A Literature Review and Industry Analysis of Informal Investment in Canada: A Research Agenda on Angels

4. Research Agenda

In the academic literature, the largest bodies of work to date have been accomplished in: the United Kingdom by Mason, Harrison, van Osnabrugge, Stevenson and Coveney; and in the U.S. by Wetzel, Fiet, Gaston, Busenitz, Barney and MacMillan. Notable significant efforts have been made in Canada, Sweden and Finland, however, the research efforts in these areas have not matched the volume of academic productivity published in referred journals from the areas previously noted. To use only Canadian information in a report such as this is to provide a lens too narrowly prescribed to be able to see the field clearly. Though some work beyond Canada has been incorporated, it only touches the surface^{Footnote 20}. The short time frame, and terms of the study do not permit such a detailed discussion.

The focus of the literature world-wide began in the early 1980s with the identification of personal demographics and investment characteristics; the age, background, professional experience, wealth and income characteristics of angels were primarily important. As well, interest revolved about the types of firms they selected, their criteria for investing, the size of their investments and how much capital they had yet to invest. In the late '80s, it was apparent these individuals existed and their importance confirmed, therefore, the focus shifted to investigating angels' motivations and attitudes about their investment priorities. Examples of these types of studies included attempts to outline their risk and return profiles and their criteria for investing.

More recently, the focus has gravitated to more theoretically-based examinations of behaviour, attitudes and motivations in an attempt to identify some basic understanding on which to explain observed behaviours. The last five to ten years have been characterised by forays into agency theory (the nature and difficulties of 'agent acting on behalf of principals'); financial theory (the inefficiency of the angels' financial marketplace); procedural justice theory (decision processes designed and engaged in by the participants are perceived more fairly); game theory (the various outcomes which result from multiperiod games when played with several variables); sociology; psychology and economic theory. The most recent research is focussing on motivations and cognitive processes.

The entrepreneurship literature is serving as an important springboard for research about informal investors. There are good reasons for using entrepreneurial research as a template for angel research. Firstly, many angels have been, or are, entrepreneurs. Understanding them as entrepreneurs may lead to important insights regarding their motivations and actions. Secondly, the environments in which entrepreneurs and angels act are similar in terms of uncertainty, risk, and financial obligation, therefore potentially heralding similar processes.

The benefit to the emergence of theoretical frameworks for angels is that they will generally apply to all angels, and not just those of a particular area. The problem with research that is demographically and characteristically laden is that it is heavily case dependent meaning that somewhat different findings will be achieved from one area to another and findings are not generaliseable from one group of angels to another. This has already been well documented by a variety of studies. Theoretically based work generally means our findings will apply to all angels. As in the entrepreneurship literature, integrating various perspectives and disciplines and applying analytic, empirical and experimental tools will help develop explanatory and predictive theory (Amit 1993). Thus, the results of theoretically rigorous work in Canada will have applications to all policy makers and researchers.

4.1.1 Recommendations

Based on the number of funded reports, there is support for knowledge acquisition regarding angels in Canada. That research, however, must now move beyond the descriptive qualities of Canadian and regional informal investors to more theory-based understanding such as the rest of the literature beyond Canadian borders. Research into angels motivations, cognitive processes and behaviours will transcend borders and be of value to all those who appreciate the significant risks assumed by this group. Researchers contracted to conduct angel research should be encouraged to further pursue their findings in publications so academics world wide may be exposed to Canadian knowledge.

Increase support for deal generation research. Deal generation represents the least understood aspects of the informal investment process. We may observe angels peripherally, appreciate their importance, or recognise their importance to entrepreneurs, but we know little about how angels' perspectives affect how they find deals and where they look for them. Well recognised researchers have indicated that the best deals may be gone before ever get to the business introduction network stage. Some business introduction sites have had very mixed results; the results of the CCIP project are awaited. Yet in this midst, there are exceptional angels picking and funding exceptional projects. We need to find out what they do.

There are considerable questions regarding the nature of the deal generation process and the activities angels employ to find entrepreneurs. Because we have focussed on the passivity of business introduction services and informants, there is no real understanding of the activities and thought processes that occupy successful and unsuccessful angels. The deal search entails finding proposals, identifying good opportunities, spotting the potential growth industries and characterising correctly the managing entrepreneurs. The spectacular successes of some corporate angels, such as Matthews of Newbridge Networks, suggest that cognitive processes precipitate activities which generate repeatable successes beyond great odds. A greater understanding about the specific activities in which angels engage to identify suitable proposals promotes the dissemination of more practical prescriptions for entrepreneurs.

Objective evaluation of the CCIP program against independently established objectives, such as results obtained elsewhere, will enhance impartial evaluation of the program's results.

Develop and support research in search of exit process discovery. Exits are critical to the angel investment process as the system is currently entrepreneur-focussed. They need more support at a policy level and greater understanding at an individual research level. We are still very far away from having a well rounded understanding of how angels pursue exits, if they do, the primary method of exit, and the details of the relationships between the entrepreneur and the angel five to seven years hence. Better exit opportunities, better exit returns and better exit relationships will undoubtedly improve repeat angel activity. Though yet untested, habitual informal investors may be a product of successful exits. Successful exits and possible subsequent habitual activity may promote further depth of insight into the angel process. Empirical observations about exits may result in observations about high and low ability entrepreneurs and the nature of the search process by which the angel discovered them.

Encourage understanding of the heterogeneity of angels by differentiating between novice and habitual informal investors. Novice angels invest once and may or may not invest again. Habitual informal investors have decided to re-invest. Novices make considerable contributions collectively and generally spend a greater range of funds. Habitual angels are recognised as being very important since their individual contributions over a period of time can be substantial. The highly successful corporate entrepreneurs are often associated with this category. It is likely that the motivations, attitudes and cognitive processes are very different between those who invest once and those who go on to invest, but distinguishing characteristics are not yet recognised. Pursuing understanding of these differences may uncover meaningful insights for future action and policy development.

Research to focus on the tax implications of selling shares profitably. Some informal investors are very successful, however, when populations are surveyed representatively there are strong indicators that large numbers of investments are lost in whole or in part^{Footnote 21}. With that as the background, the returns and manner of exit for successful investments takes on greater importance. Informal investors pay more tax on their returns than other countries where informal investment is common. If we are interested in encouraging this type of risk capital – which has precious few substitutes – the informal investors may be encouraged by better tax treatment on the exit side. In conjunction with the previous recommendation, there is little theoretical or empirical evidence about actual returns, successful methodologies, best practices, tax treatments, or losses.

Explore informal investment within the context of other disciplines which have acquired more scholarly attention such as entrepreneurship. More meaningful than any other characteristic, is the former entrepreneurial role played by a significant number of angels. Undoubtedly, this characteristic is central to understanding angels and its determination should occupy a large part of the thinking when designing future angel research. It also appears to be the essential ingredient in many of the corporate angels when their role is one of the successful entrepreneur spending the fruits of their labour. The development of cultural, cognitive and behavioural links between entrepreneurs and informal investors have yet to be fully explored, yet have the potential to explain actions and motivations more than the descriptive activities to date. Other disciplines which are currently being explored are finance, economics, and psychology, for example.

Encourage research depth and breadth to allow bases for comparison within the same research design and sampling methodology: Research efforts do not need to be so narrowly defined that we specify and isolate small groups for study. When research efforts narrowly isolate small groups for study, comparison between studies is difficult because research designs and sampling methodologies differ. Therefore, the results become meaningful only with respect to the specific group of people who were studied. The benefits that arise from highlighting the differences amongst populations are largely methodological in execution, but provide rich comparisons in understanding. Such comparisons may include: the diversity amongst habitual investors and novice investors; the differences between family investments and arm's length investors; cognitive comparisons between investors who have been entrepreneurs and those who have not; and so on. Breadth and depth of knowledge comes to the field by precisely not narrowly defining the group.

The issue of family investments needs to be revisited: In the informal venture capital classification, family and friends are often tossed aside as being less than arms' length and, therefore, not worthy of discussion by those interested in informal venture capital. Preliminary indications are, however, that habitual angels are making most of these investments^{Footnote 18}. Habitual angels are expected to have more experience and understanding of the informal venture capital process, so it is interesting that they are making informal investments to family. Furthermore, isolating this group does not fairly represent the significant contributions made by informal investors who know the entrepreneurs' characters and backgrounds very well by virtue of family relation. Knowledge about the entrepreneurs' backgrounds and credibility is shaping up to become an area worthy of significant study since exploratory indicators show that better returns are achieved in ventures where previous knowledge of the entrepreneur exists. Furthermore, the reintroduction of family, friends and neighbours into our sample selection process produces a potentially rich source of diversity for comparison purposes, not only about the investment habits and motivations of all individuals who invest in well known acquaintances, but of the details of the relationships amongst the investors and investees.

Encourage development of representative sampling methodologies: When research is commissioned, funds need to be devoted to sampling methodologies which permit more inference since Canada's large geographic expanse does not allow us to easily draw conclusions from one pocket to another. At one time, difficulties locating angels for study was largely an issue of their invisibility. While their population is still hard to define, methodological advances such as random sampling from incorporation records have improved the representativeness necessary for most statistical inference. These methods are more expensive than convenience sampling techniques that do not permit inference to the wider population of angels. Furthermore, convenience samples require researchers and readers to make 'judgements' about the information since the method of collection does not permit statistical inference to the angel population in general.

Action research is another methodology to pursue. Action research occurs at the interface between the academy and the economy. It is similar to the case study method, but is more proactive and involves testing proposed remedies. At a local level, action research studies the problems and identifies remedies based on innovation and an understanding of the literature. The proposed remedies are tested on a small scale while researching the problem, the remedy and the results.

Expand the policy focus to investor-focussed, not just entrepreneur-focussed: In practice, the entrepreneur/informal investor relationship is very entrepreneur-focussed. Current interest emphasises the entrepreneurs' search for capital, the entrepreneurs' difficulty in finding angels, the entrepreneurs' need for assistance in developing business plans, and developing means of identifying and meeting angels. The CCIP program is essentially a means of finding angels for entrepreneurs' not visa versa. If interest in informal investors becomes investor-focussed, thinking will begin to emerge which focuses on the needs of investors. Currently, scant attention is paid to the high failure rates of possible investments, poor potential returns, poor actual returns, or exit opportunities. If entrepreneur/angel relationships are to be profitable and sustainable, there must be a focus by policy makers and researchers on the needs and requirements of angels, not just entrepreneurs. Failure to recognise angels' needs in the entrepreneur/angel relationship fails everyone.

Proprietary actions by those who are charged with promoting angels hinder research, development of better understanding, dissemination of opportunities as well as angels' prospects for finding better investments. Chambers and Boards of Trade should be encouraged to share their knowledge, understanding and wealth of understanding about angels.

Increase the volume of commissioned work: Aside from the anecdotes about specific angels, and two reports since 1995, all of the information being reported in the media is old. The industry needs new insights. Three key sources of information formed the bases for this report: academic research and reports within Canada, academic research from researchers beyond Canada, and journalistic articles and media stories. Much of the information is derived from press reports and journalistic accounts from the media. Though necessary and interesting, this type of information is anecdotal and not subject to the rigours of research efforts which would representatively and objectively evaluate observations and results.

To date, research in Canada has shown that a significant amount of investment activity is taking place. Riding and associates at Carleton University (Short, Blatt, Haines, DalCin, Duxbury, Safrata), Suret, Arnoux and Dorval at Laval, and the more recent works by Farrell at Saint Mary's University, and Lionaise and Johnstone in Cape Breton, are the academics interested in informal investment research in Canada. Amit produces substantive theoretical understanding about entrepreneurs and venture capital. Now that there is an appreciation for the magnitude and nature of the angel phenomena, it is reasonable to pursue why. Its importance suggests more research effort be devoted to angel motivations, syndication activities, and habitual behaviours.

^{Footnote 18} Farrell, 2000 (forthcoming). Babson Kaufmann Entrepreneurship Research Conference, Boston, MA.