The angel investment decision: insights from Australian business angels

1 Introduction

Tracey Beikoff was on the verge of closing her business; her invention, Rescue Swag, a first aid kit designed to be used as a sling, splint and immobilisation device, had sold only a couple of hundred units. She could not grow without more money, and she had exhausted her supply; she needed investment. Luckily, Tracey was able to connect with an angel investor who liked her product and saw that Tracey was keen to learn and try new things. Tracey got the capital and has sold nearly 100,000 rescue swags in just 2 years (Shark Tank, 2015).

Unfortunately, for thousands of other entrepreneurs, accessing capital is a significant problem. Getting seed funding, often from ‘triple F’ finances – founders, family and friends – is relatively straightforward. But like Tracey, many entrepreneurs struggle to get growth funding. And funding is just part of what new entrepreneurs need. They also need help finding new customers in order to grow and be successful (Gouveia, 2017). For this ‘smart’ finance, entrepreneurs turn to business angels, defined by Mason and Harrison (2008) as ‘a high net worth individual, acting alone or in a formal or informal syndicate, who invests his or her own money directly in an unquoted business in which there is no family connection and who, after making the investment, generally takes an active involve in the business’. This definition explains the what or who of a business angel, but not the why. What motivates business angels, like Tracey's, to invest in a business? What influences business angels in their decision making?

To address this question, we use a qualitative method to explore the decision-making process of angel investors. We conduct an abductive inquiry into the activities and behaviour of business angels, developing an understanding of the underlying drivers motivating angel financiers. To address the difficulty of finding business angels willing to be interviewed (Harrison and Mason, 1996; Vitale et al., 2006), we adopt the unique approach of interviewing active participants in the entrepreneurial ecosystem, providing corroborating evidence and developing insight into angel financing. This approach addresses concerns of a small population and provides a richer, more comprehensive understanding of the process, expanding the depth of the analysis (Morse et al., 2002). It is unique within the angel finance literature, representing a valuable technique for researchers.

There is substantial new research investigating business angels’ ‘investment criteria’ during the decision-making process (see, for example, Croce et al., 2016; Mason et al., 2016) adding to the established literature (Feeney et al., 1999; Mason and Stark, 2004). A key limitation of the extant literature is its failure to distinguish criteria used at the screening and detailed evaluation stages (Smith et al., 2010). We address this issue by breaking down investment criteria into discrete categories and linking them to the decision-making process, identifying primary influencing factors of business angels during the initial investment decision.

We identify and address three problems with the investment decision-making literature. First, exploration of the importance of post-investment involvement during the decision-making process is lacking. Post-investment involvement is a factor weighed by business angels prior to an investment being made and is considered as early as deal origination. Second, some models in the literature fail to adequately address the importance of the exit. We find that the exit is of particular importance to angels who consider it throughout the decision-making process even as early as deal origination. Third is the problem of application of investment criteria. While the literature assumes that criteria are linked to a screening/evaluation/due diligence stage, we find that they apply to each step of the decision-making process, suggesting that angel investment decisions are iterative and complex.

We make two contributions with our methodological approach. We develop an analytical framework addressing the challenges of the iterative nature of angel investments by integrating investment criteria with the decision-making process. These investment criteria, normally associated with an evaluation stage, are organised into three categories: financial factors, business strategy factors, and personal and relationship factors. In applying this framework, we contribute to the literature by using a unique approach of interviewing business angels along with other participants in the market in order to provide corroborating evidence.

We identify four themes driving the decision-making process of angel financiers in Australia: first, the role personal experience plays in the decision-making process, along with its influence on investment criteria; second, the importance of trust throughout the process; third, the emphasis placed by angels at the earliest stages of the decision-making process on their post-investment involvement; and finally, the importance of realistic expectations.

We begin this paper with a review of the literature, providing an overview of the Australian context and identifying gaps in the literature in relation to decision-making processes and angel investment criteria. We then outline our methodological approach, justifying a qualitative approach, identifying challenges and the ways we address these challenges. We offer an analytical framework from which we base the interviews. We then present the findings in the context of the four major themes identified during the analysis stage of the research. Finally, we offer some thoughts on the implications of these findings for future research.

2 Literature review

2.2 Decision-making process of business angels

While business angels and institutional venture capital funds both aim to make a return, some investment criteria used by business angels differ from institutional funds (Harrison and Mason, 2000). Business angels seek to mitigate their risks through two methods: by investing in an industry or sector where they have experience (Wetzel, 1983) and by being actively involved in managing the firms in which they have invested (Mason and Harrison, 2000). Venture capitalists decide on whether to invest by looking at a proposed project, while business angels focus on the entrepreneur's ability to run the business (Aernoudt, 1999). Maxwell et al. (2011) add that business angels use shortcut decision-making heuristics. While formal investors tend to concentrate on risks linked to the product and the market, business angels focus on risks linked to the entrepreneur (Fiet, 1995; Aernoudt, 1999). Further, while analysis by formal investors is driven by financial factors, business angels are driven by the desire to guide and monitor a project (Aernoudt, 1999).

The findings of research into investment motivations of business angels are contradictory. For example, Hill and Power (2002) stress that, contrary to Aernoudt's (1999) findings, for some angels, cash is the primary (and only) motivation. Aernoudt's (1999) findings support early research recognising that non-financial rewards play an influential role in decision making (Wetzel, 1983) and have been identified as a main driver for angel investing (Tashiro, 1999). The importance of non-financial rewards is highlighted in the literature. For example, Stedler and Peters (2003) find that motivation for investing is a mix of financial and non-financial rewards, and that sharing professional experience and contributing to a successful start-up is considered particularly important.

The investment decision-making process of business angels has attracted considerable interest from scholars. White and Dumay (2017) note that research into angel decision making covers a broad range of topics, including readiness for funding (Brush et al., 2012), trust, agency issues and risk reduction (Lahti, 2011; Maxwell et al., 2011), and whether business angels place emphasis on the opportunity or the entrepreneur (Clark, 2008; Mitteness et al., 2012). Botelho (2017) discusses what business angels require in an investment proposal. The studies also enable incubators and governments to better understand what makes business angels different from other sources of capital, further highlighting the importance of business angels for the development of entrepreneurial ecosystems (Prevezer, 2001; Neck et al., 2004).

A number of researchers have examined the investment decision-making process, identifying different stages based on a ‘chronological’ or ‘linear’ approach (though some researchers highlight that, for business angels, the process is iterative, e.g. Paul et al., 2007; Haines et al., 2003). The multi-stage approach to the investment process provides a useful framework to develop an understanding of investment criteria and actions associated with each step (Botelho, 2017) and, ultimately, assists in identifying the underlying drivers influencing business angels during the initial investment process. Figure 1 summarises these different decision-making models.

Early research into the business angel investment decision process focused on formal venture capital decision making, with its five-stage model: deal origination, screening, evaluation, deal structuring and post-investment activities. The angel process is similar. Riding et al. (1993) and Duxbury et al. (1997) developed a five-stage model: deal origination and first impressions, review of business plan, screening and due diligence, negotiation and consummation. A limitation to this model is that it does not acknowledge angels’ post-investment involvement. Feeney et al. (1999) provides a literature synthesis documenting the linear progression of venture capital decision making, arguing that the decision-making process of business angels is similar to the process used by institutional investors. This model, shown in Figure 1, addresses the limitation of the Riding et al. model by including post-investment involvement. However, it lacks an exit stage.

Van Osnabrugge and Robinson (2000) present an eight-stage model they claim is applicable to both business angels and venture capitalists. Given the differences between these two types of investors, this claim is questionable (Mason and Stark, 2004), but the model makes a significant contribution by covering a greater range in the process (from pre-investment to exit) and by acknowledging the importance of factors considered prior to investment – motivations, criteria and the search for deals. Botelho (2017) suggests that these pre-investment criteria could be more efficiently placed in a single stage, deal origination, as in Haines et al.'s (2003) model; however, the iterative nature of angel investment decisions, particularly during familiarisation, screening and bargaining (Paul et al., 2007), suggests that criteria may be revisited during the different stages of the process.

The model proposed by Haines et al. expands Tyebjee and Bruno's (1984) five-stage model by introducing due diligence, negotiation and decision making as separate stages in place of evaluation and structuring. Haines et al. (2003), like Van Osnabrugge and Robinson (2000), includes an exit stage, emphasising ‘post-investment activity’. Van Osnabrugge and Robinson (2000) assert that this stage is a monitoring activity, whereas Haines et al. adopt a broader approach by including ‘value-added’ activities at this stage. A key strength of Haines et al.'s model is the clear separation of each stage across the entire investment process (Botelho, 2017), enabling more detail at each stage. These stages, however, are compressed by their later work (Riding et al., 2007), allowing for a simpler description of the process.

Paul et al. (2007) adopt a five-stage process noting that, while the angel investment process is generally sequential, it is not orderly and can be characterised as iterative. The first three stages of the research – familiarisation, screening and bargaining – represent an iterative assessment where the ability to validate both hard and soft data is crucial to progression to subsequent stages. These stages are further separated, with the familiarisation stage similar to deal origination with ‘meeting the entrepreneur’ added. The screening stage includes an initial and detailed screening where business angels use personal networks to assess the entrepreneur and, in addition to evaluating the business, determine what contribution they can make to the business beyond their financial investment. It is at this stage that a business angel decides to invest. Consequently, the amount of time spent on the proposal at this stage increases, with work on business plans a ‘back and forth’ process between angel and entrepreneur. The bargaining stage is the last of the ‘iterative’ stages proposed by Paul et al. (2007), corresponding to the ‘due diligence’ and negotiation stages presented in the preceding models.

The contribution of Paul et al. (2007) is significant as it highlights the iterative nature of angel investing. They argue that it is erroneous to suggest the process is straightforward and ‘neat’, but rather that it is an assessment that incorporates both market/business and personal factors (Paul et al., 2007). This is supported by Mason and Harrison (2003), who show that impression management abilities of entrepreneurs are critical when raising finance from external investors. Finally, Paul et al. (2007) highlight that business angels are more likely than venture capitalists to emphasise personal factors, a finding supported by a number of other studies (Mason and Stark, 2004; see Feeney et al., 1999).

3 Methodology

To answer the research question, it is necessary to develop a deeper understanding of the angel decision-making process. And to determine ‘what’ the ‘underlying drivers’ are, it is necessary to ask how and why. This approach is more explanatory and deals with operational links that need to be traced over time, rather than mere frequencies or incidence (Yin, 2014). We explore the perspectives of individual business angels, seeking to determine why decisions were taken and how they were implemented, and attempting to gain an insight into their experiences, thoughts and understanding of the investment process. To do this, the qualitative interview was chosen as the means of collecting data.

Interviews are useful when looking for detailed information about thoughts and behaviour, and provide a suitable platform for in-depth exploration of an issue (Boyce and Neale, 2006). Interviews allow the researcher to learn the perspectives of individuals and experiences, and are effective in discovering nuances (Jacob and Furgerson, 2012). Three broad categories of interview methods exist: structured, semi-structured and unstructured (Qu and Dumay, 2011). The structured interview approach views the interview as a tool producing objective data where interview bias is minimised (Rowley, 2012), but the minimisation of bias is at the expense of the ability to capture in-depth detail and the flexibility to change procedures and topics to adapt to the background of the interviewees (Doyle, 2004; Qu and Dumay, 2011). Given the interviewees for this study have different backgrounds and that we interviewed other players who can corroborate findings, the structured approach would yield little in the way of results.

The unstructured approach encourages respondents to ‘talk around’ a theme (Rowley, 2012), allowing the interviewer to adapt to what is being said (Bryman, 2001), but as it generates data that is difficult to compare and integrate (Rowley, 2012), it is not suitable for this study. We have chosen the semi-structured interview as the most suitable for this research as it allows interviewees to be pressed and prompted, ensuring that the question is answered sufficiently (Rowley, 2012), and to probe potentially interesting avenues of inquiry based on an understanding of the literature, the ecosystem and the interviewee. The benefit of this approach is a rich and varied body of data from which to draw results and conclusions.

We argue that the decision-making process and the investment criteria of angel investors cannot be satisfactorily addressed as separate components. Rather, these two research foci are interconnected subjects that should be treated as such in order to develop our understanding of angel investment decisions. We adopt an analytical framework (see Figure 2) that emphasises this interconnectedness. Further, the framework provides a basis from which to structure interviews and to present findings.

Table 2 provides a list of the participants, including 12 active business angels and one business angel network manager. Following these interviews, another eight participants were interviewed. These interviewees operated in related areas and included early stage venture capital limited partnerships, managers of incubators, and both federal and state government staff involved in the development or implementation of policy. Of these participants, two had past experience as angel investors. These interviews were conducted to gain further insight into points raised by the business angels, to provide corroboration and to add context to the research. In addition, we participated in less formal conversations with entrepreneurs, corporate venture capitalists (where the venture capital fund was financed by a non-financial institution) and other actors within the ecosystem. Where appropriate, the information garnered from these additional interviews and conversations has been included in the findings and discussions.

We adopted a reflective pragmatist view (Alvesson, 2003) to interviewing, allowing for challenging of interpretations and the exploration of more than one set of meanings during and after the interviews, while balancing scepticism with a sense of direction. This process allows for a more sophisticated and nuanced understanding of the data collected and the contextual position of the participants. This approach also addresses the problem of participants not being ‘competent and moral truth tellers’ (Alvesson, 2003).

We adopt a localist approach to interviews, seeing the interview as an empirical setting that assists in interrogating complex social phenomena (Qu and Dumay, 2011) and as a social context rather than merely a tool for collecting data. This position emphasises that statements made must be viewed in their social context (Alvesson, 2003). Localist interview approaches allow for the study of facts without ignoring meaning and context. Localist interviewers are involved in the production of answers through interpersonal interaction (Qu and Dumay, 2011).

During interviews and conversations, we were frequently warned about the egos in the Australian angel market, giving rise to concern about the efficacy of some responses, that is, to be mindful of Alvesson's (2003) warning about interviewees as moral truth tellers. Responses are situated accounts to be understood in the social context of the interview. This, combined with the semi-structured approach, allows the researcher to probe further and challenge responses to elicit reflection and, in some cases, contradiction.

Interview protocols are best analysed via thematic strands extracted from the material through the researcher's interpretive and conceptual efforts (Crouch and McKenzie, 2016). Prior to each interview, we made notes on how we came into contact with the participant (snowball, personal approach, via personal networks) and any expectations we had about the interview. Following the interview, we made notes based on any thoughts about the benefits of the interview and about the participant and his or her manner.

The interviews were transcribed by a professional service and imported into NVivo,3 allowing for on-screen coding and real-time annotation. The software allows for an accurate and transparent analysis and a quick way of organising what was said, when and by whom, thus providing a good overview of the data (Welsh, 2002). Prior to reviewing the interviews, we created generic nodes based on the investment decision-making process outlined in the literature review. The handling of the data was an iterative process with coding followed by reflection, creation of annotations and more coding. This resulted in new nodes being generated during the interrogation of the data, which, along with the annotations to the coded text, formed the themes of the research. The coding model used was neither inductive nor deductive, but rather a mixture of the two (see Kelle, 1997), allowing for the development of clear themes articulated by the angel investors and corroborated by the other participants.

In terms of identifying participants, we found that the chosen definition of business angel was problematic if strictly applied. Hindle and Wenban (1999) use the criterion of net worth in their definition of Australian business angels, but the term ‘high net worth individual’ – a term used in wealth management to describe those people with investable assets >$US1 million (Baker, 2016) – was problematic. Many of the participants that identified as business angels are not classified as ‘high net worth individuals’ but do meet all the other criteria in the proposed definition. We did not restrict interviewees to only those classified as ‘high net worth’, as their history of direct investment of money and time and their identification with the term ‘angel investor’, qualified them for inclusion in this study.

Further, the phenomenon of ‘sweat equity’ – a party's work effort and time as opposed to financial equity – was problematic. Sweat equity investments are made with the expectation that a capital gain will be realised from the business at some point in the future. None of the participants could be defined as having sweat equity; however, some identified with the term in the context of previous experiences and many used the term in the context of a legitimate angel finance activity. Given the complexities of sweat equity – no financial transaction and no clear point where someone gains ownership of a firm – we do not consider sweat equity to be the same as angel financing and hence we have not included sweat equity investments in this research.

4 Findings and discussion

Using the framework outlined in Figure 2, we present the responses to our questions and identify four major themes evident in the findings. An interpretation and analysis of each participant, treated in isolation, only provides an understanding of that individual placed in his or her social context. At the same time, comparing individual responses provides a description of the interview and merely facilitates a list approach to what business angels want to see in an opportunity. While this is useful for entrepreneurs and business angels alike, this type of research already exists.

This research makes a novel contribution by examining the research questions: what underlying drivers influence business angels during the investment decision-making process? To answer the research question, it is necessary to draw on common threads identified across the range of participants. Corroborating interviews serve to validate these threads, which develop into significant themes (Yin, 2014). These themes exemplify the common social world occupied by the participants (Crouch and McKenzie, 2016). To identify these themes and address the research question, it is necessary to identify common discussion points raised by all participants (angels and corroborating participants).

We identify four themes influencing business angels through the entirety of the investment decision-making process, rather than at a single stage. These four themes are:

With these four categories cross-referenced to the decision-making process via the analytical framework, we address the research gap identified in the literature review and provide a contribution to the extant research. We address the problem of the iterative nature of the process by using an integrated approach in which we identify the importance of the deal origination as a stage subject to criteria, we integrate post-investment involvement throughout the decision-making process through ‘the need to contribute’, and we highlight the prominence of exit strategy as a further stage subject to criteria.

Table 3 presents a matrix summary of the findings. Each theme is cross-referenced to the major categories of the decision-making process (where evaluation, due diligence and post-investment involvement are subject to the criteria categories – financial, business strategy and personal and relationship factors). In organising the findings in this manner, we highlight that both deal origination and exit strategy are important and considered facets of angel investing. We also show that post-investment involvement is considered throughout the process via the ‘need to contribute’ theme. Of interest here is that ‘post-investment involvement’ does not relate to number of hours or the need to monitor, but rather the contribution investors can make to the business.

The matrix provides a unique way of categorising and presenting the data and addresses the problem of criteria being analysed in one stage of the decision-making process, while identifying the key drivers influencing business angels during their decision making. At the bottom of each cell are the number of respondents, providing triangulated evidence to support our findings. In the results, the cited interview transcript is an indicative example of the data.

5 Conclusion

Tracey Beikoff was lucky – she made her way onto a successful television program and presented her business to angels with the financial resources and, most importantly, the experience and connections, to help grow her business. Before appearing on Shark Tank, she was on the verge of closing down. How many entrepreneurs try, and fail, to find an interested business angel?

This research presents insights into the initial investment decision-making process of business angels in the Australian market. We use evidence from business angels and corroborate this with interviews from other actors to answer the question ‘what underlying drivers influence business angels during the investment decision-making process?’ The answer is presented according to four themes: personal experience, trust, the need to contribute and realistic expectations. By evaluating and corroborating responses, we argue that these themes influence the entire decision-making process, rather than being relevant to a single stage. Additionally, we argue that investment criteria are not limited to consideration at a particular stage but are relevant to the entire decision-making process.

We identify four key lessons from this research experience. First, the use of qualitative research as a method in finance has several benefits. Effective interviewing, supported by corroborating evidence, produces valuable and nuanced results that are difficult, if not impossible, to identify using quantitative methods. Second, angels are difficult to identify (a well-established problem) but techniques such as snowballing yield little in the way of results. This is particularly true with markets containing ‘ego’ investors. Angel investors appear loathe to provide additional contacts, suggesting that their angel network is perhaps weak. The reticence to pass on contacts, or to refer, is concerning, not just for researchers, but for entrepreneurs who may spend time pursuing something that will not produce results. These weaknesses in personal and professional networks complicate the already difficult challenge of raising growth finance.

Third is the failure to address adequately the problem of accessing angel finance. Though formal angel networks exist, and pitch events are frequent, these networks and functions are not necessarily a good way to raise capital. While deal flow exists for angels operating in these environments, it seems that deals do not originate from these environments, and therefore, entrepreneurs may be wasting their time going directly to formal networks to find angel financing – calling into question the value these organisations bring to the ecosystem. The importance angels place on referees during deal origination means that entrepreneurs must develop trusting relationships to potentially access an angel. However, an angel may not be present in an entrepreneur's network. This ‘market organisation’, for want of a better term, is worth further investigation and requires government intervention to address the deficiency in the Australian model.

Finally, the need to contribute is an overwhelming driver for business angels and this is a double-edged sword. It is not simply enough to access a business angel and present a sound business plan. Entrepreneurs need the right angel – one who can bring something other than money. Likewise, angels are looking for businesses who can benefit from their experience and offer them the ability to add value. Identifying angels is difficult; for many entrepreneurs, identifying the right angel is almost impossible. We must look for more structured ways of addressing the disconnect between entrepreneurs and angels.

In terms of future research, five potential avenues of future research present themselves from the findings of this paper. First, the changing nature of business angels. Future research should investigate the prominence of diversification as well as its impact on the nature of angel investors – for example, whether it hinders post-investment involvement or whether this approach effectively manages risks. It should also consider the characteristics of angels ranging from the traditional, high net worth angels, to ‘working’ angels, challenging the definition of an angel investor. Adding further support to this call is the introduction of new technology and the emergence of angel groups (see White and Dumay, 2017). An examination of the prevalence and effectiveness of diversification as a risk management strategy and the relevance of angel networks will add to our knowledge of risk management and, most importantly, will address the problems associated with attempting to raise capital via angel networks.

Second, the issue of sweat equity warrants further investigation. While this research did not aim, nor expect, to discuss sweat equity, its prominence as an issue raised during interviews highlights a need for further investigation. A number of questions arise here: can sweat equity investors be legitimately called angel investors (as they call themselves) and, if so, what are the implications for the definition? What is the prevalence of sweat equity and how do these investors realise a return? How do entrepreneurs view sweat equity?

Third, the combination of the changing nature of business angels and the emergence of sweat equity give rise to the need to update the research on angel typologies (for an overview, see White and Dumay, 2017). The diversity of angel investors, as well as the influence of successful programs such as Shark Tank, raises the question of definition. The presence of investors no longer fitting the traditional definition of a business angel provides an opportunity to extend and add to existing angel typologies (for example, see Szerb et al., 2007). The key question for researchers is what are the different types of angel investors in today's market?

Fourth, the issue of the value of pitch events as a means of raising capital represents an opportunity to expand our existing knowledge. The interviewed angels questioned the value of pitch events, noting that they are networking opportunities, rather than a source of deals. Investigation into the efficacy of pitch events is warranted and will have significant benefits and implications for researchers, entrepreneurs, angels, incubators and governments.

Fifth, though not the purpose of this research, using corroborating participants highlighted some inconsistences and challenges for the angel finance market, its structure, governance and policy making. While the corroborating participants were able to verify and validate aspects of what angel investors said, there was also a disconnect between the participants – particularly angels and government policy makers. An investigation into the organisation of the marketplace, and development of the understanding of context would be beneficial and provide researchers with an opportunity to influence government policy aimed at building entrepreneurial ecosystems.

Like all studies, this research is subject to limitations. The first limitation concerns the types of questions used when interviewing corroborating participants. This research investigates the angel investing phenomenon with business angels the subject of the research. Interviewing other participants requires careful consideration of questions that effectively corroborate angel responses. For example, a person responsible for the development of government policy may have a different understanding of angel financing and view it from a different context. This is evident where, for example, a government participant was responsible for developing an incubator and thus has limited contact with business angels. In order to address this, the interviewer must either add explanation to questions, potentially biasing the response by leading the interviewee, or change the nature of the question.

The different angel typologies create a second limitation. The presence of different business angels, with different approaches to the market and different contextual understandings, creates a potential bias in responses. For example, prospective participants who present themselves as angel investors may, in fact, be sweat equity investors, thus calling into question the validity of their responses. Participants raised sweat equity as a legitimate form of angel investing, and, as such, it is difficult to rule out some of the participants for being sweat equity investors, rather than fitting the traditional definition. Further, the population of angel investors is heterogeneous, but using techniques to identify them, such as snowballing, has the potential to homogenise the population.