Angel investors are typically high net worth individuals (worth above R5m) who invest their own money in start-ups as part of a balanced investment portfolio.

Entrepreneurship is a key ingredient in economic growth, and funding is a key ingredient in entrepreneurship, but unfortunately there’s a funding gap for early stage start-ups in SA.

Business angels could be the solution.

These are the investors who allocate capital to start-ups, no doubt hoping the young businesses could be SA’s next Thawte, the Internet security company which Mark Shuttleworth sold to US company Verisign for US$575m.

Angel investors are typically high net worth individuals (worth above R5m) who invest their own money in start-ups as part of a balanced investment portfolio. This makes them different from venture capitalists, who typically manage larger sums of other people’s money in return for larger ownership in the business, and usually expect the business to already be “proven” and scalable.

The main motivation behind being an angel is financial return. These investments are highly risky, but the returns are compelling.

In the US, the average internal rate of return on investment from angel funding is 29%, assuming diversification and time frames of 5-7 years.

But don’t be fooled, averages are always misleading. “A lot of deals go badly, but a few go very well,” says Craig Mullett, president of Connecticut-based corporate finance firm Branison Group LLC. This means that angel investors need a resilient mind frame. “The businesses that flop will flare out in a year or two; successful business will take time,” he says.

Angel investing also provides a kind of psychological fulfilment. A typical angel doesn’t just write a cheque but is actively involved in building the business, providing mentorship and sharing expertise. In fact, according to the SA Venture Capital & Private Equity Association (Savca ), 35% of SA’s angels have been entrepreneurs themselves.

Unfortunately there are barriers to this kind of deal-making. The system in SA is ad hoc and inefficient, and angel deals are most likely to come from existing contacts, says Mullett.

Over the past 10 years, the total value of (known) local deals was about R100m, according to a 2010 survey by Savca and Venture Solutions.

“Because the number of people who will invest in a particular deal is quite low [because of the risk involved], you need to have a structured system,” Mullett says.

This month saw the launch of SA’s first formal angel group, AngelHub, cofounded by early-stage business development firm MyTrueSpark, venture capital firm PoweredbyVC, and Mullett. MyTrueSpark cofounder Brett Commaille (the former CEO of Remgro’s investment arm, VenFin) and PoweredbyVC executive director Keet van Zyl will be the leaders, while Mullett will play an advisory role. PoweredbyVC is responsible for managing the SA investment portfolio of Shuttleworth’s venture capital fund, HBD.

Individual investors who want to participate in activities and are able to invest R300000 or more, and institutional investors able to invest R1m or more a year, are eligible to join the group.

Such groups are common in the developed world. The first “Band of Angels” formed in the entrepreneurial hub of Silicon Valley in the US in 1994. Today the US has more than 300 groups, and Europe more than 350.

Van Zyl says angel groups will help overcome some of the barriers to start-up funding. The first is the risk perceived by investors. “You need investable capital and you need to combine money with expertise and networks.” And, of course, managing this process takes time.

Other barriers include a lack of awareness and education about angel investing, and the angel’s desire for privacy (most angels don’t scream they’re angels from the rooftops — they’d be flooded with unscreened funding requests).

Angel groups also bring economies of scale to both the entrepreneur and the angel. According to Mullett, benefits for the angel include seeing more deals with less effort, pooling expertise to screen deals, and post-investment support to enhance returns. The entrepreneur can reach more investors with one pitch, grow contacts, and get more access to advice and support as well as possible follow-on funding. “We will combine our experience in early-stage deal structuring with expertise from angels,” says Van Zyl. “It’s smart funding; you have to put your finger on the pulse and manage the investment cycle all the way to exit.”

This gives investors a chance to be involved with early-stage deals that could grow into something big.