Saturday, September 28, 2013
Be A Little Angel
Starting this week, small investors for the first time can put money up to invest in the preferred shares of young companies.
Small investors gain access to a new asset class this week.
As a result of the JOBS Act of 2012, retail buyers can put money into the preferred stock of young companies that haven’t gone public yet. This portion of the legislation—more formally known as Jumpstart Our Business Startups—goes into effect on Sept. 23, and numerous Websites stand ready to help you become what is, in essence, an angel investor.
Companies raising funds on sites such as CircleUp, Crowdfunder, and AlumniFunder are allowed to advertise these offerings to what the Securities and Exchange Commission calls “accredited investors,” who must meet certain income and net-worth requirements. Once the new measure goes into effect this week, the promotions also can be made to nonaccredited investors with far fewer assets. However, the companies do have new registration requirements with the SEC to avoid fraudulent fund raising.
This is the same provision of the JOBS Act that will allow hedge funds to advertise to retail investors for the first time, but the returns possible from angel investing are more intriguing. According to the Angel Performance Project, published by Robert E. Wiltbank of Willamette University for the Kauffman Foundation, the average return for early-stage investments is 2.6 times the initial investment in 3.5 years. That’s much better than many investment classes, including hedge funds. However, there were wide variations in returns, suggesting risk, as well.
We took a close look at San Francisco’s CircleUp (circleup.com), which focuses on businesses with revenue of at least $1 million per year that produce consumer goods. CircleUp members recently funded SmartyPants, a maker of gummy vitamins for kids and adults, as well as 18 Rabbits, which makes granola and snack bars. Rory Eakin, CircleUp’s co-founder and CEO, says his site has narrowed its investment selection for three reasons.
“We believe that the average retail investor is better at assessing consumer products than high-tech offerings such as cloud computing,” Eakin says. He also thinks the consumer-products industry is underfunded relative to other sectors, and that there’s a tremendous growth opportunity in this sector. “If we did tech, we’d be competing against venture firms and other institutional investors,” Eakin notes. Venture firms, he says, don’t have much experience doing due diligence on consumer firms, since so much of the industry concentrates on high tech.
Signing up is relatively quick and easy, though it takes a day or two to verify your identity and financial accreditation. Under the soon-to-expire rules, a household net worth of $1 million or more, not including your primary residence, or annual income of $200,000 for an individual, or $300,000 for a couple, puts you in the accredited-investor ranks. Once accepted as a member, you can browse available companies by location and industry, and converse with officers of individual firms.
THESE CONVERSATIONS, which take place on each company’s Forum page, can be extremely detailed. The answers from company reps are quite straightforward. In many cases, the companies are already producing goods, so you can go to a local store and check them out before deciding whether to provide financing.
The minimum investment varies by offering; some are as low as $1,000. CircleUp narrows the choices for members. It looks for innovative companies that already are generating pretty substantial revenue. The site has its own professional consumer-focused investors who evaluate each opportunity, handpicking those that go onto CircleUp. Members can suggest new additions to the site.
A key component of venture funding is an exit strategy. Eakin says that CircleUp hasn’t yet seen a company through to exit, as it was just opened in 2012 and the average holding period is 4½ years. Generally, this occurs through an acquisition, buyout, or initial public offering. CircleUp tries to focus on companies that could appeal to a larger brand or a private-equity firm down the road.
Is this an asset class you should consider? If you are willing to wait for a payout and do your homework, this could be extremely exciting. It’s a high-risk, illiquid asset class, but the upside is huge.
Published in Barron’s, September 23, 2013.