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Written by: Alan Trzuskoski

Introduction:

    Informal venture capital or private investor capital has for a number of decades been an important source of capital in the USA (Mason and Harrison, 1994a).  Indeed, a set of studies during the 1980s and 1990s catalogued the preferences and practices of such individuals in the USA, noting that they became involved in start-up companies and that this investment by and large also went into high technology based companies.  However, much of the focus of the research during this time was on companies and individuals in the Boston or Silicon Valley areas.  In these locations there were a number of factors that contributed to a high concentration of both high growth potential companies seeking investments, as well as high net worth individuals with personal savings to invest.  Generalizations were then drawn from such cases and assumed to be applicable to other states or locations in the USA.  The objective of this research is to investigate the case of New Jersey. 

    The paper is divided into distinct parts.  In part one we review the literature on business angels, based in the main on research developed in the UK and the USA.  In part two we catalogue the main features of New Jersey’s economic and entrepreneurial landscape.  Here we illustrate the concerns on the part of the economic development organizations in the state and set out the main research question – is there an adequate pool of informal venture capital in the form of business angels in the state or not.  Finally, we apply the main findings of the literature review to the case of the state, in particular taking into account a series of interviews conducted with angel investors and associated individuals in the state. 

Part one:  Review of Literature on Business Angels

    The term “angel” originated in the early 1900’s and referred to investors on Broadway who made risky investments to support theatrical productions. Today, the term “angel” or “business angel” refers to high net worth individuals, who invest in and support start-up companies in their early stages of growth.  A high net worth individual typically has more than $1 million in funding to invest (Linde and Prasad 11).

    Angel investors are an important and growing source of financing for the start-up and initial growth phases of technology ventures. Many of these angels invest in first time entrepreneurs before the entrepreneurs secure venture capital financing (Linde and Prasad 3).  These individuals therefore play a vital role in unlocking further rounds of financing in enabling very risky companies to fund product development.  Angel investors are regarded as angels precisely because they “rescue” such companies.  Mason and Harrison note that the typical age launch window is in the entrepreneur’s mid-thirties.  This can often be a difficult time to raise funding from personal assets (limited savings and assets); these limited assets equate to limited collateral and make it impossible to raise bank funding!  The risk profile of high technology companies involved in IT or biotechnology further complicates the matter.  Privately wealthy individuals can therefore play a crucial role in helping to unlock this conundrum (1994a). 

Angels Vs. Venture Capitalists

    There are generally six stages of financing from private equity investors.  Seed stage financing is a relatively small amount of capital provided to an inventor or entrepreneur to prove a concept and qualify for startup capital.  Startup financing is capital provided to companies completing product development and initial marketing.  First-Stage financing is capital provided to companies that have expended their initial capital.  Second-stage financing provides working capital for the initial expansion of a company that is producing and shipping as well as has growing accounts receivable and inventories.  Third-stage or Mezzanine, financing provides capital for major expansions of a company that has an increasing sales volume and is breaking even or profitable.  Finally, Bridge financing provides financing for a company that is between stages or plans to go public between six months and a year (Wetzel 183-184).

    There are a few major differences between venture capitalists and angel investors.  The most distinctive include the stage and size of investment (Informal venture capital in the UK 69).  Typically, business angels provide $25,000 to $500,000 in seed stage companies and $500,000 to $3,000,000 in startup stage companies.  Typically, venture capitalists invest between $1.5 million and $30 million in first to third round financing.  Venture capitalists invest more because the companies already have a product and a proven track record.  That makes them a less risky investment (Linde and Prasad 10).  Another difference between angel investors and venture capitalists is their role within the company.  Venture capitalist only provide funding, but angel investors typically offer much more.  According to one study 27% of angel investors took a seat on the company’s board of directors, 21% of angels provide informal consulting help on an ‘as needed’ basis, and 16% of angels took either a part time or fulltime role with their investment (Informal venture capital in the UK 90).

Profile of a Business Angel

     Most angels could be described as adventure capitalists because early stage equity investing can be risky business (Wetzel 184).  The typical angel investor is a male between the ages of 45 and 64.  Angel investors are typically self-made and probably believe “Luck is the time when preparation and opportunity meet.” (Roy D. Chapin Jr.) According to one study, nearly 75% of angels are currently either a company director or retired.  Many have started their own company.  Most angels invest less than 25% of their personal assets typically less than 3 hours from their home (Informal venture capital in the UK 76-92).

    Angel investors experience the entrepreneurial life vicariously through their investments (Wetzel 174).  Many are cashed out entrepreneurs that enjoy being involved-but-not-immersed in a start-up (Linde and Prasad 15).  They want to bring new ventures into the world, but at their stage of life they don’t want the hassle of managing day-to-day operations.  As many well-off baby boomers’ careers wind down, they are expected to join the ranks of existing angel investors (Wetzel 174-175).

    Although economic returns are important; Angel investor motives are often less financially oriented. Having founded and grown companies themselves, many angels have empathy for the extent entrepreneurs have to grow personally in order to lead their companies and to accomplish their visions. Many angels enjoy the opportunity to mentor another up-and-coming entrepreneur.  Some feel that if they had the same opportunity they might have reached greater heights or commit fewer mistakes (Linde and Prasad 72).

    Some other non-financial motivations cited by business angels include: the fun of networking with similarly interested people while helping new companies, the opportunity to keep abreast of rapidly evolving technologies and markets, the intellectual challenge of dealing with new businesses, and the creation of societal benefits (Linde and Prasad 16).

Classifications of Business Angels

    There are four major classifications of business angels: Guardian Angels, Professional Entrepreneur Angels, Operational Expertise Angels, and Financial Return Angles.  Each classification has its own characteristics and culture.

    Guardian Angels are active investors who guide and coach the management team to help them grow the company.  Guardian angels usually work with a limited set of start-ups because they can invest significant amounts of time in the company.  They have non-economic reasons for investing, but typically achieve high returns on their investments (Linde and Prasad 18-19).

    Professional Entrepreneur Angels have entrepreneurial experience but are investing outside their area of expertise.  Because of that they are usually looking for high rates of return on their investment and typically invest based on recommendations from other angels they trust and respect.  Professional Entrepreneur Angels may be Guardian Angels for other ventures but are currently looking to build their expertise in angel investing (Linde and Prasad 19-20).

    Operational Expertise Angels are or have been, senior executives for major companies in the start-up’s target industry.  Their “gold-plated” Rolodex and industry insight can be crucial for any startup. Usually, other angels approach Operational Expertise Angels for due diligence insights and confirmation of the deal quality.  These angels tend to invest for non-economic reasons as well as economic returns (Linde and Prasad 20).

    Financial Return Angels are high net worth investors with little industry or entrepreneurial experience.  They have typically made their money through the stock market, real estate, inheritance, or professional occupations not related to starting companies.  These investors are looking for high rates of return by investing in start-up companies, but do not desire to be actively involved with the start-up (Linde and Prasad 20-21).

Location of Angels

    For fear of a flood of equity financing seekers, angel investors are typically very private about their business.  Few will even consider an investment without a referral from a trusted member of their network (Informal venture capital in the UK 85).  However, entrepreneurs can find angels in several different ways.

    Networking events are regularly hosted to introduce Entrepreneurs to potential investors.  One such host is the Venture Association of New Jersey (VANJ).  In addition to meet and greets, VANJ also hosts a monthly workshop to help both entrepreneurs and investors alike. 

    Another way entrepreneurs find investors is through member organized angel clubs.  They are groups of active angels using their combined networks to source, screen, investigate, negotiate, invest in, and manage emerging company investments.  Members bring different skills to the group and value to the entrepreneurs.  These clubs generally have some sort of public identity.  Many can be found through newspaper articles or their websites (Linde and Prasad 52-57).  One such New Jersey organization is named Jumpstart (www.jumpstartnj.com).

    There are two kinds of third-party matching services.  Non-profit matching service organizations typically allow entrepreneurs to list their venture opportunities with the service.  Little or no screening is conducted by the matching service organization, and angels typically conduct their own due diligence, negotiations and investing.  For-profit matching and investment organizations provide screening, due diligence and investment services for member angels (Linde and Prasad 53-54).

What do private equity investors look for in a deal?

    If you are contemplating private equity investments your goal must be much more than self-employment.  You must have a burning desire to build an enterprise that will seize every opportunity for profitable growth and, ultimately, provide liquidity for your investors.  Your venture must be positioned in a market that provides such opportunities, and your vision and business plan must support expectations of $10 to $20 million dollars in revenue over the next five years (Wetzel 170-171).

    Different investors have very different investment criteria.  As an entrepreneur it pays to do your own due diligence about an investor.  Choosing the right investor to pitch your idea is crucial.  An impatient investor that does not understand the entrepreneur’s vision can be the downfall of the relationship and even company.  It adds unneeded stress to an already overworked entrepreneur.  The quality of the management team and size of the market, and exit strategies appear to be the most important criteria investors consider (Wetzel 182-183).

    Venture capitalist Robert Simon says, “I invest in people first and foremost. Smart people will find great opportunities, and I will never know the sectors or technologies as well as smart people.”  To all investors the overall quality of the team is crucial, but it is often the entrepreneur that is the key. Some investors are looking for a sales-oriented entrepreneur willing to bow out of the CEO role as soon as the time comes.  Other investors want a strong technical founder as CEO to take the company all the way through an initial public offering (IPO) (Roberts 1-19).

    The majority of angel investors invest in the market they have had prior experience with.  Most investors are looking for a large market opportunity in a fast-growing sector.  According to one venture capitalist “If the market is great the rest of the attributes don’t matter.”   According to another “Markets trump people and technology.  We can build something, but if no one wants it, we’ve got a big problem.”  “A unique technology doesn’t count for much if no one will buy it.” (Roberts 1-19)

    Different investors have different exit strategies in mind.  On all accounts an IPO is the most favorable outcome for investors.  Some investors will not invest in a company unless they feel that it has a good chance of going public.  Other investors are content for a company to be acquired, and still others will invest in a self-sustaining company that possesses the potential to consistently grow over time (Roberts 1-19).

Part Two: New Jersey Economy

Figure 1- Patent Activity

- Source www.uspto.gov

Figure 2 – Patents in Each State as Percent of US Total

- Source www.uspto.gov

Figure 3 – California Non-Farm Establishments with Paid Employees - sic codes: 60 Depository institutions, 61 Nondepository credit institutions, 63 Insurance Carriers, 67 Holding and Other Investment Offices

Figure 4 - Massachusetts Privately Held Nonfarm Establishments with Paid Employees - sic codes: 60 Depository institutions, 61 Nondepository credit institutions, 63 Insurance Carriers, 67 Holding an Other Investment Offices

-Source www.zapdata.com

Figure 5 - New Jersey Privately Held Nonfarm Establishments with Paid Employees - sic codes: 60 Depository institutions, 61 Nondepository credit institutions, 63 Insurance Carriers, 67 Holding an Other Investment Offices

-Source www.zapdata.com

Figure 6 - California Privately Held Nonfarm Establishments with Paid Employees Communication industry (sic code) 48

-Source www.zapdata.com

Figure 7 - Massachusetts Privately Held Nonfarm Establishments with Paid Employees Communication industry (sic code) 48

Source www.zapdata.com

Figure 8 – New Jersey Privately Held Nonfarm Establishments with Paid Employees Communication industry (sic code) 48

Source www.zapdata.com

Figure 9 – California Privately Held Nonfarm Establishments with Paid Employees Pharmaceutical industry (sic code) 2834

-Source www.zapdata.com

Figure 10 – Massachusetts Privately Held Nonfarm Establishments with Paid Employees Pharmaceutical industry (sic code) 2834

-Source www.zapdata.com

Figure 11 - New Jersey Privately Held Nonfarm Establishments with Paid Employees Pharmaceutical industry (sic code) 2834

-Source www.zapdata.com

Figure 12 - Numbers are in thousands

Source http://www.irs.gov/pub/irs-soi/98pwart.pdf

Figure 13 - Venture capital dollars in 2004

Source http://www.ventureeconomics.com/vec/stats/2004q4/nation_us1.html#state

Figure 14 - A weighted measure of the value and number of initial public stock offerings of companies as a share of gross state product

Source - http://www.neweconomyindex.org/states/2002/03_dynamism_04.html

Figure 15 – Universities per million populations

http://www.utexas.edu/world/univ/state/

Figure 16 – Incubators per million population

http://www.gaebler.com/Gaebler_Entrepreneurs.htm

*these numbers are all from one published source, but upon additional research I found a number of states that had many more incubators than listed.  New Jersey was however, overstated.

Non-Community colleges in New Jersey

    •         Berkeley College
    •         Bloomfield College
    •         Caldwell College
    •         Centenary College
    •         The College of New Jersey
    •         College of Saint Elizabeth
    •         Drew University
    •         Fairleigh Dickinson University
    •         Felician College
    •         Georgian Court College
    •         Kean University
    •         Monmouth University
    •         Montclair State University
    •         New Jersey City University
    •         New Jersey Institute of Technology
    •         Princeton University
    •         Ramapo College
    •         Richard Stockton College of New Jersey
    •         Rider University
    •         Rowan University
    •         Rutgers University
            •          Camden
            •         New Brunswick/Piscataway
            •         Newark
    •         Saint Peter's College
    •         Seton Hall University
    •         Stevens Institute of Technology
    •         Thomas Edison State College
    •         University of Medicine & Dentistry of New Jersey
• William Paterson University

-Source http://www.utexas.edu/world/univ/state/

Joint Private/Public Industry Groups

Private Sector Industry Groups

Joint Private/Public Research Institutes

Business Incubators in NJ

Conclusion

    New Jersey rates high in many of the metrics used to measure entrepreneurship, but given the business conditions of the state it could rate much higher.  In recent years New jersey has not only been unable to attract startup companies, but it has been unable to keep the ones started here. Why is this?

    At the onset of this study I believed it was due to a lack of money available from investors to early stage companies.  However, I now believe it is more likely due to a lack of quality investment opportunities.  That lack of quality investments could be due to any number of reasons, but are most likely due to four key factors.  They include a high cost of living, a lower percentage of higher education institutions, a low absolute number of business incubator centers, and an inadequate number of opportunities for collaboration.

    New Jersey is handicapped because it not only has a high cost of living, but is also the most densely populated state in the union.  Those reasons make affordable housing not only a commodity, but difficult to find.  However, due to technology and communication advances New Jersey is at a major disadvantage in this new thinking economy.  People no longer need to be physically close to large cities or established industry structures.  They are free to live in areas with lower costs of living and possibly even a higher quality of life.

    Although the number of Universities New Jersey has rates well against most of the nation, it is significantly behind the entrepreneurial leaders on both an absolute and per million values.  This lack of higher education may have also contributed to the low numbers of business incubator centers. 

    Business incubator centers are essential to entrepreneurship, especially in a state with such a high cost of living.  They provide entrepreneurs with both cost effective rent, and shared supporting services like printing, copying, Internet and phones. Incubators can do this because those costs are shared among several startup companies.  Incubators continue to add value by establishing networks of business angels, venture capitalists, lawyers and accountants that specialize in startups and are looking for their next great deal.

    My final reason for New Jersey’s lack of quality investments are the very few opportunities for collaboration.  There are many companies and universities independently doing research, but there is very little collaboration.  In order to spark innovation private companies should be working with universities, as well as government, and even other private companies.  Universities need to work with each other, and government.  In the leading entrepreneurial states like California, Colorado, Massachusetts, New York, and Washington this practice seems commonplace (Life Science PDF).

Recommendation

    If New Jersey is serious about increasing entrepreneurship within the state I believe that currently economically depressed areas are the key to success.  The state needs to build high quality low cost housing as well as available business incubator space in the same local area.  Affordable housing and offices give entrepreneurs more flexibility to bootstrap their companies for a longer period of time without becoming dependant on investors.  This plan should also improve local economies by creating new revenue and eventually creating jobs for people already living there.  In my mind this is a win-win situation, but it will take time and investments from the state.  Is New Jersey serious about reclaiming its stigma as an innovative and entrepreneurial economy?

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