Expected Returns to Stock Investments by Angel Investors in Groups

• Published date: 01 September 2014
• Date: 01 September 2014
• Author: Ramon P. DeGennaro,Gerald P. Dwyer
• DOI: http://doi.org/10.1111/eufm.12002

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

Abstract

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.

C

2013 Blackwell Publishing Ltd

© 2013 John Wiley & Sons Ltd

Ramon P. DeGennaro and Gerald P. Dwyer

740

© 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.