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What keeps millionaires from becoming angel investors?

Guest post by: Karen Rands

Article Overview: It is estimated that only 10% of those millionaires that would qualify as accredited investors actually invest capital into early stage private companies. Recognizing that all investments with potential to produce at least double digit ROI have some risk associated with that asset class investment. So with the socio-economic benefits of angel investing - bring innovation to the market, create jobs, create wealth - why don't more millionaires at least dabble in angel investing? This article explores the theories uncovered by Author Karen Rands' investigative team.

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What keeps millionaires from becoming angel investors?

Interestingly enough, if you were to ask the average millionaire their thoughts on entrepreneurship, capitalism, and creating wealth; you would likely get comments such as the following:

"Entrepreneurs are the backbone of our society. They create jobs and bring innovation to the market."
"It is only in creating wealth that anything gets done or paid for."
"I'd rather give my money to an entrepreneur with half a brain and the gumption to go out and do something with it, than some government empty suit that is just going to give it away. "
"The people who solve problems make the biggest bucks."
"Buy low and sell high!"
"The free market - capitalism - gives you personal freedom - to choose your future destiny."
"I seek to invest my money where I can get a return on investment...the greatest reward relative to the risk."
So with thoughts and feelings like this, what keeps millionaires with the capital on hand to make alternative investments and invest in early stage private equity opportunities? It is estimated that 10% of the American population has the means to qualify as an accredited investor, that translates to millions of potential investors, yet only a few hundred thousand participate in angel investor type deals.

Sounds like emotionally, they "get" why entrepreneurs need to be developed, the value of "giving back" by investing time and money into innovative and capable early stage companies. So why is it that less than 10% of those that could, actually do?

Our investigative team has determined there are three fundamental road blocks to bringing more millionaires into the world of angel investing. First, the very regulations intended to keep fraud out of the process and protect high net worth individuals is actually creating an environment that prohibits accredited investors access to information about angel investing and in obtaining guidance regarding making wise private investments.

Broker Dealers are authorized by the SEC to represent companies seeking capital and to solicit investment from accredited investors on behalf of their client "the private company". Because of their inherent audit costs they typically only work with companies raising over $3 Million and with revenues to support their fees of $5K -$10K a month plus 10% commission on the backend and warrants on the stock offering. When a client commits, their floor of brokers begin to peddle that private placement to their high net worth clients, and even phone solicitations to potential investors off of lists they have purchased, in increments as little as $10,000 so as to not negatively impact that client's portfolio should they lose that money. The investors typically just take the advice of their broker/adviser without much investigation on their part regarding the investment offer. Brokers push this out to their affiliated investment advisers that have "hung their license" with the broker dealer as required by FINRA. The investment adviser typically will take more care in offering it to their clients because many may not have the liquidity for that type of investment, but it still trickles down to the web of associated brokers to that broker dealer. The potential angel investor only gets to see deals that have been "vetted" by the broker dealer, not because it is a good investment that has followed the same analysis process when vetting a class of stock or other alternative investment, but because the broker is being paid to sell it to the investor. The broker doesn't provide independent assessment of different private investment opportunities to find the best one or two that would fit the investor's criteria. They may go as far as to discourage them from allocating any of their investment dollars toward private placements, primarily because they only get compensated at the time of the initial purchase, not ongoing as is the case with other investment products. Which leads to the second obstacle.

Second, greed and fear within those that are authorized to assist companies in obtaining capital and in advising clients about private investments ultimately limit the free market exchange of capital between potential investors and entrepreneurs.

When an entrepreneur that may be raising $500K to $1M as a start up, pre-revenue or not yet profitable early stage company approaches the wealth manager and financial adviser to see if they know any potential angel investors, the adviser takes a position that they can't show the deal to their clients because it would be considered "selling away" and they could lose their license. They expect to be paid (greed) for any financial transaction they recommend or advise their client, the investor, to invest in. The managing Broker/Dealer will only represent and promote private offerings of entrepreneurs that have signed a representation agreement with that firm and paid a retainer with a contractual obligation to pay commission fees. Companies at this early stage do not have the fees to pay the Broker/Dealer so they must find investors through networking and pitch events. It is very rare to find a financial adviser or wealth manager that recognizes that some of their clients plan to, are inclined to and even want to invest in private companies, for all the reasons listed above, and will view their role as a trusted adviser to help their client make decisions about the deal in the interest of protecting the portfolio, not because they will be compensated. The fear comes in to play because, even if they don't take a commission on the transaction, they fear that Big Brother FINRA will come knocking on their door and determine that they sold a financial product that was not being offered by the Broker Dealer that carries their license - thus they have "sold away" from their managing Broker.

Third, although there is ample opportunity for investors to learn how to invest in stocks and make wise stock picks, and to invest in real estate of various types, there is little to no opportunity for high net worth men and women to learn about angel investing. They may have heard about it as an asset class or heard the stories of wealthy people becoming millionaires from private investments in companies that have gone public, get 20 or 40 times their investment. But when it comes to figuring out what a term sheet looks like, how to do due diligence, how to mitigate their risk in an investment of this nature, they really don't know where to begin and most often learn by losing. Learning on how to make better angel investments by losing a tens of thousands of dollars is a horrible way to learn and is in fact equivalent to the electric shock treatments for negative reinforcement. What better way to make the wealthy avoid angel investing like the plague than to throw them to the wolves, let them make a bunch of emotional investments, lose all their money and swear they will never do it again. According to a University of New Hampshire study of angel investor groups from a few years ago, 66% of those investors that join an angel group for the purpose of making early stage private investments, don't actually make investments. Why? Because they feel they do not have the knowledge to make good investment decisions -- knowledge of the process, the legal aspects, the ways to mitigate risk, how to negotiate terms.... all the things they need to evaluate and complete a transaction. Since they don't know how, they simply don't.

So although changing the government's position on how angel investments are handled is virtually impossible, and in fact is moving toward further regulation if elements of the Financial Reform Package is passed, we can provide educational opportunities to investors to learn more about angel investing. The internet is a great place to find information, specifically the ebook series Learn to Be an Angel Investor that breaks it down in bite size chunks and offers examples for investors to follow. Every angel group should offer a mentoring and educational program. People that make early stage private investments should share their experiences with their affluent neighbors and encourage them to plug into the groups they are involved with. With these actions we can 'de-mystify" the process of becoming an angel investment and help millionaires see the double bottom line benefit of investing time, money, experience into early stage companies to bring innovation to market, create jobs and create wealth for all involved.

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Article Tags: alternative investments, angel investing, broker dealer, entrepreneur, investment strategies, Learn How to be an angel investor, private investments, raising capital, return on investment, risk mitigation, SEC Regulations, selling away, venture capital, wealth advisors, wealth creation

About the Author: Karen Rands
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Karen Rands, is a sought after expert in the art of raising capital and furthering the pursuit of investors and entrepreneurs coming together to bring innovation to market, create jobs and create wealth. Karen's companies, Launch Funding Network and the Network of Business Angel Investors, under the Kugarand Holdings corporate umbrella, provide strategic advice and counsel and unique environments for both entrepreneurs and investors. Investors can get free excerpts of her Learn To Be An Angel Investor ebook series at http://HowToBeAnAngelInvestor.com and Entrepreneurs can get free tips, ezine and other info about connecting with investors at http://GetInvestorMoney.com Follow her on Twitter at http://twitter.com/karen_rands She is considered a Compassionate Capitalist and Economic Architect. She considers angel investors who provide the needed capital to entrepreneurs so they may bring innovation to the market, create jobs and create wealth as the cornerstone for economic growth in any community. She left the corporate world in 2001 and has been working to educate both entrepreneurs and investors and to provide a platform for them to connect more efficiently. Karen graduated with her bachelor degree in Economics from Emory University and her MBA from the University of Florida, and remains committed to a life of learning and giving.

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