Categorization of angel investments: an explorative analysis of risk reduction strategies in Finland

Abstract

Recent studies have proposed that future research on business angel typologies should focus on individual investments rather than investors. This study is a response to this proposal. It suggests that investments can be divided into subgroups in accordance with the comprehensiveness of business angels' due diligence and the strength of their involvement in the ventures. The sample comprises 53 investments by Finnish business angels. Four investment categories were identified: (a) gambles; (b) conventional angel investments; (c) due diligence-driven investments; and (d) professionally safeguarded investments. These investments are compared with respect to the general characteristics of the investors and investments, investment criteria and general investment preferences and to the level of relationship-specific investments by entrepreneurs. The results point to several substantial differences between these groups. The study helps entrepreneurs to understand what they can expect from angel investments.

Keywords:

• categorization
• business angel
• due diligence
• involvement
• risk reduction

Notes

 1. Due diligence aims at reducing investment risks through considering all the aspects relating to an investment opportunity: the entrepreneur (management), the firm, the product as well as the external environment (e.g. Smart 1999).

 2. Retrieved from www.tilastokeskus.fi (17 April 2008).

 3. Regardless of venture capitalists' greater concern for financial returns, two studies have shown that BAs' investments yield a higher return on the invested capital (see Lumme, Mason, and Suomi 1998; Mason and Harrison 2002).

 4. Owing to the shortage of information available on the investment opportunity, it is not always possible for BAs to use third party information, such as due diligence reports prepared by accountants, lawyers and consultants, to corroborate their own assessment (see e.g. Harrison and Mason 2002).

 5. One of the two investors held a large portfolio of investments and had been investing in privately held businesses for more than 10 years, while the other investor had only recently started his investment activities.

 6. The size of the population of BAs is dependent on the criteria applied to define the term BA. Given the stringent definition used in this study, in the absence of an accurate estimate, an educated guess is that the amount is in between 400 and 500 (see http://www.tekniikkatalous.fi/tyo/article44016.ece). Then the sample would feature approximately 10%–12.5% of the population.

 7. In applying the snowball sampling a BA participating in the interview is asked to refer names of investors that are known to possess the required characteristics (fulfil the conditions assessed). A potential problem with this technique is that the demographic characteristics of the referred investors will be more similar to the investors referring them than would happen by chance (see e.g. Malhotra and Birks 2003).

 8. Retrieved from http://www.pr-inside.com/summary-of-finnish-high-tech-company-capital-r1445852.htm.

 9. When the most recent investment was highly atypical, the investors could choose an investment that is more in line with their style of investing.

10. The investment requirements tend to increase with the stage of development of the investee company. A significant positive relationship was found between the size of the investment and the stage of development (r = 0.365; p < 0.01).

11. All the criteria investigated in this study are measured on a seven-point Likert scale ranging from 1 = not important to 7 = very important.