Angels spend less, but seed more

Angel investors nationwide spent fewer dollars in the first half of the year, but funded a larger number of companies, according to a report released last week by the Center for Venture Research at the University of New Hampshire.

The report estimates that angel investments in the first half of 2009 totaled $9.1 billion, down 27% from $12.5 billion invested in the same six-month period last year. However, 24,500 entrepreneurial ventures received angel funding in the period, a 6% increase from the 23,100 during the same period a year ago.

Jeffrey Sohl, director of the Center for Venture Research, says the data “indicates that while angel investors have not significantly decreased their investment activity, they are committing less dollars, resulting from lower valuations and a cautious approach to investing.”

Health care services and medical devices accounted for the largest share of investments, with 28% of total angel investments in the first half of 2009, followed by software (14%), electronics and hardware (14%), industrial and energy (1%), which includes many green technologies and retail (8%).

Angels also showed a decreased appetite for backing seed and startup deals. In the first half of the year, 27% of angel investment activity was in the seed and startup stage, a decrease of 19% over the same period in 2008.

“That’s been a systemic change over the last three to four years,” says Sohl, who also notes that there are a few likely catalysts that are pushing angels to later stage deals.

One possibility is that angels, increasingly cautious with their money while in the midst of the current economic downturn, are looking for companies with a longer track record. Another explanation is that later stage companies unable to secure venture capital from early stage firms, which are also being more judicious about what new companies to fund, are turning to angels. An additional possibility is that older companies are seeking capital because the growth in sales are slower than expected.

Ian Sobieski, managing director of Menlo Park, Calif.-based Band of Angels, says the investment stage matters far less to angels than capital efficiency. While it may look like angels are trying to go later stage, he says, “the shift is more to deals where the financing risk is much less.” That is, companies should have modest startup and operational expenses, a clearly defined market opportunity, and a profitable business model.

Sobieski points to two investments from the Band of Angels—LegalCloud and Practice Fusion—as examples of how angels are investing in less risky ventures.

Legal Cloud runs data centers for law firms who pay for the service. Practice Fusion runs a free medical record platform that is accessible through a Web browser. It makes money providing a channel for pharmaceutical companies and other providers of medical products services to reach doctors, Sobieski says.

While angels are investing less overall, there’s no marked drop in the number of people making investments. The Center for Venture Research estimated that there were 140,200 active angel investors in the first half of the year, virtually unchanged from 2008.

However, they’re rejecting more deals. In the first half of the year, angels invested in about 9% of the companies brought to their attention, according to the report. That’s way down from four years ago, when about 23% of companies that reached out to angels received investment.

Sohl says the reduced investment rate reflects heightened caution on the part of angels, but is not so low as to stifle innovation, noting that the normal range is 10% to 15 percent.