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Kremer: Angel investing rises despite economic downturn

By Brian E. Clark
For WisBusiness.com

The recession has been cruel to start-ups – just as it has forced big companies to their knees – but it also has presented big opportunities for investors who are looking for good deals.

That’s the word from Joe Kremer, who heads the Wisconsin Angel Network, a group of well-heeled investors that backs companies that are just getting off the ground. He defines so-called “angels” as wealthy early-stage venture capitalists, many of whom have started and run companies themselves and have a strong tolerance for risk.

“Angels are patient and also offer mentorship,” he said. “When times get tough, they stand behind their entrepreneurs. But at the end of the day, they want to make money and they are looking for large-growth opportunities for anything they invest in.”

Though investment in nascent firms fell by 25 percent nationally in 2008 -- and remains down significantly this year -- Kremer said Wisconsin angel networks and funds increased the number of companies they backed from 42 in 2007 to 53 in 2008 for a total investment of $15 million, up from $11 million the prior year.

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Joe Kremer will discuss trends in early stage investing Aug. 13 in Milwaukee. The meeting is for entrepreneurs and potential backers of start-ups.

The gathering will be held at Brookfield Suites Hotel and Convention Center, 1200 S. Moorland Road, just off I-94 in Brookfield. Registration and networking begins at 11:30 a.m., lunch at noon and the presentation at 12:30 p.m. The cost is $10 for students, $25 for Wisconsin Innovation Network members, $35 for non-members and included with WIN corporate memberships. Click here to register online.
He said the reason they increased their investing was two-fold. The first was that they were helping out companies already in their portfolios, many of which were having problems with lines of credit and needed infusions of cash.

The second driver, according to Kremer: "During an economic downturn, valuations come down. It’s a bargain paradise for investors who have cash.”

Kremer said many company valuations decreased significantly, some up to 60 percent. That means a start-up that was valued at $3 million in mid-summer of 2008 might have been worth as little as $1.5 million or less when the stock market tanked last fall.

“It’s the same company, but in a troubled economy it had a steeply discounted price,” he said. “That helped drive a number of the investments.”

Nor did it hurt, he said, that many investors here in Wisconsin are eligible to receive a 25 percent tax credit for money they put into qualified new ventures.

No figures are available for how Badger State angel groups have invested this year, but the overall venture capital market in Wisconsin plummeted during the first six months of 2009.

According to a report from the National Venture Capital Association, Wisconsin companies raised $6.5 million of venture capital funding through June, a drop of more than 80 percent from a year earlier, and the state's slowest start since 2005.

Kremer cautioned that angel investors make up only a small fraction of the VC market.

“Typically, angels make up 8 percent to 10 percent of the market,” he said. “But last year, that figure grew to 15 percent.”

Kremer said the alternative for angels who did not support companies they had previously backed might well have been seeing those start-ups fail.

“We have plenty of examples like that last fall with the tightening of the credit markets,” he said. “Companies lost lines of credit that they had had for years, so angels stepped in some cases where venture capital firms walked away.”

On the flip side, he said some angel investors closed portfolio companies that they deemed poor investments.

“Ultimately, they are venture capitalists. So they don’t always do what might be in the best interest of the entrepreneur who is running a company that isn’t working. They do look after their own investment interests.”

Though eight of 10 companies in which angels and VC firms back usually fail, Kremer said investors are always looking for that proverbial “home run.”

He said the best example of that is a man who put $100,000 into a start-up called Yahoo (you may have heard of it) and saw a return with a multiplier of 50,000 that earned him a whopping $50 million.

“That’s a massive example and that’s certainly atypical,” he said. “But entrepreneurs who are raising money would all like to shoot for that. They hope that they will be among the 20 percent who make it and give backers a good return.”

Kremer said investors usually talk about returns in the size of “10X,” which means a $100,000 investment will be worth $1 million after about five to seven years.

He said 2009 is continuing to show lower than typical numbers in the investment world, with some parts of the capital market actually “imploding.”

Though there are deals to be had by investing in strong start-ups, he said the venture capital world is going through a shake-out.

He said the VC market has shrunk by 50 percent from where it was five years ago and will shrink by another 50 percent again.

“If you go back to the heyday of VC investing in about 2000 and 2001, there were around 2,000 firms out there. We are now down to 1,000 and no one knows quite how far it will fall because that market is seeing some major upheaval.”

The down economy is one major reason for VC firms reversal of fortune, but Kremer said the number of firms grew too large for the total investment possibilities that were out there.

“There are two sides to the coin,” said Kremer. “Every time there is a downturn there is a scary part, but there are also massive opportunities that are created.”

At a recent angel summit, Kremer said many participants said that although a huge amount of wealth has been lost on the stock market and investments have decreased significantly, there is a potential for big gains, too.

“Most angels are ‘exited entrepreneurs,’” he said.

The profile of angels in the U.S. is people who has been investing for about a decade, has around 10 start-ups they are backing. They’ve also been entrepreneurs for about 15 years.

That means they have lived through both economic downturns and rebounds and know the ropes, he said.

Kremer will discuss trends in early stage investing Aug. 13 in Milwaukee. The meeting is for entrepreneurs and potential backers of start-ups. See details in the gray box at right.


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