Most of two quarters have passed since last Septembers catastrophic collapse of world financial markets. This recession may be flat-bottomed and long. What does this mean for angels and angel groups (and the companies they invest in)?

It seems clear that less total money will be invested in pre-revenue and early stage companies. This means there will be more demand from companies needing cash. New companies will have to progress further without outside investment, and a new category of orphan companiesthose that have lost venture capital or angel backingmay appear. That said, not all of the news is bad.

Angels plan to stay in the game

Although the economy is having an impact on the size and frequency of angel groups investments, nearly half the angel group leaders who responded to an Angel Capital Association (ACA) survey conducted in November, 2008 said that their levels of investment will increase or stay about the same in 2009. Another third of the respondents anticipated that investment will decline.

The supermarket, electric razor, television, Laundromat, helicopter, SPAM, and the first night baseball game were all innovations of the 1930s, says John Huston, founder of Ohio TechAngels in Columbus, OH. Economic crises spur creativity. Angels believe this and so are actively seeking deal flow. I have not heard a single angel group complain that they have wonderful deals they cannot fund because their members dont have the capital.

The definition of a wonderful deal, however, has changed, and, even though todays valuations are likely to be lower (often to entrepreneurs dismay), finding the right deal in a recession will take more time and diligence.

We are looking for entrepreneurs whose products will sell better in a down economy and that dont need more capital than angel groups can provide, Huston says. Ideas that are highly capital efficient and can get to cash flow breakeven without venture capital money will get priority attention. While angel investing is the on-ramp to the venture capital superhighway, we arent counting on that highway as much as we used to.

In Ohio, Huston says angels are not seeing a decrease in deal flow. If anything, deal flow might be up as people are coming out of the corporate environment and deciding they want to be more in control of their own destiny, he says. The issue is that a lot of people have great ideas, but they are stuck in yesterday. The worlds greatest bowling ball might be a very fine new invention, but in a recession, few are interested in funding a bowling ball startup.

Knox Massey, executive director of Atlanta Technology Angels in Atlanta, GA, saw deal flow in his area increase dramatically in the fourth quarter of last year and at beginning of 2009, but says it seems to be flattening out.

There is a lot of wait and see from many companies, Massey says. Angel groups that are seeing this may want to encourage entrepreneurs to get out into the market and submit business plans to as many qualified angel groups as possible. Our group and many others Ive talked with across the country are looking for promising deals. We are feeling more cautious and our personal portfolios have taken a hit, but as angel group members and investors, we want to hear from entrepreneurs.

Syndication helps portfolio companies stay alive

When it comes to capital, seed and early stage companies are being squeezed from all sides. Startup companies that do have revenue from sales are likely to see their sales decline. With the tightened credit situation, even companies that have had ongoing relationships and excellent credit standing with banks or lending institutions are seeing their lines of credit cancelled and cant secure new debt.

Entrepreneurs who might have been solid candidates for venture funding six or eight months ago are finding that VC money isnt an option today. Even companies that may have already received VC funding or thought they had such funding lined up are finding out that additional institutional capital is not available.

The regional and national syndication processes angel groups across North America have put in place over the last two to three years can help fill this capital gap. In the ACA survey, 47 percent of respondents planned to increase their co-investment activities with other angel groups. Groups are increasingly in discussions about syndicating deals to help existing portfolio companies accomplish the milestones to reach cash flow positive and also to invest in new deals.

Additionally, about one-fourth of the ACA survey respondents plan to start up new funds. We are raising a $4 million angel sidecar fund, says Susannah Malarkey of the Alliance of Angels in Seattle, WA. Our group did 15 new deals in 2007 and 18 in 2008, and we anticipate that the fund will invest along side the AoA in subsequent rounds on some of those deals as well as in new opportunities. When you look at all the really good companies that got started in downturns, those are the ones that had great exits when things turned around.

Angels mentor capital is more valuable than ever

Angels are an engaged asset class, and realistic straight-talk can be invaluable in helping entrepreneurs survive these rocky times. Many angels worked through the recessions of 1981-82 and 1987, and some endured 1973 through 1975. They know that it is one thing to understand cash flow management intellectually and another thing entirely to be forced to live it.

Angels have a principal-to-principal relationship like no other asset class, says John May, managing partner of the New Vantage Group in Vienna, VA. We must use our experience and wisdom to help entrepreneurs. We have to help them question every assumption and re-examine every aspect of their businesses, planning for the worst this recession could be.

Cash is king, but there may be ways for companies to grow through partnering, mergers, or exits that might have been dismissed or overlooked before. There is nothing normal about these times; we shouldnt assume a normal approach to anything, says May.
One traditional assumption has been that government wouldnt be much involved in stimulating early stage businesses, but that might be changing with federal or state tax credits or stimulus initiatives. Angels can help shine the light on local, state, and, federal grants as well as other opportunities.

Another positive thing is the availability of good people. While the financing risk is going through the roof, Huston says, the staffing risk is diminishing. Those fortunate entrepreneurs who have enough cash to make it through the next several quarters without needing to raise capital will be able to cherry pick the best and the brightest to put together a remarkable team. That team will be battle-hardened and exceedingly valuable in a few years when we come out the other end of this.

Angel groups stay connected and visible

This recession is bad and is likely to be flat-bottomed and quarters long, says May. Just as we are assessing our portfolio companies realistically, angel groups need to examine our own operations.

Whether a group relies on dues, sponsorships, or support from economic development organizations or other institutions, May suggests reconfirming all relationships. We also need to be willing to re-think how we are doing our day-to-day operations, he says.
For example, do regional angel meetings and networking events with other angels and groups become more of a priority as angel syndication becomes more important the longer the recession lasts? If deal flow does slow down, does it make sense to use meeting time to add more education and training, such as the ACEFs Power of Angel Investing seminars or workshops?

One of the best things about the angel group movement is the willingness to share information and ideas with other angels, Huston says, and in this period of great uncertainty, being part of a group is more beneficial than ever.