Despite potential pitfalls, angel investing attracts wealthy individuals looking to diversify portfolios


Seed money. (bigstock/bigstock)
November 3, 2013

Washington lobbyist Heather Podesta didn’t join K Street Capital as an angel investor with the expectation that every upstart she funnels money into will blossom into a multibillion-dollar business.

That would be ideal, of course. But Podesta and other members of the early-stage investment group realize that the majority of young companies fizzle out before their early financial backers ever see a return.

“I’m not going to assume that they’re all going to be winners, but doing this type of investing is a long-term investment, and one that you do with other investments in mind,” Podesta said. “It’s just another way to diversify your portfolio and have fun at the same time.”

An increasing number of wealthy individuals are wading into the venture capital waters through angel investing — the earliest stage of investment in which companies collect less than $1 million to get up and running.

Once confined primarily to technology circles, the investment practice has gained broader attention thanks to Web sites such as AngelList and television shows such as ABC’s “Shark Tank.” High-profile examples of venture-backed successes, such as Facebook and Twitter, don’t hurt either.

The Center for Venture Research at the University of New Hampshire found that the number of active angel investors in 2012 was 268,160, up from roughly 200,000 a decade earlier.

What’s more, the total number of dollars invested by angels grew to $22.9 billion from $15.7 billion over that same decade. The number of start-up deals nearly doubled to 67,030 from about 36,000.

K Street Capital is unique in that its members hail from industries known for producing wealth but not necessarily venture capitalists, such as lobbying, law, public affairs and banking.

Founder Evan Burfield said the group’s membership has grown from eight people 18 months ago to approximately 40 today, all of whom meet the Securities and Exchange Commission definition of an accredited investor, meaning they make at least $200,000 a year or their net worth exceeds $1 million.

“That was the premise from the beginning, how do we help to tap into the kinds of people that have an awful lot of financial — but also social and intellectual — capital in the region who aren’t yet participating in the start-up economy?” Burfield said.

“For an awful lot of them, they’re certainly looking for an investment vehicle that has the potential to generate significant returns,” he said.

The coming introduction of equity-based crowdfunding promises to make the practice accessible to individuals in lower income brackets as well. Though the SEC has yet to finalize its guidelines, equity-based crowdfunding will essentially allow entrepreneurs to raise small sums from many different people in exchange for a piece of their company.

Crowdfunding’s loudest detractors have worried that too little regulation could result in individuals of limited means funneling their life savings into shoddy upstarts, only to see that investment squandered and yield no financial return.

Whether those scenarios prove true or not, wealth managers are unlikely to suggest their clients pour large sums of money into start-ups until crowdfunding is more proven. Even then, betting on start-ups leads to more losers than winners, Burfield said.

“One of the first things we always talk about with our new members is they should assume any check they write is lost money and be pleasantly surprised if that money comes back,” he said. “That’s just the nature of angel investing and the risk involved.”

To mitigate the risk, Burfield said most K Street Capital members cut eight to 12 checks a year. That creates a wide-ranging portfolio which can improve the chances of success. But Paul Singh, a partner at business accelerator 500 Startups, said that smart angel investing, the kind with the most potential to yield a return on investments, requires more than just spreading money among many firms.

“If you really want to invest directly into companies, you must mentally commit to treating this like a full-time job,” he said.

“Investors new and old have to start thinking carefully about their discipline, their methodology of investing,” Singh added .

Podesta, the lobbyist and K Street Capital member, describes the experience of angel investing as “intellectual oxygen.” You often witness how entrepreneurs solve problems large and small in unexpected and innovative ways, she said.

Regardless of the returns, Podesta intends to stick with it for the time being.

“There’s this mysterious aura around angel investing,” Podesta said. “People don’t know how to access it. It feels like there are a lot of barriers to entry, but with a little education, it is possible.”

Steven Overly covers the business of technology, biotechnology and venture capital in the Washington region for The Washington Post and its weekly Capital Business publication. In that capacity, he has written about start-up struggles, investment trends and major drug discoveries.
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