For companies that go public, how do those that were backed primarily by angel investors fare against those primarily backed by venture capitalists? That was one of the questions addressed in a working paper recently published by two professors from the University of New Hampshire. They examined data related to the pre-initial public offering (IPO) shareholders of companies that subsequently went public. The conclusions from the study provide interesting information that should be considered for companies looking to go public as part of their long term capitalization plan.
The Paper: Initial Public Offerings and Pre-IPO Shareholders: Angels versus Venture Capitalists
The working paper, entitled Initial Public Offerings and Pre-IPO Shareholders: Angels versus Venture Capitalists, was authored by William Johnson and Jeffrey Sohl. The authors examined the public offering documents of IPOs between 2001 and 2007, eliminating public offerings under $5, REITs, banks, foreign issuers, and the like. Their final sample consisted of data from 665 IPOs.
The authors took a look at the details of who owned more than 2% of the issuer prior to the offering, classifying them as management (including family of management), angel investors, venture capitalists, or other corporate entities. In drawing their conclusions, the authors made a number of assumptions as to which category a given shareholder fit. In the data sample, roughly 13% of the issuers had only angel investor backing, 33% had only venture capital backing (with very little or no angel investor backing), 16% had a combination of angel investor and venture capital backing, and 38% had neither angel or venture capital backing.
Reexamining the Value of Angel Investors
Here are some of the authors’ interesting conclusions:
- While VCs were generally able to attract higher quality investment bankers to underwrite public offerings, venture capitalists tended to be involved with public offerings that were underpriced when compared to companies that were only angel investor backed or that did not have angel or venture capital backing.
- Shareholders in angel investor backed companies were significantly more likely to sell some of their shares in the IPO as compared to other companies that were not backed by angel investors.
- Angel investors invested money in more diverse industries (e.g., wholesale and retail, manufacturing) than venture capital firms. VCs tended to focus overwhelmingly on technology-based industries.
- The average size IPO for venture capital backed companies was smaller than any other group of companies. The highest average size IPO came from companies that were neither angel investor nor venture capital backed; in fact, the average size IPO of this group of companies was more than 2.5 times that of venture backed firms.
- While firms that had neither angel investor nor venture capital backing had the largest IPOs, they also took the longest to go public (average of 28 years). Of the types of companies examined, the quickest to go public were those companies that had both angel investor and venture capital backing (average of 11 years).
A few things to keep in mind when reviewing the results of the study. First, the data in the study was correlational, not causational. In other words, having angel or venture capital backing does not necessarily cause lower public offering valuations or earlier public offerings. There could be, for example, other reasons for the apparent underpricing such as the higher quality investment bankers creating higher post-offering interest in the offered securities. Second, there were a number of assumptions built into the study’s data as to who was an angel investor and who was not. When I was reviewing the assumptions, I could think of a number of examples in my experience that were counter to the assumptions made. In fairness to the authors of the study, with imperfect information one needs to make a number of assumptions when looking at a large amount of data and counterexamples do not necessarily invalidate the general trends or conclusions of the authors.
Long Term Capitalization Plan
As the authors indicated in their conclusion, “[o]ur results suggest that prior to making a decision about obtaining angel versus venture financing, private firm management should also consider the consequences of such early investors on IPO firm proceeds raised in an eventual IPO.” Indeed, drawing from the results and conclusions such as those in this and other studies is an important part of developing a good long term capitalization plan.