The (not so) puzzling behavior of angel investors

Vanderbilt Law Review

Volumn 61, Issue 5, 2008, Pages 1403-1451

  Ibrahim, Darian M ^a  

^a UNIVERSITY OF WISCONSIN LAW SCHOOL   (United States)

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EID: 57249105542     PISSN: 00422533     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (327)

1. There is no technical definition of an angel investor (sometimes referred to as a private investor" or "informal venture capitalist"), although most descriptions of angels focus on two characteristics: wealth and the investment of personal funds. First, an angel typically qualifies as an "accredited investor" under the securities laws, which means she has over $1 million in net worth, or income over $200,000 in each of the last two years (or $300,000 with spouse) and reasonably expects to reach the same income level in the current year. 17 C.F.R. § 230.501(a) (2008). Second, an angel invests her own funds, as compared to venture capitalists and other financial intermediaries, who invest the funds of others.
2. Drawing the line between the "friends and family" and "angel" categories can sometimes be difficult, as in the case of non-immediate family members like Uncle Joe. There is no precise definition of an angel investor, see supra note 1, but non-immediate family members are often counted in the angels category.
3. See infra note 57 (discussing the estimated size of the angels market).
4. See MARK VAN OSNABRUGGE & ROBERT J. ROBINSON, ANGEL INVESTING: MATCHING START-UP FUNDS WITH START-UP COMPANIES - THE GUIDE FOR ENTREPRENEURS, INDIVIDUAL INVESTORS, AND VENTURE CAPITALISTS 5 (2000) ("Venture capitalists get all the press, but the vast majority of entrepreneurial funds are actually funded by business angels, especially those firms in their earliest stages.").
5. Robert E. Grady, Testimony before the U.S. House Committee on Education and the Work Force, 2 (Mar. 11, 2004) (explaining that venture-backed firms employed over 12.5 million people and in the year 2000 accounted for approximately 11% of the U.S. Gross Domestic Product). The current president of the Rauffman Foundation, Carl Schramm, contends that in a world of globalization and outsourcing, entrepreneurship is America's remaining comparative advantage. See generally CARL J. SCHRAMM, THE ENTREPRENEURIAL IMPERATIVE (2006).
6. See infra note 180 and accompanying text.
7. Hannah Clark, Are Angel Investors Heaven-Sent?, FORBES, May 4, 2006, http://www. forbes.com/entrepreneurs/2006/05/04/entrepreneurs- finance-angels cx-hc-0504angel.html.
8. According to the Angel Capital Association ("ACA"), the professional alliance of angel groups in the U.S. and Canada, there were approximately 114 angel groups that were full members of the ACA in the U.S. in 2006. ACA data show an average total investment for each angel group at $1.78 million for the year (including investments by individual angel group members, which is the most common form of angel group investment practice). ACA Angel Group Confidence Report, Mar. 27, 2007, available at http://southeastvc.blogs.com/southeast-vc/files/angel-group-confidence-report- results.pdf (last visited Sept. 20, 2008). Multiplying that figure by the number of groups gives a total of $202.9 million invested by all angel groups. The largest angel groups are all full members of the ACA, but even if we assumed an equivalent amount of investment outside of ACA-member groups, the total is no more than $406 million, or 1.6% of the total $25 billion angel market. See infra note 57 (discussing the total size of the angel market). I thank Luis Villalobos for this observation.
9. Google Milestones, Google.com, http://www.google.com/corporate/history. html#1999.
10. Company History, Yahoo.com, http://docs.yahoo.com/info/misc/history.html.
11. PAUL A. GOMPERS & JOSH LERNER, THE VENTURE CAPITAL CYCLE 1 (2000).
12. PAUL A. GOMPERS & JOSH LERNER, THE MONEY OF INVENTION: HOW VENTURE CAPITAL CREATES NEW WEALTH 10-11 (2001).
13. Michael Rlausner & Rate Litvak, What Economists Have Taught Us About Venture Capital Contracting, in BRIDGING THE ENTREPRENEURIAL FINANCING GAP 54, 58-59 (Michael J. Whincop ed., 2001). Value-added services can be as important as financial capital. eBay, for instance, was a profitable start-up that did not require outside funding. Yet it sought venture capital, which was provided by Benchmark Partners, in recognition that a venture capitalist's connections and expertise would be essential in securing a seasoned CEO and other executives. RANDALL E. STROSS, EBOYS: THE TRUE STORY OF THE SIX TALL MEN WHO BACKED EBAY AND OTHER BILLION-D OLLAR START-UPS 22 (2000).
14. See Joshua Lerner, Venture Capitalists and the Decision to Go Public, 35 J. FIN. ECON. 293, 314 (1994) (observing that experienced venture capitalists appear better able to time IPOs than their less experienced counterparts).
15. The investment contracts might include an amendment to the start-up's corporate charter (to create and designate preferred stock), a stock purchase agreement, and an investor's rights agreement.
16. See, e.g., Philippe Aghion & Patrick Bolton, An Incomplete Contracts Approach to Financial Contracting, 59 AM. REV. ECON. STUD. 473, 479 (1992).
17. See Ronald J. Gilson, Engineering a Venture Capital Market: Lessons from the American Experience, 55 STAN. L. REV. 1067, 1076 (2003) ("The special character of venture capital contracting is shaped by the fact that investing in early stage, high technology companies presents [uncertainty, information asymmetry, and opportunism] in extreme form.");
18. George G. Triantis, Financial Contract Design in the World of Venture Capital, 68 U. CHI. L. REV. 305, 311-12 (2001) (observing that financial contracting is more difficult in venture capital than in bank lending).
19. Gilson, supra note 17, at 1077.
20. While most academics have focused on the potential conflicts between venture capitalists and entrepreneurs, there are other notable conflicts present in this setting. See Robert P. Bartlett, III, Venture Capital, Agency Costs, and the False Dichotomy of the Corporation, 54 UCLA L. REV. 37 (2006) (discussing conflicts between different venture capitalists investing in the same start-up);
21. Jeffrey N. Leavitt, Burned Angels: The Coming Wave of Minority Shareholder Oppression Claims in Venture Capital Start-up Companies, 6 N.C. J.L. & TECH. 223 (2005) (discussing conflicts between angels and venture capitalists);
22. Rate Litvak, Venture Capital Limited Partnership Agreements: Understanding Compensation Arrangements, (Columbia Law & Econ. Research Paper No. 254, 2004), available at http://papers.ssrn.com/sol3/papers. cfm?abstract-id=555626 (discussing conflicts between venture capitalists and venture fund investors).
23. See GOMPERS & LERNER, supra note 11, at 134 (explaining that syndication "allows the venture capital firm to diversify its portfolio, thereby reducing the exposure to any single investment. ... By syndicating investments, the venture capitalist can invest in more projects and diversify away some of the firm-specific risk.").
24. See id. at 131; Rlausner & Litvak, supra note 13, at 62-63.
25. Venture capitalists typically enjoy bargaining power over entrepreneurs, although bargaining power can shift over competition to fund the most desirable start-ups or in times of flush times for private equity, when more cash is available to spend. See STROSS, supra note 13, at 25 (explaining that in competitions to fund the most attractive start-ups, the bargaining power shifts in favor of the entrepreneur);
26. William W. Bratton, Venture Capital on the Downside: Preferred Stock and Corporate Control, 100 MICH. L. REV. 891, 897-98 (2002) (reciting the "once-prevailing story about venture capital transactions [that] entrepreneurs so need venture capital that they cede both a majority of stock and control of the boardroom," but calling the once-prevailing story "incomplete");
27. Theresa Sullivan Barger, How to Dance with Angels, CFO.com (Apr. 30, 2007), available at http://www.cfo.com/article.cfm/9097739/c- 90983097f =home-todayinfinance (discussing that in the current market where large amounts of both venture capital and angel finance are available, bargaining power shifts to start-ups to decide whose funding to accept).
28. See Steven N. Kaplan & Per Strömberg, Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts, 70 REV. ECON. STUD. 281, 304 (2003) (discussing staged financing).
29. Gilson, supra note 17, at 1080. As Rlausner and Litvak observe, however, this signal only works if the entrepreneur can accurately gauge the value of his business. Rlausner & Litvak, supra note 13, at 56.
30. Gilson, supra note 17, at 1079; Darwin V. Neher, Staged Financing: An Agency Perspective, 66 REV. ECON. STUD. 255, 255-56 (1999) (observing that staged financing mitigates the entrepreneur's holdup potential).
31. GOMPERS & LERNER, supra note 11, at 139;
32. see also Klausner & Litvak, supra note 13, at 56 ("Most important among these contract terms is the staged nature of venture capital investment.").
33. Kaplan and Strömberg's survey of 213 venture capital investments in 119 portfolio companies during the late 1990s found that 95.8% of all rounds used convertible preferred stock, with convertible preferred stock being the sole security in 79.8% of all rounds. Kaplan & Strömberg, supra note 23, at 284 tbl.1. 38.5% of the rounds used participating preferred stock, which entitles the holder not only to its preferential return, but also to share in the proceeds of the common stockholders on an as-if-converted basis.
34. Id.
35. On the other hand, preferred stock receives disfavored treatment in litigation. See Bartlett, supra note 19, at 101-07 (discussing Delaware's narrow approach to construing preferred stock rights).
36. A sale is commonly counted as a liquidating event for purposes of triggering the venture capitalist's preference. Preferred stock also carries a dividend preference, but since start-ups rarely pay dividends during their life, the dividend preference is only valuable if it is cumulative, thereby entitling the venture capitalist to a greater payout upon liquidation or sale. Rlausner & Litvak, supra note 13, at 64.
37. Id.
38. See Ronald J. Gilson & David M. Schizer, Understanding Venture Capital Structure: A Tax Explanation for Convertible Preferred Stock, 116 HARV. L. REV. 874, 893-901 (2003) (suggesting that preferred stock can be used to transform current ordinary income into deferred capital gains, creating management incentives).
39. See William A. Sahlman, The Structure and Governance of Venture-Capital Organizations, 27 J. FIN. ECON. 473, 506-14 (1990) (explaining that venture capitalist control rights minimize agency costs).
40. See D. Gordon Smith, The Exit Structure of Venture Capital, 53 UCLA L. REV. 315, 326 (2005) ("Because venture capitalists typically gain additional board seats with each round of investment, over time the board composition provisions of venture-backed companies tend to move from 'entrepreneur control' or 'contingent control' to 'investor control.' ").
41. DEL. CODE ANN. tit. 8, § 141(a) (2006) ("The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors . . . ."); Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 NW. L. REV. 547 (2003) (arguing in favor of "director primacy").
42. See Raplan & Strömberg, supra note 23, at 289-90 (documenting that venture capitalists control start-up boards only 25% of the time, with contingent or shared control in 62% of the cases);
43. see also Bratton, supra note 22, at 891-98 (using the Kaplan and Stromberg findings to theorize that the parties prefer shared control to effectuate low-cost transfers of control).
44. Jesse M. Fried & Mira Ganor, Agency Costs of Venture Capitalist Control in Startups, 81 N.Y.U. L. REV. 967, 988-89 (2006).
45. Gordon Smith's recent empirical study found that the vast majority of venture capital investment contracts contained negative covenants against engaging in business combinations (81.47%), amending the charter in ways adverse to the venture capitalist (91.01%), redeeming or paying dividends to the common stock (70.84%), and issuing more preferred stock (80.38%) without the venture capitalist's approval. Smith, supra note 33, at 346.
46. Id. at 348-55.
47. See infra note 164 and accompanying text. The push for an early exit may be even more pronounced with inexperienced venture firms looking to "grandstand" to establish a reputation.
48. See generally Paul A. Gompers, Grandstanding in the Venture Capital Industry, 42 J. FIN. ECON. 133 (1996).
49. See Rlausner & Litvak, supra note 13, at 57 (identifying an entrepreneur's private benefits from delaying exit as "salary and other compensation, social status, and psychic benefits of managing a business").
50. It also should be noted that the venture capital investment contract may reduce uncertainty, information asymmetry, and agency costs in the form of opportunism by entrepreneurs, but in doing so it may allow opportunism by venture capitalists. Whether reputational constraints can serve as an adequate deterrent to a venture capitalist's opportunistic temptations is the subject of debate. See infra notes 150-53 and accompanying text.
51. For commonly used staging terminology, see Jeffrey Sohl, The Early Stage Equity Market in the USA, 1 VENTURE CAPITAL 101, 106 (1999).
52. See Joshua Lerner, "Angel" Financing and Public Policy: An Overview, 22 J. BANKING & FIN. 773, 778 (1998);
53. Hans Severiens, The Band of Angels: The Origins of Collaboration, in STATE OF THE ART: AN EXECUTIVE BRIEFING ON CUTTING-EDGE PRACTICES IN AMERICAN ANGEL INVESTING 18, 21 (John May & Elizabeth F. O'Halloran eds., 2003) [hereinafter STATE OF THE ART] (observing that "while some hot companies could absorb these larger sums [provided by venture capitalists], the average unproven start-ups that needed $1 million to build a prototype and hire a couple of people were left out of consideration").
54. See Sohl, supra note 42, at 109 (observing that the "handoff from angel investors to venture capitalists typically occurs in the $2-3 million range). The recent litigation between venture capitalist Benchmark Partners and start-up Juniper Financial reveals an instance of more substantial venture capital investment. Juniper received a first venture round of $20 million, a second round of $95.5 million, and a third round of $145 million.
55. Benchmark Capital Partners IV, L.P. v. Vauge, No. Civ. A. 19719, 2002 WL 1732423, at * 2 (Del. Ch. July 15, 2002), affd sub. nom. Benchmark Capital Partners IV, L.P. v. Juniper Fin. Corp., 822 A.2d 396 (Del. 2003).
56. Paul A. Gompers, Optimal Investment, Monitoring, and the Staging of Venture Capital, 50 J. FIN. 1461, 1473 (1995) (noting that most venture capitalist investments are made after the first year).
57. See Jeffrey E. Sohl, The U.S. Angel and Venture Capital Market: Recent Trends and Developments, 6 J. PRIVATE EQUITY 7, 14 (2003) ("The [capital] gap ranges from $100,000 at the low end, the point at which the money raised from friends and families and bootstrapping runs out, to the $2 million range on the high end, the time when the venture would historically become attractive enough to catch the eye of venture fund investors.").
58. There are exceptions, such as specific venture funds devoted to early stage investments, but early stage investments are not the industry norm. To underscore this observation, Van Osnabrugge and Robinson found that in 1998, during the height of the dot.com era when venture capitalists were said to move into earlier stage investments, still only 28% of all venture capital was invested in early stage deals. VAN OSNABRUGGE & ROBINSON, supra note 4, at 49.
59. On the decision to invest, Gompers and Lerner write:
60. The typical venture organization receives many dozens of business plans for each one it funds. Although most proposals are swiftly discarded, serious candidates are extensively scrutinized through both formal studies of technology and market strategy and informal assessment of the management team. (It is not unusual for a venture team to complete 100 or more reference checks before deciding to invest in a firm.)
61. GOMPERS & LERNER, supra note 11, at 5;
62. see also John L. Orcutt, Improving the Efficiency of the Angel Finance Market: A Proposal to Expand the Intermediary Role of Finders in the Private Capital Raising Setting, 37 ARIZ. ST. L.J. 861, 873-74 (2005) (explaining that it is more cost-effective to spread sizeable due diligence costs over a larger investment).
63. On monitoring, see GOMPERS & LERNER, supra note 11, at 171 ("Venture capitalists' oversight of new firms involves substantial costs.");
64. John Freear et al., Angels on Angels: Financing Technology-Based Ventures -A Historical Perspective, 4 VENTURE CAPITAL 275, 278 (2002).
65. GOMPERS & LERNER, supra note 11, at 171-84 (discussing how venture capital board membership varies with geographic proximity to the start-up and during times where greater oversight is needed).
66. Sohl, supra note 46, at 15 (observing that "without seed and start-up capital, many of these high-tech ventures do not even get past the initial stages of development").
67. See Tony Stanco & Uto Akah, The Relationship Between Angels and Venture Capitalists in the Venture Industry, LAB2IPO, 2005, at 6, http://lab2ipo.org/A2VCSurvey/VC%20Angel %20Survey%20v.final.pdf (using the conveyor belt analogy).
68. Sohl, supra note 46.
69. Andrew Wong, Angel Finance: The Other Venture Capital at 12 & 43 tbl.2 (Working Paper Series 2002), available at http://ssrn.com/ abstract=941228;
70. id. at 11 ("Most firms that receive [angel] funding are less than 12 months old. In comparison, the average age of first funding for venture-backed firms is greater than one year.") (citation omitted).
71. See infra notes 209-10 and accompanying text.
72. See John Freear & Jeffrey Sohl, The Characteristics and Value-Added Contributions of Private Investors to Entrepreneurial Software Ventures, 6 J. ENTREPRENEURIAL FIN. 84, 89 (2001) (asserting that "the research [on the funding of software ventures] provides added evidence to support the existence of a complementary relationship between private investors and venture capital funds");
73. cf. Brent Goldfarb et al., Does Angel Participation Matter? An Analysis of Early Venture Financing 27 (Working Paper Series 2008), available at http://ssrn.com/abstract=1024186 (arguing that in those "Series A" financing rounds where angels and venture capitalists compete to fund, entrepreneurs will prefer angels for reasons suggested in this Article, creating an adverse selection or "lemons" problem for venture capitalists).
74. Sohl, supra note 46, at 13 ("The typical angel deal is an early-stage round (seed or start-up) in the $100,000 to $2 million range.");
75. Wong, supra note 53 (noting that angel rounds averaged $1 million). Some accounts from the early to mid-1990s suggest that the transition from angel to venture capital financing occurred sooner, around $500,000 to $1 million.
76. John Freear et al., The Private Investor Market for Venture Capital, 1 FINANCIER 7, 8 (1994);
77. John Freear & William E. Wetzel, Jr., Who Bankrolls High-Tech Entrepreneurs?, 5 J. BUS. VENTURING 77, 87 (1990).
78. Although it is difficult to estimate the total size of the angel market due to its informality, studies suggest that during modern times it has ranged from an average of about $25 billion per year to a peak of $50-$60 billion during the height of the dot.com era in 2000. See VAN OSNABRUGGE & ROBINSON, supra note 4, at 69;
79. Freear et al., supra note 56, at 7. The venture capital market also rose sharply during the dot.com era. Venture capitalists invested $3.8 billion in start-ups in 1995, followed by $10 billion in 1997, $35.6 billion in 1999, and over $100 billion in 2000.
80. See Sohl, supra note 46, at 13. The years since the dot.com bust have seen a return to average venture capital investments of around $20 billion per year. ANDREW METRICK, VENTURE CAPITAL AND THE FINANCE OF INNOVATION 13 (2007). In 2006, angels and venture capitalists each invested approximately $25 billion.
81. See CENTER FOR VENTURE RESEARCH, THE ANGEL INVESTOR MARKET IN 2006: THE ANGEL MARKET CONTINUES STEADY GROWTH, (2006) available at http://unhinfo.unh.edu/news/docs/ 2006angelmarketanalysis.pdf (citing total angel investments in 2006 at $25.6 billion).
82. VAN OSNABRUGGE & ROBINSON, supra note 4, at 69.
83. Id. at 108 (stating that 75-83% of angels have prior start-up experience);
84. see John Freear et al., Angels and Non-Angels: Are There Differences?, 9 J. BUS. VENTURING 109, 111 (1994) (citing studies for the proposition that a majority of angels "have entrepreneurial experience as owners or managers").
85. See infra note 135 and accompanying text.
86. See Freear & Wetzel, supra note 56, at 96-97 (discussing that 70% of entrepreneurs considered the value-added services of angels to be very or moderately productive);
87. Sohl, supra note 42, at 112 (explaining that entrepreneurs described the mentoring they received from angels "to be as valuable as the capital").
88. Sohl, supra note 42, at 102.
89. Michael V. Copeland, How to Find Your Angel Investor, BUS. 2.0 MAG., Feb. 28, 2006, http://money.cnn.com/2006/02/28/ magazines/business2/angelinvestor/index.htm; see also Google Milestones, Google.com, http://www.google.com/corporate/history.html#1998.
90. See supra notes 16-19 and accompanying text.
91. See Dirk Bergemann & Ulrich Hege, Venture Capital Financing, Moral Hazard, and Learning, 22 J. BANKING & FIN. 703, 703-11 (1998) (discussing the optimal shares for the entrepreneur and the venture capitalist in the context of common stock, debt, and convertible securities);
92. Francesca Cornelli & Oved Yosha, Stage Financing and the Role of Convertible Debt, (Centre for Econ. Pol'y Res. Discussion Paper No. 1735, 1997), available at http://www. ceprorg/pubs/new-dps/dplist.asp?dpno= 1735;
93. Neher, supra note 25;
94. Jeffrey J. Trester, Venture Capital Contracting Under Asymmetric Information, 22 J. BANKING & FIN. 675, 675-80 (1998) (considering the preferred versus debt choice under asymmetric information).
95. See Wong, supra note 53, at 2 ("Despite the importance of angel funding, much of what is known about angels is incomplete and not well understood. Very few academic studies have examined angels, in part because data on angel investment is difficult to obtain.").
96. VAN OSNABRUGGE & ROBINSON, supra note 4, at 144 (noting that "studies have found that business angels usually learn of investment opportunities through a network of friends and family, business associates, accountants, and lawyers as referrals");
97. MIT ENTREPRENEURSHIP CENTER, VENTURE SUPPORT SYSTEMS PROJECT: ANGEL INVESTORS 28 (2000), http://entrepreneurship.mit.edu/Downloads/ AngelReport.pdf [hereinafter MIT Study] ("The angels we interviewed said they received their highest quality deals from their network of trusted business associates."). In what is credited as the earliest article on angels, William Wetzel observed that the angels market is "virtually invisible, inefficient, and often misunderstood."
98. William E. Wetzel, Jr., Angels and Informal Risk Capital, SLOAN MGMT. REV. 23, 24 (1983).
99. VAN OSNABRUGGE & ROBINSON, supra note 4, at 46 ("If it becomes widely known that an individual has money to invest, then he or she may be besieged with hundreds of proposals per year, when his or her desire may be only for three or four.").
100. Id. at 84 (noting that in their attempts to interview angels, angels were often asked for an extensive explanation as to how they were found, with a number refusing to answer).
101. See Jeffrey E. Sohl, The Private Equity Market in the USA, 5 VENTURE CAPITAL 29, 42 (2003) (explaining that research on the "terms and conditions" of angel investment contracts is "acutely missing from the current knowledge base").
102. On the types of studies that comprise the existing literature on angels, see Freear et al., supra note 48, at 279 ("The majority of the research output. . . has been empirically based, seeking to learn more about the attitudes, behaviour and characteristics of the angel population (often known as the 'ABCs' of angels).");
103. Wong, supra note 53, at 8 (asserting that while most studies of angels "focus mainly on descriptive statistics of investment size [his] paper focuses on the control aspects of angel investment").
104. Much of what we currently know about angels comes from the University of New Hampshire's Center for Venture Research and its affiliated academics, including John Freear, Jeffrey Sohl, and William Wetzel. The Center's website address is http://wsbe.unh.edu/cvr/.
105. See generally Wong, supra note 53.
106. Id. at 4.
107. For example, Stephen Prowse offers a small study of Dallas-area angels. Stephen Prowse, Angel Investors and the Market for Angel Investments, 22 J. BANKING & FIN. 785 (1998).
108. VAN OSNABRUGGE & ROBINSON, supra note 4, at 175 ("Angels often use relatively simple investment contracts.");
109. Sohl, supra note 42, at 112 (noting that angel "[d]eal structure, as stated in their terms and conditions, tend to be briefer and more informal than those of venture capital funds");
110. MIT Study, supra note 67, at 36 (explaining that angels who invest in a small number of deals, are new to angel investing, or who invest primarily for nonfinancial reasons "use informal or simple term sheets, or in some cases, there is no term sheet").
111. Wong, supra note 53, at 18 (observing that "staging is not a frequently used control mechanism by angels").
112. Id.
113. Robert Wiltbank & Warren Boeker, Returns to Angel Investors in Groups 8 (Working Paper Series, 2007), available at http://papers.ssrn.com/sol3/papers.cfm?abstract-id= 1028592;
114. see also Bob Goff, The Sierra Angels: Broadening the Charter, in STATE OF THE ART 70, supra note 43, at 83 (asserting that during tough times, angels "must be prepared to help fund subsequent rounds for portfolio companies").
115. Wong, supra note 53, at 19 ("Common equity is the most prevalent security, used in 34% of all [early stage] rounds and 39.5% of angel-only rounds.").
116. Prowse, supra note 73, at 790.
117. Fried & Ganor, supra note 36, at 1009.
118. Wong, supra note 53, at 15 (discussing the fact that a board seat is granted in only 42.5% of angel rounds).
119. See Freear & Sohl, supra note 55, at 96 (observing that only 20% of angels funding software ventures had representation on the board).
120. See John Freer et al., Raising Venture Capital: Entrepreneurs' View of the Process, 1990 FRONTIERS ENTREPRENEURSHIP RES. 223-37 (reporting that 71% of angels were on boards);
121. Prowse, supra note 73, at 790 ("Angels are very often on the board.");
122. Jeffrey E. Sohl & Jill Areson-Perkins, Current Trends in the Private Equity Financing of High Tech Ventures: An Analysis of Deal Structure 5 (2001) (unpublished manuscript, on file with the Vanderbilt Law Review) (noting that "for venture capitalists, as well as angels, board representation is an important consideration").
123. But see Fried & Ganor, supra note 36, at 1009 ("Unlike VCs, angels generally do not acquire control rights and board positions.").
124. Wong, supra note 53, at 53 tbl.6 panel D.
125. Prowse, supra note 73, at 790.
126. Wong, supra note 53, at 53 tbl.6 panel D.
127. VAN OSNABRUGGE & ROBINSON, supra note 4, at 199 ("Freear, Sohl, and Wetzel's finding that in the United States 'private individuals were more inclined to leave the method of liquidation undefined at the time of investment than were venture capital funds' still rings true.") (citation omitted).
128. Wong, supra note 53, at 53 tbl.6 panel D. Unsurprisingly, I have not come across evidence of a traditional angel bargaining for registration rights.
129. Sohl, supra note 42, at 111 ("In many cases there is a lead investor that brings the investment opportunity to these co-investors as a means of risk sharing and pooling of capital to round out the financing requirements.");
130. Sohl, supra note 46, at 13 (explaining that a typical angel round involves six to eight investors);
131. Wong, supra note 53, at 23 ("On average, twelve angels co-invest in a round."). Syndication can be less attractive to active angels who invest to play a hands-on role in the entrepreneurial process if co-investors also wish to play that role.
132. See VAN OSNABRUGGE & ROBINSON, supra note 4, at 136 (citing one angel as stating: "Co-investors attract if I'm in it purely for the investment; if it's an investment where I have a hands-on role it doesn't attract - otherwise you have too many egos involved, and it leads to conflict.").
133. Stephen Prowse observes that passive angels rarely exist in a syndicate without an active angel. Prowse, supra note 73, at 788.
134. See VAN OSNABRUGGE & ROBINSON, supra note 4, at 109 (discussing studies by Freear and Wetzel, J.D. Aram, and R.J. Gaston);
135. Prowse, supra note 73, at 788 ("Many angels do not make more than one investment per year, although there are a few full time angels that will make four or more per year.").
136. Freear et al., supra note 48, at 277 ("Angels will tend to invest in entrepreneurial ventures as part of a total portfolio that contains investments with differing risk characteristics.").
137. See infra notes 127-32 and accompanying text (detailing how angels select their investments).
138. Wong sought to reduce selection bias by sampling entrepreneurs that received angel funding rather than angels themselves. Wong, supra note 53, at 8-9.
139. Kevin Hindle & Susan Rushworth, The Demography of Investor Heaven: International Research on the Attitudes, Behaviour and Characteristics of Business Angels, in BRIDGING THE ENTREPRENEURIAL FINANCING GAP 10, 10 (Michael J. Whincop ed., 2001).
140. A 2000 MIT study of 26 experienced angels in the Silicon Valley and Route 128 areas found larger investments and greater use of venture capital-like terms among these investors. MIT Study, supra note 67, at 37;
141. see also Peter Kelly & Michael Hay, The Private Investor-Entrepreneur Contractual Relationship: Understanding the Influence of Context, 2000 FRONTIERS ENTREPRENEURSHIP RES. 258, 264 (observing that "we found that more experienced investors incorporated more contractual safeguards up front than their less experienced colleagues");
142. Prowse, supra note 73, at 788 ("The more sophisticated angels tend to insist on investment contracts that resemble the ones written in the organized private equity market, which contain lots of mechanisms to overcome moral hazard problems and protect them in the case of poor performance, whereas unsophisticated angels omit even the most basic protections.").
143. Broader taxonomies have been attempted, although none have matched the categories of angels with contracting behavior. See VAN OSNABRUGGE & ROBINSON, supra note 4, at 85-90 (providing some of the taxonomies of angels that have been suggested over the years, including one taxonomy that includes ten types of traditional angels);
144. MIT Study, supra note 67, at 17-21.
145. But see Freear et al., supra note 48, at 281 ("Perhaps fortunately, the spate of new terms [for angels], once in full flood, is drying up.").
146. MIT Study, supra note 67, at 37 (observing that "even experienced angels do not achieve all the stringent venture capitalist terms. They do not have the negotiating power of venture capitalists . . . .").
147. Despite a robust angel market, the funding gap still exists. See William K. Sjostrom, Jr., Relaxing the Ban: It's Time to Allow General Solicitation and Advertising in Exempt Offerings, 32 FLA. ST. L. REV. 1, 3-4 (2004) (suggesting that the funding gap could be filled if the SEC allowed general solicitation in exempt offerings);
148. Sohl, supra note 46, at 14 (attributing the funding gap to capital and information inefficiencies);
149. Colleen DeBaise, On Angels' Wings, WALL ST. J., Mar. 19, 2007, at R6 (discussing proposed "Access to Capital for Entrepreneurs Act of 2006," which would have provided a 25% tax credit for angel investing).
150. It could be that angels as a group maintain their dominance over funding early stage start-ups by eschewing the venture capital model, but there is little evidence that venture capitalists wish to move into this space, and good reasons why this is so. See supra notes 47-49 and accompanying text.
151. See supra notes 90-92 and accompanying text.
152. See VAN OSNABRUGGE & ROBINSON, supra note 4, at 172 (explaining that only 38% of angels in the UK seek assistance from lawyers and accountants);
153. Fried & Ganor, supra note 36, at 1009 ("Because angels invest less than VCs and are generally less sophisticated, their financing agreements are much more informal.");
154. Orcutt, supra note 48, at 896 ("Why angels employ weaker screening and monitoring mechanisms is not entirely clear. It could be due to lack of sufficient resources or lack of knowledge on how to conduct such activities.").
155. See supra note 95 and accompanying text.
156. See Jill E. Fisch, Can Internet Offerings Bridge the Small Business Capital Barrier?, 2 J. SMALL & EMERGING BUS. L. 57, 74 (1998) (discussing the fact that the Small Business Association's "ACE-Net" service, a matching service for small business issuers and angel investors, defines angels as accredited investors).
157. Interpretative Release on Regulation D, Exchange Act Release No. 33-6455, 48 Fed. Reg. 10,045, 10,045 (Mar. 10, 1983) ("[Accredited investors are not included in computing the number of purchasers in offerings conducted in reliance on Rules 505 and 506. Also, if accredited investors are the only purchasers in offerings under Rules 505 and 506, Regulation D does not require delivery of specific disclosure."). Of course, it could also be that we do not think wealthy individuals are necessarily more sophisticated for purposes of making investment decisions, but that they are better able to absorb losses from poor decisions.
158. See supra note 59 and accompanying text.
159. See Victor Fleischer, The Rational Exuberance of Structuring Venture Capital Start-ups, 57 TAX L. REV. 137, 140 (2003) (asserting that "this Article calls attention to the value of seeking out rational explanations before accepting irrational ones-especially when analyzing the behavior of sophisticated experts").
160. See Leavitt, supra note 19, at 224 ("Angels generally invest with the expectation that, should the company progress as planned, one or more venture capital ('VC') firms will subsequently invest.").
161. See supra Section III.A. On the other hand, some angels may invest in companies that do not wish to go on to attract venture capital.
162. See Sieverens, supra note 43, at 29 (noting that in the fallout years after the dot.com bust, the Band of Angels investment organization was "more willing to look at companies that are unlikely to go the venture capital route and can make do with less. While those types of opportunities are not likely to be IPO candidates, they can often be attractive acquisitions for larger concerns once their businesses are profitable and established.").
163. See supra note 12 and accompanying text.
164. Wiltbank & Boeker, supra note 77, at 1 (finding that 7% of angel exits provided 75% of all investment returns through a study, albeit of angel groups).
165. See STROSS, supra note 13, at 24 (observing that well-known venture capitalist Benchmark Capital received 1,500 funding proposals in 1997 and funded only nine);
166. VAN OSNABRUGGE & ROBINSON, supra note 4, at 146 (noting that "venture capitalists invest in only about 1-3 percent of proposals received").
167. See STROSS, supra note 13, at 25.
168. See Wong, supra note 53, at 26 (asserting that "more angels leads to a faster time to venture financing. This is evidence that angels can play a networking role; a larger number of angels leads to a larger network of contacts and faster venture capital financing.").
169. MIT Study, supra note 67, at 46 ("Active angels are often requested to leave the Board once professional investors participate in subsequent financing rounds .... They sometimes resent being removed from the Board.").
170. Stanco & Akah, supra note 51, at 3;
171. see also KAREN SOUTHWICK, THE KINGMAKERS: VENTURE CAPITAL AND THE MONEY BEHIND THE NET 224-25 (2001) (discussing the fact that some venture capitalists look down on angels as being amateurs or not on the venture capitalists' level, although most venture capitalists still acknowledge the need for angels).
172. Stanco & Akah, supra note 51, at 11. Quotes from surveyed venture capitalists emphasized the point. For example, one venture capitalist stated that "there is a tendency to think a cram down and conversion [of an angel's preferred stock] to common is 'necessary' for follow-on venture financing."
173. Id. at 12. Another had the following advice for angels: "Deal structuring so that terms don't complicate a VC round that follows. Creating the structure, driving the company to key milestones, etc., to make follow-on VC rounds cleaner and more likely."
174. Id. at 15.
175. Id. at 11 (finding that 78% of venture capitalists registered this complaint).
176. Posting of John Callaghan to PEHUB (on file with the Vanderbilt Law Review).
177. Convertible debt presents an interesting dilemma for venture capitalists. It creates a more complicated angel round, but by deferring valuation until the next round, it allows venture capitalists to eliminate their biggest problem with angels-overvaluation. See MIT Study, supra note 67, at 38 ("Some high tech angels use convertible debt to avoid the battle over valuation with the entrepreneur. These securities allow the venture capitalist or other second round investors to set the value of the company in the next round . . . and provide the angel seed investors a discount to that round.");
178. see also D. GORDON SMITH & CYNTHIA A. WILLIAMS, BUSINESS ORGANIZATIONS: CASES, PROBLEMS, AND CASE STUDIES 160 (2004) (finding that angel investors in Madison, Wisconsin-based NeoClone Biotechnology International, LLC took convertible debt that allowed for conversion to equity on the upside, but offered debt's superior protection on the downside).
179. SUSAN L. PRESTON, ANGEL INVESTMENT GROUPS, NETWORKS, AND FUNDS: A GUIDEBOOK TO DEVELOPING THE RIGHT ANGEL ORGANIZATION FOR YOUR COMMUNITY 57 (2004).
180. Sohl & Areson-Perkins, supra note 83, at 5.
181. See Brian J. Broughman & Jesse M. Fried, Renegotiation of Cash Flow Rights in the Sale of VC-Backed Firms 51 tbl.1 (UC Berkeley Pub. Law Research Paper No. 956243, 2008), available at http://papers.ssrn.com/ sol3/papers.cfm?abstract-id=956243 (documenting that venture capitalists take fewer liquidation preferences in the early stages than the later stages).
182. This may seem odd, that later-stage investors receive greater preferences given that earlier stage investors take more risks. However, "last-in, first-out" is standard practice in venture capital investing.
183. See Bartlett, supra note 19, at 76 ("Later investors typically want to be the first in line to get their original investment (and hopefully their return on investment) out."). Early stage investors are compensated for their extra risk by receiving a larger share of the company for less money.
184. See Gilson & Schizer, supra note 31, at 885.
185. See infra notes 164-66 and accompanying text.
186. Gilson, supra note 17, at 1091.
187. See Prowse, supra note 73, at 789 ("The primary criterion that angels use to screen proposals is whether the entrepreneur is previously known and trusted by them or by an associate who they trust.");
188. Wong, supra note 53, at 28 (asserting that "angels have specialized information and have a high ability to screen for higher quality projects. Many investors have made their fortunes in the same industries that they subsequently invest in."). In some cases passive angels invest outside of their geographic locality or area of expertise, but the active angel in the syndicate will either be local or an industry expert, or both.
189. See Wong, supra note 53, at 4 ("Because the [venture capitalists] are not as familiar with the entrepreneur as the local [angel] investors, more formal control mechanisms need to be implemented to protect their investment.").
190. See Orcutt, supra note 48, at 895 (explaining that referrals from other angels are considered high quality, while referrals from accountants and attorneys are considered of lower quality).
191. Freear et al., supra note 56, at 11 (noting that localization produces efficiencies in the angel market);
192. MIT Study, supra note 67, at 28 (discussing how angels build their "network of trust");
193. Jeffrey E. Sohl & Bruce Sommer, Angel Investing: Changing Strategies During Volatile Times, at 20 (working paper, on file with the Vanderbilt Law Review) (finding that angels use personal networks to overcome information asymmetry with entrepreneurs).
194. See SMITH & WILLIAMS, supra note 119, at 160 n.5 (explaining that entrepreneurs like angels because they tend to perform less due diligence than venture capitalists).
195. See Sohl, supra note 42, at 115 ("Electronic networks have been largely unsuccessful to date, less than 1% of equity capital raised in 1997 was harvested on-line.") (citation omitted).
196. See generally ANNALEE SAXENIAN, REGIONAL ADVANTAGE: CULTURE AND COMPETITION IN SILICON VALLEY AND ROUTE 128 (1994) (describing the intimate Silicon Valley culture).
197. VAN OSNABRUGGE & ROBINSON, supra note 4, at 109 (observing that "venture capitalists for the most part have little entrepreneurial experience" and are instead " 'financial MBA-types' ");
198. cf. SOUTHWICK, supra note 115, at 66-67 (noting that some venture capitalists prefer to hire individuals "who get an MBA and jump almost directly into the financial industry" while others emphasize prior entrepreneurial experience-the latter being currently in vogue due to increasing venture capitalist specialization).
199. Sohl, supra note 42, at 112 (discussing how angels live close to their investments to facilitate interactions and provide value-added services);
200. MIT Study, supra note 67, at 32 ("Most active angels will not invest in opportunities outside a 1-2 hour driving range.").
201. For more on the trust point, see infra Section III.C.2.b.
202. Wong, supra note 53, at 24.
203. Margaret M. Blair & Lynn A. Stout, Trust, Trustworthiness, and the Behavioral Foundations of Corporate Law, 149 U. PA. L. REV. 1735, 1757 (2001): Where trust can be harnessed, it can substantially reduce the inefficiencies associated with both agency and team production relationships. Trust permits transactions to go forward on the basis of a handshake rather than a complex formal contract; it reduces the need to expend resources on constant monitoring of employees and business partners; and it avoids the uncertainty and expense associated with trying to enforce formal and informal agreements in court.
204. Wong suggests that the large residual claim held by entrepreneurs (angels take only about 20% of the company in exchange for their investment) better aligns the interests of angels and entrepreneurs than in venture capital (venture capitalists take 33-40%). Wong, supra note 53, at 22. Even if the difference in percentage ownership is not significant (Wong acknowledges the possibility), the fact that the angel's stock is common like the entrepreneur's, while the venture capitalist's stock is preferred, may lend some support to Wong's suggestion that angel-entrepreneur incentives are better aligned.
205. Transaction cost economics dictates that both ex ante and ex post costs of contracting be considered. Ex ante costs are "the costs of drafting, negotiating, and safeguarding an agreement;" ex post costs are the costs of enforcement and enforcement mechanisms. OLIVER WILLIAMSON, THE ECONOMIC INSTITUTIONS OF CAPITALISM 20-21 (1985). The recognition that ex post processes are not costless was a significant advancement of transaction cost economics over neoclassical economics.
206. On the relationship between costly contracting theory and transaction cost economics see GOMPERS & LERNER, supra note 11, at 31 (equating costly contracting theory with Williamson's arguments on contractual completeness);
207. Alan Schwartz & Joel Watson, The Law and Economics of Costly Contracting, 20 J.L. ECON. & ORG. 1, 3 n.l (2004).
208. See Luca Anderlini & Leonardo Felli, Incomplete Contracts and Complexity Costs, 46 THEORY & DECISION 23, 38 (1999) ("Complexity is not necessarily associated with devising the contract but rather with the writing and enforcement of such a contract.").
209. Benjamin Klein, Why Hold-Ups Occur: The Self-Enforcing Range of Contractual Relationships, 34 ECON. INQUIRY 444, 447 (1996).
210. GOMPERS & LERNER, supra note 11, at 31.
211. Id. at 33.
212. See Schwartz & Watson, supra note 140, at 16 ("Complex contracts - those having a greater number of clauses or requiring a court to evaluate information from many different sources - are assumed to be more expensive to write than are simpler contracts.").
213. See VAN OSNABRUGGE & ROBINSON, supra note 4, at 174 (quoting an angel as saying that the "legals were disproportionate to the size of the investment").
214. There has been at least one attempt to create a model to predict the optimal level of contractual completeness in a given situation. See Ronald A. Dye, Costly Contracting Contingencies, 26 INT'L ECON. REV. 233 (1985).
215. See supra Section III.C 1.a.
216. See Goldfarb et al., supra note 55, at 2 ("Our results suggest that legal control in seed rounds is not cost-effective because these investments are generally small.").
217. I thank Jesse Fried for this observation.
218. See Klein, supra note 142, at 455 (discussing the complimentary relationship of self-enforcement and court-enforcement).
219. See D. Gordon Smith, Venture Capital Contracting in the Information Age, 2 J. SMALL & EMERGING BUS. L. 133, 153-54 (1998) (describing the conventional wisdom).
220. See Bernard S. Black & Ronald J. Gilson, Venture Capital and the Structure of Capital Markets: Banks Versus Stock Markets, 47 J. FIN. ECON. 243, 252-53 (1998) (arguing that reputational constraints imposed by geographic proximity between venture capitalists and entrepreneurs are an adequate check on venture capitalist opportunism);
221. Sahlman, supra note 32, at 513.
222. See Smith, supra note 151, at 160-62 (observing that neither entrepreneurs nor venture capitalists have a vehicle for amalgamating or transmitting information about venture capitalist reputation, such as a stock exchange or required disclosures, and that entrepreneurs may have self-serving reasons not to pass along negative information about venture capitalists).
223. See supra note 109 and accompanying text.
224. Of course, allegations of unscrupulous behavior could haunt the entrepreneur in the future, although there is some question as to whether the typical entrepreneur is a "serial" entrepreneur who would be harmed by such allegations. Venture capitalists are obviously repeat players and therefore must be concerned about their reputations.
225. See generally F. HODGE O'NEAL & ROBERT B. THOMPSON, O'NEAL'S CLOSE CORPORATIONS (3d ed. 1998) (discussing the dynamics of close corporations and recent court decisions affecting them).
226. For a discussion of an angel's potential minority oppression claims against venture capitalists, see generally Leavitt, supra note 19.
227. See, e.g., Wilkes v. Springside Nursing Home, Inc., 353 N.E.2d 657, 658-62 (Mass. 1976).
228. See supra notes 96, 100-04 and accompanying text.
229. See Robert Daines, The Incorporation Choices of IPO Firms, 77 N.Y.U. L. REV. 1559, 1563 tbl.l (2002) (presenting empirical findings on the incorporation choices of IPO firms).
230. Nixon v. Blackwell, 626 A.2d 1366, 1379 (Del. 1993).
231. See STROSS, supra note 13, at 87 (observing that in the mid-1990s venture capitalist Benchmark Partners pledged to contribute 3% of a fund's capital, compared to the industry standard of 1%);
232. Gilson, supra note 17, at 1071 (finding that a venture capitalist puts up only one percent of the capital).
233. Paul Gompers & Josh Lerner, An Analysis of Compensation in the US Venture Capital Partnership, 51 J. FIN. ECON. 3, 3-27 (1999) (conducting an empirical study that found management fees of 2-3% and a large concentration of carry at 20%);
234. see also Victor Fleischer, Two and Twenty: Taxing Partnership Profits in Private Equity Funds, 83 N.Y.U. L. REV. 1, 23-24 (2008) (criticizing the tax treatment of the carry as capital gain instead of ordinary income).
235. But see Litvak, supra note 19, at 3-4 (critiquing the Gompers and Lerner study on staleness and methodological grounds and concluding from an independent study that "the compensation of VCs varies significantly across venture firms").
236. GOMPERS & LERNER, supra note 11, at 19 ("Almost all venture and buyout funds are designed to be 'self-liquidating,' that is, to dissolve after ten or twelve years.").
237. Id. at 4.
238. The need to control the start-up's exit, in particular, is a product of the venture capital cycle. See Smith, supra note 33, at 316 (describing how the exit "allows fund investors to evaluate the quality of their venture capitalists and, if necessary, to reallocate their funds away from venture capital to other investment vehicles or from less successful venture capitalists to more successful venture capitalists").
239. See VAN OSNABRUGGE & ROBINSON, supra note 4, at 99 (observing that the "agency relationship for the venture capitalist firm (with its fund providers) forces the venture capitalist to choose different investment practices from those of the less-restricted (and less-accountable) business angel").
240. See supra note 1.
241. Sohl, supra note 42, at 111 ("Angels typically have longer exit horizons than their venture fund counterparts and thus the capital they provide is termed patient capital.").
242. See VAN OSNABRUGGE & ROBINSON, supra note 4, at 116-17 (contending that financial gain is the primary motivation for angel investment, and citing one angel as disfavoring the term "angel" investor because it implies the precedence of altruism over financial reward).
243. MICHAEL STATHIS, THE STARTUP COMPANY BIBLE FOR ENTREPRENEURS 134 (2004) (emphasis removed).
244. VAN OSNABRUGGE & ROBINSON, supra note 4, at 117-18;
245. MIT Study, supra note 67, at 14 ("Angels enjoy the adrenaline rush of emerging company volatility, but without the 80-hour workweeks and the burden of ultimate responsibility for the company.").
246. VAN OSNABRUGGE & ROBINSON, supra note 4, at 117.
247. Id. at 139 (observing that "angels most often chose one investment over another primarily according to the opportunity to get actively involved in the investee firm"). Of course, syndication means that each start-up will have an active angel and several passive ones; those passive angels may be the active angels in other ventures.
248. MIT Study, supra note 67, at 31 (finding through a survey of experienced angels that geographic proximity to the angel was one of the two most important criteria when considering potential investments).
249. See supra note 135.
250. See John Freear et al., Angels: Personal Investors in the Venture Capital Market, 7 ENTREPRENEURSHIP & REGIONAL DEV. 85, 92 (1995) (noting that nearly 25% of angels work in a full- or part-time capacity in their investment start-ups).
251. Freear et al., supra note 56, at 11 ("The most influential non-financial factor was the satisfaction derived from assisting an entrepreneur build a successful business.");
252. Wetzel, supra note 67, at 31;
253. MIT Study, supra note 67, at 14 (discussing the "empathy" that angels feel for entrepreneurs and the desire to help them avoid mistakes that angels themselves may have made as entrepreneurs).
254. Wetzel, supra note 67, at 31.
255. Feld Thoughts, Is it Angel Investing or For-Profit Philanthropy?, http://www.feld.com/blog/archives/002013.html (Oct. 23, 2006, 18:42 EST).
256. See, e.g., Frank B. Cross, Law and Trust, 93 GEO. L.J. 1457, 1487 (2005) ("Contracts may thus be viewed as the 'antithesis of simple trust.' ");
257. Lawrence E. Mitchell, Trust. Contract. Process., in PROGRESSIVE CORPORATE LAW 185, 186 (Lawrence E. Mitchell ed., 1995) (arguing that "contract begins from a situation of distrust");
258. Larry E. Ribstein, Law v. Trust, 81 B.U. L. REV. 553 (2001) (explaining that law can undermine trust);
259. cf. Deepak Malhotra & J. Keith Murnigham, The Effect of Contracts on Interpersonal Trust, 47 ADMIN. SCI. Q. 534, 556 (2002) (arguing that the relationship between trust and contract "appears to be far from clean and simple").
260. But see T.K. Das & Bing-Sheng Teng, Between Trust and Control: Developing Confidence in Partner Cooperation in Alliances, 23 ACAD. MGMT. REV. 491, 496 (1998) (finding that trust and control can function as parallel phenomena);
261. Carol Rose, Trust in the Mirror of Betrayal, 75 B.U. L. REV. 531, 554 (1995) (observing that law can induce trust by allowing contracting in situations where it otherwise would not occur).
262. Steward Macaulay, Non-Contractual Relations in Business: A Preliminary Study, 28 AM. SOC. REV. 55, 64 (1963). Macaulay was focused on ongoing business relationships. It could be said that angel finance does not present the same situation because angels usually fund one round in a particular start-up and then make room for the venture capitalists. However, angel finance is a multi-period game in the sense that it is localized within small geographic communities where entrepreneurs may know one another, meaning that an angel's reputation transcends any one relationship.
263. Blair & Stout, supra note 138, at 1806.
264. Rathryn E. Spier, Incomplete Contracts and Signaling, 23 RAND J. ECON. 432, 432 (1992).
265. Id. at 433.
266. This is especially true if not requiring such contracts is embedded in angel financing practice, as it appears to be. The classic article on embeddedness is Mark Granovetter, Economic Action and Social Structure: The Problem of Embeddedness, 91 AM. J. SOC. 481 (1985).
267. Oliver E. Williamson, Calculativeness, Trust, and Economic Organization, 36 J.L. & ECON. 453, 453-72 (1993).
268. See generally Victor Fleischer, Brand New Deal: the Branding Effect of Corporate Deal Structures, 104 MICH. L. REV. 1581 (2006) (discussing the use of contracts and deal structure for branding purposes).
269. Blair & Stout, supra note 138, at 1750-51. Williamson, on the other hand, thought such non-calculative notions of trust were best reserved for "very special relations between family, friends, and lovers" and had no place in commercial exchange. Williamson, supra note 187, at 484.
270. See supra notes 7-8 and accompanying text.
271. Angel groups are alternatively referred to as angel investment organizations, angel alliances, or angel syndicates.
272. Band of Angels, www.bandangels.com (last visited Aug. 18, 2008).
273. MIT Study, supra note 67, at 13. According to the Band of Angels website, membership is now above 120. Band of Angels, www.bandangels.com (last visited Aug. 18, 2008).
274. See James Geshwiler, Common Angels: An Evolving Tradition, in STATE OF THE ART 134, supra note 43, at 141 (citing research by Jeffrey Sohl).
275. See ACA Angel Group Confidence Report, supra note 8.
276. I thank Jesse Fried for suggesting the last reason as a possible explanation for the development of angel groups. As he has argued elsewhere, the investment in preferred stock can protect angels against venture capitalist opportunism. See generally Fried & Ganor, supra note 36;
277. Leavitt, supra note 19.
278. Jeffrey Sohl distinguishes angel groups from traditional angels by their "size, visibility, and entrance mechanism." Sohl, supra note 42, at 113.
279. See VAN OSNABRUGGE & ROBINSON, supra note 4, at 44 ("To retain members' anonymity, many of these syndicates . . . establish a storefront (or façade) for the general public").
280. Compare Carol Sands, The Angels' Forum and The Halo Fund: The Rise of the Professional Angel, in STATE OF THE ART 32, supra note 43, at 32 ("It was clear to [Silicon Valley's The Angels' Forum organization] that diversity was the key to successful development, so we set out to assemble a group of dedicated angel investors with different skill sets (operations, engineering, finance, sales, marketing, business development, legal, and human resources)."), with Severiens, supra note 43, at 22 (noting that the Band of Angels "organizing committee made it clear right from the start that membership in our group would be limited to those with high-tech credentials, and thus lawyers, bankers, real estate developers, and so on were not the kind of members we were seeking").
281. For example, all members of Silicon Valley's Tenex Medical Investors have "substantial life science expertise." Norm Sokoloff, Tenex Medical Investors: Niche Investing, in STATE OF THE ART 42, supra note 43, at 44.
282. See, e.g., MIT Study, supra note 67, at 61.
283. See, e.g., VAN OSNABRUGGE & ROBINSON, supra note 4, at 45 (describing the typical practice: "Each member can decide individually whether to participate in a particular deal that the syndicate decides to undertake and how much he or she wants to be involved in each investment they make.");
284. Severiens, supra note 43, at 23 ("Right from the start, it was decided that [Band of Angels] would not pool our funds. Not everyone is interested in the deals some of us invest in, so we leave it to the individual members to invest according to their tastes, interests, and risk profiles.").
285. Severiens, supra note 43, at 23 ("[W]hen [Band of Angels] invest[s] in a single deal, a pool is formed, but we still act as individuals and the stock certificates are made out in our individual names.").
286. See Sands, supra note 199, at 35-39.
287. See supra notes 7-8 and accompanying text (discussing estimates on the aggregate size of the angels market and breakdown between traditional angel investments and angel group investments).
288. See Goff, supra note 77, at 75 ("The Sierra Angels' funding 'sweet spot' is $200,000 to $1,000,000.");
289. see also ACA Angel Group Confidence Report, supra note 8 (noting that the average amount of total funding provided by each U.S. angel group in 2006 was $1.78 million).
290. VAN OSNABRUGGE & ROBINSON, supra note 4, at 43-44 (finding that angel groups allow angels to "make larger and more frequent investments (though these remain smaller than those funded by even small venture capital firms)").
291. Sohl, supra note 46, at 15.
292. See Susan Preston, Seraph Capital Forum: National Trends in a Local Context, in STATE OF THE ART 62, supra note 43, at 68 ("With venture capitalists moving farther up the funding chain, a second funding gap has opened up between $2 million and $5 million-a gap that few individual angels can fill. The potential white knight is the angel organization.").
293. See Severiens, supra note 43, at 20-21.
294. It should be much easier to conduct empirical studies of angel groups than traditional angels because they are far more visible. This Article should also provide a framework for designing these studies, at least to the extent they are concerned with contract design.
295. MIT Study, supra note 67, at 63.
296. Id.
297. Series A Preferred Stock Financing Term Sheet (on file with the Vanderbilt Law Review);
298. XZY Venture Inc. Summary of Deal Terms (on file with the Vanderbilt Law Review). I thank Luis Villalobos for providing these.
299. Severiens, supra note 43, at 23.
300. But see Geshwiler, supra note 194, at 142-43 (finding that Common Angels "recommend a fairly standard, clean term sheet without multiple liquidation preference, too low a valuation, or other 'bells and whistles' ").
301. Robyn C. Davis et al., Angel Healthcare Investors: Capitalizing on Innovation, in STATE OF THE ART 146, supra note 43, at 157;
302. see also STATHIS, supra note 171, at 133 ("[T]he increasing trend is for angels to receive preferred stock, although it lacks many of the stipulations found in the preferred stock issued to venture capitalists.").
303. See, e.g., Severiens, supra note 43, at 22 (reporting that a Band of Angels member who serves as the sponsor of a start-up in front of the entire group will take a seat on the board if an investment is made).
304. Goff, supra note 77, at 76: The Sierra Angels encourages its portfolio companies to choose the most effective candidates for heir boards of directors rather than insist that the network be given a seat. In instances when the group does not have a board seat, our member sponsor frequently acts as an informal advisor, and, as a rule, we expect visiting privileges at board meeting[s].
305. The angel group will be even harder to distinguish from the early stage venture capitalist if the hallmark of angel investing-the investment of personal funds-is relaxed and angel groups also begin to invest other people's money. Indeed, some angel groups are now doing just that by tacking on "sidecar" investments for an angel's friends and family to at least some deals. See Sands, supra note 199, at 39 (finding that the Angels' Forum's "creation of The Halo Fund in 2000 allowed our friends and family members as well as institutional investors to coinvest in the group's best deals"). So in a sense, angels are now also investing other people's money, although the ratio is extremely small compared to the venture capitalists' predominant use of investment funds. Still, the trend is toward a further blurring of the angel/venture capitalist line.
306. Mark C. Suchman, On Advice of Counsel: Law Firms and Venture Capital Funds as Information Intermediaries in the Structuration of Silicon Valley (1994) (unpublished Ph.D. dissertation, Stanford University) (on file with Stanford Sociology Department).
307. See supra notes 122-24 and accompanying text.
308. See Band of Angels, About the Band FAQs, http://www.bandangels. com/faqs/index.php (last visited Aug. 18, 2008) (stating that Band of Angels founder Hans Severiens was a former venture capitalist "who formed friendships with many of the first generation of Silicon Valley entrepreneurs and high technology executives-the founders of Fairchild, National Semiconductor, Genentech, Intel, Compaq, Kleiner Perkins, and Sequoia").
309. See supra note 117 and accompanying text.
310. On the other hand, some venture capitalists lament the nonfinancial "dinner club" aspect of angel groups. See MIT Study, supra note 67, at 63 ("Some venture capitalists do not feel that angel groups support their companies well. They characterized angel clubs as dinner clubs in which members participated in due diligence, but did not sufficiently leverage their expertise and networks in building the company after the investment had been made.").
311. See supra notes 127-34 and accompanying text.
312. See Wilbank & Boeker, supra note 77, at 6 (finding that half of investments by angel group members were unrelated to the angel's industry experience, which correlated to returns on investments that were only half that of investments in the angel's field of expertise).
313. VAN OSNABRUGGE & ROBINSON, supra note 4, at 45 ("In most cases, one member of the syndicate acts as the lead angel, assuming a liaison role between the entrepreneur and the syndicate. In other cases, an outsider with no financial commitment to the group ... is hired to perform this function.") (citation omitted).
314. See supra notes 172-77 and accompanying text.
315. Wiltbank & Boeker, supra note 77, at 7.
316. See supra notes 146-49 and accompanying text.
317. John May, co-founder of a Washington, D.C.-area angel group, suggests that costly contracting theory plays a role in determining whether his angels bargain for a board seat. John May The Dinner Club: Embracing the New Economy, in STATE OF THE ART 120, supra note 43, at 127 ("When a board seat is inappropriate for the size of our investment, we often take on an advisor role.").
318. Preston, supra note 209, at 68-69.
319. Goff, supra note 77, at 72.
320. Jeffrey E. Sohl, Angel Investing: A Market Perspective, in STATE OF THE ART 2, supra note 43, at 12 ("In 2000 and 2001, indications were that 36 and 41 percent, respectively, of angel organization members did not make an investment. This compares with 32 percent of investors in 1998.") (citation omitted).
321. See William H. Payne, Tech Coast Angels: An Alliance of Angel Networks, in STATE OF THE ART 54, supra note 43, at 58 (explaining that Tech Coast Angels' members are required to invest at least $50,000 each year);
322. Sokoloff, supra note 200, at 46 (discussing the fact that members of Tenex Medical Investors "were expected to invest at least $75,000 yearly (this has been relaxed in the current economy)"). In addition, social networking can pay off financially in other ways for some angel groups, who have been known to start businesses together outside of the group.
323. See Davis et al., supra note 216, at 161: Not only have many of the members developed friendships but also several have created new businesses together outside of [Angel Healthcare Investors]. Two of the original members joined with two later members to launch a specialty pharmaceuticals company that has the potential to reshape the value chain of drugs coming off patent. One founding member joined with a newer member to create a fund of hedge funds investing in non-health-care companies and offered the fund to members and other high-networth individuals.
324. See Davis et al., supra note 216, at 161 (finding that of Boston's Angel Healthcare Investors, "[s]everal shared philanthropic interests have emerged since the group was founded .... A recent example is the endowment of a charity at a well-known local university to acknowledge the contributions to the school and to health care nationwide by a member of AHI.");
325. Barry Moltz, Prairie Angels: Redefining Midwest Investing, in STATE OF THE ART 108, supra note 43, at 115 (reporting that Prairie Angels in Chicago has "donated money to a nonprofit organization in town that trains inner-city youth to become familiar with Web sites and expand their technical expertise").
326. Seraph Capital Forum, http://www.seraphcapital.com/ (last visited Aug. 18, 2008).
327. See supra Section III.C.2.b.