Bull and Bear Market Trends Provide Little Incentive to Angel Investors to Fund Startups

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(Last Updated On: July 7, 2017)

Silicon Valley startups usually do not have a lot of problems attracting investors because of the abundance of venture capital in the region. Similarly, New England startups are blessed to operate in the region with significant financial support from private investors. On the other hand, young companies located outside Silicon Valley and New England continue to struggle to attract capital because 72% of capital raised stays bicoastal. However, new companies are being born all over the country. Healthy startup ecosystem depends on angel investors to consistently write checks to local companies  in other to propel business growth. Angel investors are individuals, putting their own savings on the line. Because of that, I would argue that both strong bull and strong bear markets will provide little incentive for angel investors to lock in their cash with a startup.

Who is an Angel Investor?

Angel investor is popular, colloquial name for an accredited investor under SEC rules. Only accredited investors are allowed to invest in startups, either directly, or via equity crowdfunding platform. SEC believes that only well off individuals are financially savvy enough to invest into risky asset class, private companies.

Accredited Investor Requirements:

  • To be an accredited investor, a person must demonstrate an annual income of $200,000, or $300,000 for joint income, for the last two years with expectation of earning the same or higher income.
  • A person is also considered an accredited investor if he has a net worth exceeding $1 million, either individually or jointly with his spouse.

The financial threshold needed to be an accredited investor is not completely out of reach for most successful corporate executives nearing the retirement age. In fact, most angel investors are successful professionals that want to contribute their expertise to a startup, stay engaged with latest and greatest business trends and make some money in the process. Assuming that most angel investors did not simply inherit their nest egg, but have earned it over the course of their career, it’s safe to say that these people are very sensitive to financial risks.

Asset Diversification is a Key to a Successful Portfolio 

Pick any book you want on investing and you will be advised to diversify your portfolio across different asset classes and different sectors. Personally, I never invest more than 10% of my account value into a single stock. Some investors break down their portfolio into assets that are no larger than 2-3% of the overall portfolio. Similarly, an angel investor should not invest more than 10% of her overall investment portfolio into hard to liquidate startup private equity.

Correlation Between Stock Market Performance and Angel Investment Activity

It is interesting to observe a dynamic between public stock market and angel investment activity. Angel investors are individuals deploying their own (retirement) funds into stocks, bonds and private equity. When stock market is strongly trending into either bullish or bearish direction, it is hard to ignore trader’s psychology: green when stocks are trending higher and fear when stocks are nosediving and losing value (Angel Investment activity decreased during market selloff in 2016) .Because of that, I would argue that during strong bull market, angels will allocate their money into public markets for a quick return, and vice versa.

S&P500 Index Chart
S&P500 Index Chart

Since November 2016 election, the US stock market went into overdrive. In just short six months, S&P500 Index climbed upward at unprecedented rate of 15%. At the same time, the money that has been sitting on sidelines started flowing into the equities as the trading volume also doubled.  If you had $100k sitting on the sidelines, would you rather buy $SPY ETF and make quick 15% profit of just $15k in just six months, or would you write $100k check to a cash strapped entrepreneur that needs Seed money? I would argue that most people would ride the stock market bull trend as long as it last and when the market stabilizes into a neutral patterns offering near zero returns, think about financing startups again because their money is not being put to a better use somewhere else.

Similarly, during the bear market, investors are anxious to preserve their wealth, so most likely they will just sit on cash, bonds, less risky assets waiting for downtrend to end. With financial anxiety being on his mind, angel investor is more likely to hibernate and not support budding entrepreneurs financially.

2017 Angel Investment Activity

I cannot claim with statistical certainty that there is a correlation between US public stock market performance and angel investment activity, we do know that angel investors are being less active all throughout 2016 and 2017.

Angel Investment Activity 1Q2017
Angel Investment Activity 1Q2017

PitchBook & NVCA 1Q 2017 US Venture Monitor tracks and publishes venture capital investment activity. The number of Seed Round deals in 1Q2017 (827 deals) is only half the size compared to the number of deals at the peak in 2Q2015 (1,526 deals). Not only did number of seed round checks went down 50%, but the size of the check too shrank from $1.5M to $1M.  At the same time, new business creation is trending higher, so there are more entrepreneurs chasing smaller and smaller pot of angel investment money.

Competition for Seed Round Increases

Startup founders should plan for a difficult Seed Round fundraising process because angel investors are increasingly sitting on the sidelines, they are writing less checks and smaller checks. At the same time, angel investors have more startups to chose from because new business creation is increasing. Also, tremendous bull market of 2016—2017 is too temping to avoid  which will leave even less money going toward illiquid private equity with high risk and long time required to see any profit.

To get off the ground and survive, startups  located outside Silicon Valley need to bootstrap having enough money to cover at least the first year of operation. They also  need to be maniacally focused on customer discovery and market research, because mismatch between market need and product offering is the kiss of death for a new business. 

I am always happy to work with early stage technology businesses as a part-time CMO, lend an extra hand to resource strapped entrepreneurs and help them build sustainable, profitable company. Call me to chat about your ideas and needs for customer discovery, market research and Seed Round fundraising strategies.

About Dragana Mendel 85 Articles

Dragana Mendel is a President and Principal Consultant at ANAGARD, LLC. In her role, she provides management consulting services to small and medium size businesses on the best strategy to achieve their short and long term goals.