argues that American culture is based on a habit of excess consumerism, which makes the country an excellent market because if businesses sell something, local consumers will buy it.

"But in Asian markets, even in Japan - where the economy is more Westernized - there's a much stronger perception of value for money," he explains. "Why do I need to buy this next thing? So entrepreneurs need to understand there's a much greater need to put value in the market and not just marketing hype."

Despite the wealth of quality targets seeking seed capital, the life of an angel investor remains challenging in Asia. One reason is that there is still a limited appreciation by the entrepreneurs of the notion of "smart money," particularly in China. Many company founders still view angels as merely another source of funding, without realizing - or wanting - the fact that they have operational expertise which can aid them in expanding and raising venture capital in the future.

Chris Evdemon, Beijing-based angel investor and partner at incubator Innovation Works, attributes the status quo to what he calls the "recirculation phenomenon." In Silicon Valley, for several generations, successful entrepreneurs have put the money that they earn back into the system - by startingadditional companies or becoming angels or VCs or mentors. Here in Asia the ecosystem is still at its first generation.

"In China, the guys who have built multibillion-dollar companies like Baidu, Tencent and Alibaba are in their early 40s at most and are still running these companies. They haven't ‘graduated' yet and decided to become angel investors themselves," explains Evdemon. "This is starting to happen but we need to wait a couple of cycles before a really healthy ecosystem is generated."

The relative immaturity of the ecosystem, as well as the vast physical distances between opportunities, mean that angel investors in Asia have to reach across a larger geographical base to secure the top deals.

"Being prominent, being ‘out there' is so important," says Anand RP, an investment associate at fund-of-funds Squadron Capital and part-time angel investor. "I know a really good angel investor in India and he's always travelling - to an entrepreneurs cocktail in Delhi, then Hyderabad the next day, and then Chennai the day after that. You have to run around a lot."

Building relationships

One way that angels have tried to circumvent this issue is through the formation of angel networks. These organizations typically have branches in different cities and arrange to see the best several projects presented to them together on a weekly or monthly basis.

Examples of this model in China include AngelVest and China Business Angel Network (CBAN); Singapore is home to BANSEA, the biggest network in Southeast Asia; and India's Mumbai Angels recently brought on board Squadron Capital as an LP.

Innovation Works' Evdemon says that when he first moved to Asia in 2005, he found joining a syndicated angel group a useful move for getting to know other investors and the way they operated. He asserts, however, that top-quality deals never reach these networks, as experienced entrepreneurs prefer to approach their desired backer directly, a claim that David Chen, co-founder of AngelVest, disputes.

"Super angels [investors who are able to write large enough checks to invest alone] don't necessarily get the best deals - not always," he says. "If entrepreneurs have their own contacts, it's true that they'll seek them out. But most of them won't. We, however, do have those contacts and the brand to keep on getting them."

Some angel networks have leveraged their contacts one step further and established their own funds. As in the US, these vehicles generally follow one of two possible models.

The first type is structured like the archetypal venture capital or private equity fund, with capital from LPs including pension funds and endowments. The managers are former ‘super angels,' who are employed on a full-time basis to invest in seed-stage opportunities. China's first few funds of this kind were launched earlier this year.

The second type of fund sees large groups of angels band together - through a network - and invest their own money not only in deals, but also in a sidecar vehicle managed by a full-time team that co-invests in opportunities alongside the angels. While AngelVest represents a perfect example of this, there's doubt among industry participants whether this model will be widely adopted in Asia.

"People would rather do larger funds with bigger economics," says Chen. "Many investors feel that the scale is too small for them and also, they don't have the skillset to judge which companies are investible. Due to the demand for angel funding, you would think that the number of angel funds will grow, but the question is: Can these funds be successful, and can their GPs articulate a strategy that LPs can buy into?"

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• Topics
• Early-stage
• Greater China
• South Asia
• Southeast Asia
• seed
• China
• India
• Singapore
• Southeast Asia
• Innovation Works