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million to $5 million and 158,000 households worth between $5 million and
$10 million. Also note that 0.7 percent have a net worth of $1 million to $5
million. Less than 0.2 percent have a net worth of $5 million to $10 million.
The Challenge

EXHIBIT 1.2 Structure of the High-Net-Worth Private Investor Market

Structure of Net Worth
Net Worth U.S. Households
$500,000 1,773,593 (1 .9%)
$1,000,000 672,098 (0.72%)
$5,000,000 158,690 (0.17%)
$10,000,000+ 9,334 (0.01%)
$9.8 trillion market 2,613,715

Structure of Affluence (Income)
No. of Returns†
Adjusted Gross Income*
$100,000“200,000 2,597,908 (2.26%)
$200,000“500,000 676,038 (0.5%)
$500,000“1,000,000 118,350 (0.1%)
$1,000,000 or greater 52,019 (0.045%)
3,444,315 (2.905%)

*Total number of returns = 114,700,000.

Includes salary, interest, dividends, stock sales, capital gains. Could be individual,
joint return, single, or unmarried filing separately.
Source: Internal Revenue Service

So the percentages of households correlate closely to those percentages of re-
turns. Those with incomes of $200,000 to $500,000 equal 0.5 percent of re-
turns; those with incomes of $500,000 to $1 million filed 0.1 percent of the
returns. Thus, the numerical similarities point to a similarity between the
structure of income and net worth. Still, the fact remains: discretionary net
worth forms the true measure of our target market.
The majority of investors represented in the categories of net worth
ranging from $1 million to $10 million are self-made. Most rich Americans
have earned their money; theirs is not inherited money, reveals the 1995
Rand study by the Santa Monica nonprofit research group. These individu-
als have built and own their own companies and have generated their per-
sonal fortunes through hard work and through understanding an industry or
a business.
However, while these numbers seem large”a $9.8 trillion market and
approximately 2.6 million U.S. households that might be appropriately tar-
geted”the market for higher-risk, developmental, or expansion deals is sub-
stantially less than that. A portion of these investors is not composed of
accumulators, or people investing in growth investments with possible cap-
ital appreciation; instead, they represent savers and those looking for in-

come from their investments”circumstances incompatible with earlier-stage
Other circumstances also lessen the pool of investment dollars. The dol-
lars diminish when you correct statistics for geographic locale and proximity
of the company seeking the direct investment, and age of the prospective in-
vestor. The dollars also diminish when you scan such items as net worth (ex-
clusive of house and car), previous investment history, current holdings,
status and role in the business community, and interests in specific industries.
Considering the circumstances, our own calculations indicate that for
higher-risk, early-stage, manufacturing-related deals, the true market con-
tracts to about 400,000 investors. This range exists because investors who
engage in direct investing in early-stage deals typically surface only a few
times a year, and only when seeking new investments that follow a liquida-
tion or windfall event, or simply when they are in the mood for a change.


Although it is true that private investors prize their privacy and that obtain-
ing information about private transactions in this highly secretive market is
difficult, ICR™s proprietary research in building its national database of angel
investors, plus other important studies, can help us understand the extent of
the activity of the high-net-worth investor™s direct investment in early-stage
Angels are financially sophisticated private investors of means willing to
provide seed, research and development (R&D), start-up, and expansion
capital to investors and young or less-experienced entrepreneurs for high-
risk ventures. For many entrepreneurs, the process of finding angels proves
to be inefficient, and for many, frustrating and disappointing. You could
make hundreds of presentations, spend countless hours and untold dollars
searching for the hard-to-find private investors”unless you use proven
strategies to identify them and, thereby, establish contact. This is why seg-
menting the high-net-worth market into target categories most appropriate
for your particular venture remains even more critical in today™s challenging
capital-raising market.
In his landmark study funded by the Small Business Administration,
Dr. Robert J. Gaston suggested that approximately $55 to $56 billion a year
was being placed into as many as 720,000 companies. Dr. William Wetzel,
Jr., at the University of New Hampshire Whittemore School of Business
has suggested that approximately $15 billion of this $55 to $56 billion was
being placed into approximately 60,000 very-high-risk, early-stage, seed,
The Challenge

R&D, or start-ups per year. Meanwhile, the Small Business Development
Center at the University of California, Irvine, has suggested that in California
alone approximately $30 billion is being invested in about 240,000 transac-
tions per year.
The debate on the size of this “invisible” market still rages. Josh
Friedman wrote recently in the Los Angeles Times that angels invest in 50
times the number of deals as venture capitalists do, although in smaller
amounts. In the United States, his research posits, approximately 300,000
angels invested $30 billion, although this was sown from 2001 levels.
Longer-term estimates by Jeffrey Sohl made in 1999 in Venture Capital
Journal indicate that angels invest about $20 billion per year in 30,000 deals.
The National Venture Capital Association estimated the angel investment at
$100 billion in 1998.
As Osnabrugge and Robinson observe in Angel Investing, “obtaining ac-
curate numbers for the size of this market is difficult.” We agree that the best
market size estimates are, at best, extrapolations, attempts to quantify what
the academic and business literature”and even the popular press”know is
essentially a secret capital market.
Although these estimates vary, the amount of capital and number of
transactions involved signal a vast market. In contrast, the venture capital in-
dustry invested a full year total of $21 billion in 2002 into 3,011 deals, of
which only $303 million went into seed and start-up transactions. This rep-
resents significantly less total investment when compared with $106 billion
invested in 2000 and $41 billion invested in 2001 by the professional venture
capital industry.
Simply put, private investors, or business angel investors, are a primary,
if not the primary, source of capital for early-stage and growing companies.


It is no longer a question of whether angels are a viable capital resource for
early-stage ventures. Angels are a source”in fact, the primary source”of
capital, worth the entrepreneur™s time, energy, and financial resources to seek
and access; they should be considered before other alternative, nontradi-
tional capital resources. One entrepreneur we worked with felt motivated to
turn first to an angel instead of an institutional investor because of the will-
ingness of angels to commit large stakes in individual companies based on
the understanding that angels, in turn, want a voice in management.
Speaking to the San Francisco Business Times, he put it this way: “The typi-
cal venture capital firm wants to get involved only when you are further

along”and for more money than you need. The primary advantage of going
with individuals is that it is much quicker and you can tailor the details of the
deal to the individual investor.”
If you have a successful track record as an entrepreneur, the institutional
venture community is more inclined to look at your next deal. But what of
the other 99.9 percent of entrepreneurs seeking start-up capital. Without the
lengthy record, where can they turn?
We estimate that more than two million high-net-worth individuals with
the financial capital, when combined with the lowest interest rates in 45
years and poor stock market performance, offer the potential for investment
into higher-risk, higher-return ventures. More than ever, there are organiza-
tions, research groups, networks and academics studying about and publish-
ing in the angel capital market. Angel capital has gone mainstream! These
veterans offer money and added value to those entrepreneurs who can figure
out a strategy to reach them and present their vision and their deals in a per-
suasive and compelling manner.
When you want to bring in a funding partner early, and you want active
involvement and access to their brainpower and perspective based on start-
up experience, the angel investor is hard to beat. Research shows that ven-
ture capital gets involved when entrepreneurs are further along with their
companies. Dealing directly with angels can be quicker, even in today™s more
cautious investment environment, and entrepreneurs can tailor the details of
their deals to the individual investor. Especially when seeking to raise less
than $3 million, and searching for investors who bring expertise that can
complement the management team, angels offer an edge. Furthermore, when
entrepreneurs don™t want to give up significant control too early, active an-
gels offer the best game in town.


So, as many entrepreneurs in our experience have discovered, these investors
are worth accessing.
Still, there exists the old problem of meeting these investors. In his book
Giant in the West, Julian Dara writes that Joseph Strauss attempted to get
funding to build the Golden Gate Bridge for 19 years before he found A.P.
Giannini, who ultimately financed the $6 million necessary for construction.
Although contemporary entrepreneurs have been creative in identifying and
accessing alternative sources of capital for their growing ventures, we have
to be realistic: How many of us have the patience of a Joseph Strauss?
For many entrepreneurs, finding, attracting, building relationships with,
and closing with private business angel investors remains inefficient. The rea-
The Challenge

son is simple: Angels prize their privacy. These individuals are hard to find;
moreover, a fair review of the literature will indicate that there is little formal
guidance in identifying their whereabouts. Currently, most angel investors
are located primarily by word-of-mouth contacts from other investors or by
reliance on professional intermediaries with a book of investors in related
Angels are hard to locate for the simple reason that they are not legally
bound to disclose their activities and are secretive about their investment in-
terests, since once “outed” everyone eagerly solicits them to access their
wealth. Is it any wonder they cling to their privacy? Because of these circum-
stances, you could make hundreds of presentations, spend countless hours,
and waste thousands of dollars searching for private investors; largely, labor
lost. Lost, that is, unless you learn to use proven strategies that make the
search more efficient. This means not only identifying these people but also
establishing contact and managing relationships with them throughout the
funding process.
The challenge, then, lies in efficiently accessing these investors. How do
you find them? Chapter 3 will tell you how. But before tracing a strategy that
works, you need the information in Chapter 2 on direct, private investment
to determine whether your deal”and you”are financeable.

The Solution:
The Private Placement

Giving half the business away to make it four times bigger makes
the entrepreneur twice better off.
”an Angel Investor

Sixty percent of transactions concluded at the seed, R&D, and start-up
stages have fairly fixed financing structures. It is no accident that the trans-
action structure most commonly used by angels is the private placement. The
formal definition of a private placement is the issuance of treasury securities
of a company to a small number of private investors in the form of senior
debt, subordinated debt, convertible debt, common stock, preferred stock,
warrants, or various combinations of these securities. Although the vast ma-
jority of these investments by institutional investors involves debt securities,
exempt offerings are common, involving direct, equity, and/or debt investing
by private investors.
The informal, more practical, realistic definition of the private place-
ment is any deal that the entrepreneur can legally negotiate and an attorney
can write up. In essence, the private placement in angel transactions becomes
a written record of the agreement and deal struck between the entrepreneur
and the angel investor, which is precisely why we do not advocate indulging
prematurely in overly structured transactions. Peddling highly structured
transactions in the current angel market precludes the angel™s propensity to
negotiate. More constructive for the entrepreneur is an open-minded, nego-
tiation-oriented approach. This more flexible posture, when supported by a
strong business plan, is the constructive strategy to open the negotiation


door with prospective investors. In fact, our experience tells us that angels
are more inclined to circle wagons around less-structured deals, leaving them
free to assemble legal, accounting, investment banking, and other expertise
to structure an agreement acceptable to all the parties, and based on the par-
ticular attributes of the deal.
With private placement investments, private investors often require di-
rect participation in a venture in order to limit the downside risk associated
with relatively illiquid investments. These direct participatory investments
begin with transactions for a smaller amount and generally are more quickly
arranged than public offerings. Besides, because of the lack of Securities and
Exchange Commission (SEC) requirements, these more flexible transactions
let the company circumvent onerous public offering requirements and access
the nonaffiliated market without full regulatory compliance. Thus, these in-
vestments prove much less expensive to all concerned.
The relaxation of SEC requirements is possible under private placement
exemption offered by Section 4(2) of the Securities Act of 1933. More re-
cently, Regulation D offers entrepreneurs a safe harbor; in other words, by
complying with Regulations D™s relatively easy-to-follow exemptions, entre-
preneurs can offer shares of stock in their company directly to a limited num-
ber of individual or organizational investors, for example, to angels. It is true


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