Angels, entrepreneurs, and diversification: PART 1

Entrepreneurs in economics

The entrepreneur plays a crucial role in a healthy economy. That is true in terms of secular growth and especially at turning points. A few months ago, MSNBC ran an amusing story entitled something like ‘The Accidental Entrepreneur.’ It was amusing because it was written as if it was a new thing for people to become self-employed or start a business when unemployment is high.

My reaction to the article was that this would be a slow recovery because there were too few accidental entrepreneurs. At the macroeconomic level, the difference in the rate of recovery in employment as measured by the employer survey verses as measured by the household survey is the best way I know to gain some insight into the phenomenon. It’s a crude measure, but in seems to work. A few months ago the relation seemed anemic; now it seems erratic

The Huffpost Social News recently ran a piece entitled “Proposed 'Protections' for Angel Investors are Unnecessary and Will Hurt America's Job Creators” (see http://www.huffingtonpost.com/robert-e-litan/proposed-protections-for_b_511284.html ). It was written by Robert E. Litan of the Kauffman Foundation ( www.kauffman.org ). The Kauffman foundation is a respected advocate for entrepreneurs.

The point of the piece is quite simple. Anything that discourages the flow of capital to entrepreneurs is counter-productive from the perspectve of job creation. Constraining their access to angel investors does just that.

There are a few points worth adding. First, equity capital is particularly hard for entrepreneurs to access. Thus, angel investors are particularly valuable. The alternatives for many entreprenuers are family, friends, and personal resources. Often this involves draining retirement accounts or literally “betting the ranch” with a big mortgage. The result is increased concentration risk as well as increased leverage risk for the entrepreneur.

Second, equity capital and borrowed capital, like bank loans or SBA-backed funds, have differential economic implications. They are targeted at different risk profiles. Most new businesses don’t succeed. An early stage equity investor doesn’t have to be as conservative as a banker. The equity investor is incorporating a different risk level into a portfolio. Therefore, some looses are consistent with the risk level of equity investors. Thus, they can take positions no bank would. Angel investors are a source of capital for businesses that incorporate risks such as large, early stage R&D expenses Those businesses require someone willing to risk capital in order to exist. High risk ventures will be hurt by the phenomena Litan highlights.

Finally, access to angel investors and early stage equity capital has different impacts on different industries. Although less focused on entrepreneurs, JOB CREATION AND DESTRUCTION by Steven J. Davis, John C. Haltiwanger, and Scott Schub is worth the read. Although dated, the book is under-read. It is worth the time if for no other reason than that the authors look at the issue of churn in employment using employer data.

Unfortunately, it only focuses on manufacturing. That isn’t deadly from the perspective of this last point. The book shows that even within manufacturing the impact of new businesses is different across industries. One would suspect the difference is even greater between manufacturing and other industries. It would seem logical that more capital-intensive industries would have greater barriers to entry if any source of capital is discouraged. It would be an unfortunate unintended consequence of protecting angel investors if it has a particularly negative impact on manufacturing.