Angel investment: Not for the faint-hearted

Angel investment: Not for the faint-hearted

The number of individual investors putting their money directly into entrepreneurial firms is increasing rapidly. According to the Small & Medium Business Administration, there were 3,600 "angels" in 17 angel clubs as of the end of last year. The number has since tripled within a month.


Demographics of such angel investors are also changing. Previously, most of them were business owners in their forties or older. Now, many younger fixed-income earners and even people with little knowledge of the business are joining this risky fray.


An angel investment refers to the direct injection of cash from individuals or small groups of investors to buy part of a company at a very early stage, well before any initial public offering.


Expanding ranks of angel investors are, of course, a good sign of further development of the market as they funnel start-up funds into high-tech ventures. The money these private investors provide is lifeblood for firms too small even for venture capitalists. The angels are gambling that they could garner super-high returns when the firms go public.


However, higher potential returns also equate to more risky investments. For example, of the 6 million start-up companies in the United States, only 13,000 are public. If a firm's success is defined as going public, the success ratio of venture firms is a measly 0.22 percent.


Although high-growth venture firms in Korea receive many different forms of government subsidies such as preferential loans and grants, it is hard to expect the comparable success ratio here will be substantially higher than that in the US. Worse yet, considering the fact that angels usually invest in businesses too risky for venture capitalists, the success rate for the angel investment could be much lower than that pallid 0.22 percent figure.


Most of Korea's angels are reported to have little experience in evaluating a venture's business potential, a fact which furthers the concern that an angel boom could become a bust, which could help destabilize the financial marketplace. Typically, firms in which angels put money have a very high "burn rate"--or the rate at which a company spends money without any return--making it doubtful whether angels with limited financial means and knowledge can be patient enough to wait out such a long time of burning money.


The government's efforts for the past few years to nurture venture firms have proven successful. Such firms now number almost 5,000 with projections that they will skyrocket to 40,000 within five years. Vibrant small firms will soon become the engine of economic growth, replacing the role played by large conglomerates.


Most important is how the government directs its high-tech venture support. The current focus on expanding support funds can misfire, because it may lead to proliferation of greedy psudo-entrepreneurs seeking free-for-all money doled out by the government. Instead, the focus should be on efforts for improving business environments conducive to venture firms' creation and growth.


For instance, regulations prohibiting alliances between upstarts and large companies should be eliminated, so that they both can benefit from such a relationship. The government also needs to encourage a system in which small firms can share information, technology and staffs with each other.


Once these pro-business environments are in place, the hard-won venture boom can achieve something meaningful for the economy as a whole. To succeed in this situation, the government has to be careful not to overdo support while moving to release the speculative steam from the angel investment market.


We believe the venture spirit will indeed lead Korea's economy, so long as the entrepreneurial drive is not tainted by speculative bubbles and excessive government meddling. However, angel investment is certainly not an activity for the faint-hearted; it is for seasoned professionals who can easily shrug off a loss of several hundred million won.