Business Angels: The Smartest Money for Starters? Plea for a Renewed Policy Focus on Business Angels

By Aernoudt, Rudy | International Journal of Business, Summer 2005 | Go to article overview
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Business Angels: The Smartest Money for Starters? Plea for a Renewed Policy Focus on Business Angels

Aernoudt, Rudy, International Journal of Business


This paper develops different ways to stimulate business angel investment. Coping with the second equity gap can mainly happen by stimulating syndication and by setting up co-investment schemes. Investor readiness, corporate orientation, business angel networks, business angel academies and the integrated finance concept can be considered as key concepts in coping with the information asymmetry problem. Stimulating simultaneously these different aspects might be the best way to provide starters and young enterprises with smart money. Given the untapped potential of business angels, government initiatives in the field might realize a high value for public money.

JEL: G24, G38

Keywords: Business angels; Information asymmetry; Investment-readiness; Pecking order; Small firm equity gap; Smart money


Informal venture capital-equity investments made by private individuals using their own money, directly in unquoted companies in which they have no family connections, play a key role in the financing of emergent businesses (Mason and Harrison (1999a)). They are not looking to invest money, but to invest money and time. This input allows advice and guidance to be given to young entrepreneurs both on the technical and on the managerial aspects of running a business (Aernoudt (1999b)). Business angel money is hence smart money and crucial to the creation and development of new enterprises. Moreover, as formal venture capitalists are moving towards larger deals and shifting their investments to a later stage of development, creating a "second" equity gap, those so-called business angels become more important in the financing of seed, early stage and second round phases. Hence any policy to stimulate entrepreneurship and growth should consider business angel financing as a priority. Government policy to stimulate growth, innovation and especially the creation of new enterprises is rather focused on access to finance mainly through increasing the supply of capital. However, policies should be focused both on the supply side and the demand side and combined with a cultural change. Government should look at innovative ways to stimulate business angel financing rather than coping with market failures by bureaucratic subsidy schemes.


The traditional pecking order theory suggests that the financing source of choice is earnings retention, followed by external debt. External equity is the last resort. This traditional approach can however be confronted by the excessive demand for external equity, especially for start-ups. This demand can be explained by the absence of interest costs on the one hand, and fixed payback obligations on the other. Indeed, even if, as is shown by a number of surveys, desired return on seed and early stage investments are excessive, varying from 25 to around 80%, one should bear in mind that these rates depend on expected revenues and do not constitute actual interest payments.

The business angel's stake in the company will depend on the perceived worth of the company and the amount of capital that s/he wants to disburse. The owners' preference for business angel financing is hence comprehensible: no fixed financial expenses have to be foreseen in the business plan; a smart partnership between the business angel and the entrepreneur might lead to higher future net value of the company as both parties are involved and committed; and the business angel financing might open doors to second round venture capital or to classical debt financing. Therefore, and despite the non-existence of empirical evidence linked to business angel financing in the matter, we might assume that the traditional finance pecking order seems to be reversed for start-ups, especially for high-tech start-ups. Business angel financing can in this sense no longer be considered as last resort as the literature tends to suggest (Aernoudt and Erikson (2002); European Commission (2002)).

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Business Angels: The Smartest Money for Starters? Plea for a Renewed Policy Focus on Business Angels


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