Danai Pathomvanich
Oct 19, 2015
Many entrepreneurs often ask me what motivates “angel investors.”
A recent Harvard Business Review article “What angel investors value most when choosing what to fund” by Nicole Torres provides some valuable insights.
Angel investors vs venture capital
Despite the media attention currently paid to venture capitalists and hedge funds, Torres said that a 2013 study showed that angel investors (investors that provide smaller amounts of capital at early stages), fund more than 16 times as many companies as venture capitalists.
In the US alone, she said the study showed that angel investors raised more than $24.1 billion in more than 73,000 ventures through 316,000 investors.
Despite the angel investors’ substantial market size, relatively little data has been developed on the decision-making processes of those who invest in early stage startups.
What motivates angel investors
Torres said Shai Bernstein, an assistant professor of finance at Stanford’s GSB, and Arthur Korteweg of USC’s Marshall School of Business recently partnered with Kevin Laws, the COO of AngelList to analyze angel investor motivations.
They concluded that “....the average investor responds strongly to the founding team, but not so much to the startup’s traction (its sales or user base) or existing investors.”
“...our evidence suggests that at least at the very early stages, investors seem to think tremendously about the team and the founders.”
Findings not much of a surprise
Torres said these fundings weren’t that much of a surprise because the importance of founders has been emphasized before.
Nearly 20 years ago, William A. Sahlman argued that most business plans wasted too much ink on numbers, not paying sufficient attention to the information that really matters to investors: people.
“When I receive a business plan, I always read the resume section first,” he wrote. “Not because the people part of the new venture is the most important, but because without the right team, none of the other parts really matters.”
The research
Bernstein, Korteweg, and Laws research back up Sahlman’s thoughts.
Their algorithms showed that investors gave more credence to investments when they were given positive information about the founding team. Knowing that the startup had material traction or notable investors did not add any significant interest.
“This suggests that a startup’s human capital is uniquely important to potential investors.”
Team not more important than idea
At the same times, however, Torres said the Bernstein study does not argue that the team is more important than the idea, because the test didn’t allow for that comparison.
“Rather, they found that conditional on the idea, the team is quite important — more so than the product’s initial traction and ability to attract earlier investors.”
Why founding team highly valued
The study’s said founding teams were highly valued by angel investors for two reasons.
Operational capabilities of the founding team may be important at the earliest stages of a start-up, when most experimentation takes place.
Secondly, when angel investors see that the founders have graduated from top US school or work for top companies, they may have foregone other great opportunities to pursue the venture.
“.... signals that this is a really good idea and a very promising venture,” Bernstein said.
Using cues and long-term success
Because angel investors sort through thousands of startups, the researchers said they tend to use various cues to filter their pipelines, including reviewing the founders’ pedigree.
At the same time, the angel investors may also use different criteria for long-term success because many founders are often replaced before the startup’s IPO.
At the startup’s earliest stages, when it is still experimenting and trying to find the right business model, the founders are very important.
Later on, when the company is on track and growing to a larger scale, the founder becomes less important.
