Expected Returns to Stock Investments by Angel Investors in Groups

Published date01 September 2014
Date01 September 2014
European Financial Management, Vol. 20, No. 4, 2014, 739–755
doi: 10.1111/eufm.12002
Expected Returns to Stock Investments
by Angel Investors in Groups
Ramon P. DeGennaro
Department of Finance, University of Tennessee, Knoxville, TN 37996 USA
E-mail: rdegenna@utk.edu
Gerald P. Dwyer
Departmento de la Econom´
ıa de la Empresa University of Carlos III, Calle Madrid 126, Madrid,
28903 Getafe (Madrid), Spain
E-mail: gpdwyer@gmail.com
Previous research calculates realised internal rates of return on angel investments
but does not estimate expected returns. We present the first estimates of expected
returns on angelinvestments by applying a consistent statistical framework to a new
data set. Our sample spans 1972 to 2007 with 419 exited investments. Our results
suggest that expected returns on stock for angel investors in groups are about
70% per year in excess of the riskfree rate. These expected returns have a large
variance and are heavily skewed, with many losses and occasional extraordinarily
high returns.
Keywords: Angel Investor, Expected Return, Private Equity
JEL classification: G24, G20
We thank the Ewing Marion KauffmanFoundation for providing the data and Rob Wiltbank
for help clarifying some of the data’s features. We received helpful comments from
participants in sessions at Ewing Marion Kauffman Foundation and Federal Reserve Bank
of Cleveland Conferences on Entrepreneurial Finance in Kansas City and Cleveland, the
European Financial Management Association’s Symposium on Entrepreneurial Finance
and Venture Capital Markets, and conferences organised by the Association for Private
Enterprise Education and the Society for Nonlinear Dynamics and Econometrics. We also
thank participants in seminars at the College of Charleston, Ohio University, the University
of North Carolina Charlotte and the University of Nevadaat Las Vegas for helpful comments.
Stephen M. Miller, Bruce Mizrach and Paul Thistle provided helpful comments. We thank
the anonymous referee and the editor for helpful comments which improved the paper.
DeGennaro thanks the College of Business at the Universityof Tennessee and the University’s
Scholarly Activities Research Incentive Fund for support. Dwyer thanks the Federal Reserve
Bank of Atlanta for research support and the Spanish Ministry of Education and Culture
for support of projects SEJ2007–67448/ECON and ECO2010–17158. Any errors are our
responsibility. The views expressed here are ours and not necessarily those of the Federal
Reserve Bank of Atlanta or the Federal Reserve System.
2013 Blackwell Publishing Ltd
© 2013 John Wiley & Sons Ltd
Ramon P. DeGennaro and Gerald P. Dwyer
© 2013 John Wiley & Sons Ltd
1. Introduction
Angel investors investbillions of dollars in thousands of fledgling companies every year,
thereby acting as informal venture capitalists. What returns can these angels expect to
receive on their investments? Although previouswork has explored realised returns, this
paper is the first to provide estimates of expected returns on angel investments in a form
comparable to reported expected returns on stock or venture capital.
Until recently, research on the returns to investments by angel investors and angel
groups has been limited because suitable large data sets have not been available.
The Angel Investor Performance Project (AIPP) recently has provided an informative
database on comparable angel investments. These data have 588 investments of which
419 have been exited.
We use these data to explore the expected returns on angel investments. Our paper is
similar in spirit to Cochrane (2005) and Korteweg and Sorenson (2010) who estimate
the expected returns on venture capital investments and to Barnhart and Dwyer (2012)
who estimate the returns on traded stock in new industries. It differs from the prior work
on returns to angel investment by Wiltbank(2005) because we estimate expected returns
per investment per year rather than realised returns per investment. Thus, our paper
combines these strands of literature by estimating expected returns on angel investments.
The distinction between realised internal rates of return and expected returns is critical.
Realised internal rates of return do not drive financial decisions. Expected returns drive
financial decisions.
Our results indicate that the expected return on angel investments is the same order of
magnitude as Cochrane’s (2005) estimate of returns to venture capital and higher than
Korteweg and Sorenson’s (2010) estimate. The expected return estimated from the AIPP
is about 70% per year. This expected return reflects a much higher variance than returns
on traded stock and a few extraordinary payoffs.
2. Prior Literature
Information about angel investors and their investments is sparser than for many other
investments. Shane (2009) summarises institutional details and provides a solid review
of what is known about angel investors and their investments. Individual investments
tend to be informal with little publicly availabledocumentation. For this paper, we define
an angel investor as a person who provides funds to a private business which does not
have publicly traded stock and who is not a relative or personal friend of the owner or
operator of the firm.1
Angel investing is part of private equity investing but it is a relatively small and poorly
documented part. For example, Shane (2009) reports that angel investors are actually
a fairly narrow subset of the private equity market; at about $23 billion annually, it
approximates the size of the venture capital market. Much private equity is provided by
venture capital firms and other intermediaries (Metrick and Yasuda, 2011) instead of
informally as in angel investing. There is a large and growing literature on returns on
1This definition is the same as Shane’s (2009, p. 14) with the additional limitation that angel
investments are in firms which do not have publicly traded stock. Otherwise Warren Buffett
would be an angel investor in Goldman Sachs, which is not the sort of investment generally
considered to be an angel investment. We thank Stephen Miller for noting this.

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