Angel Investing in an Emerging Asian Economy by Bill Scheela and Ed Isidro

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THE JOURNAL OF PRIVATE EQUITY 1FALL 2009

What role do business angel investors play in funding small and medium-sized enterpr ises (SMEs) in

Asia’s emerging economies? While this is an important question, it is one that has not been researched, especially in comparison to busi-ness angel research in the United States and also in Europe (Gompers and Lerner [2001] and Harrison and Mason [1992]). In fact, we could only find four published studies that focused on Asian business angels (Hindle and Lee [2002], Katsuna and Harada [2004], Tashiro [1999], and Wong and Ho [2007]) and all four focused on developed economies ( Japan and Singapore), not emerging Asian economies.

Business angels are high-net-worth indi-viduals, typically with considerable business experience, who invest both their personal funds and managerial experiences into early-stage ventures (Freear, Sohl, and Wetzel [1995], Freear, Sohl, and Wetzel [2002], Morrissette [2007], and Roberts, Stevenson, and Morse [2000]). Business angels are playing an increas-ingly significant role in the United States, the United Kingdom, and Sweden in terms of providing equity investments for early-stage ventures, which are increasingly perceived by venture capitalists as being too risky and too small for investing (Aernoudt [2005], Manson and Landstrom [2006], Mason [2006], Sohl [2003a], and Wiltbank [2005]). There have

been recent calls by researchers to expand busi-ness angel research beyond Western countries to include emerging countries, including Asia (Gompers and Lerner [2001] and Harrison and Mason [1992]).

This article reports on our study of business angels operating in the Philippines. We use institutional theory as our theoretical framework in order to better understand the challenges facing business angels operating in an emerging economy characterized by a lack of fully developed institutions. Ahlstrom and Bruton [2006] recommend institutional theory as an effective foundation in studying emerging economies.

INSTITUTIONAL THEORY

Institutional theory attempts to explain the impact that contextual systems have on organizational behavior and economic per-formance (Hoskisson, Eden, Chung, and Wright [2000] and North [1990]). North [1990, p. 3] defines institutions as providing the “… rules of the game in a society or, more formally, the humanly devised constraints that shape human interaction.” Scott [1995] posits that institutional theory is comprised of three categories: normative, regulatory, and cognitive. Scott defines normative as the acceptable behavior and values of individuals and organizations. The regulatory category consists of the laws and political power that

Business Angel Investing in an Emerging Asian EconomyWILLIAM SCHEELA AND EDMUNDO S. ISIDRO

WILLIAM SCHEELA

is a professor at Bemidji State University in Bemidji, [email protected]

EDMUNDO S. ISIDRO

is a president at Philippine Venture Capital Invest-ment Group in [email protected]

JPE-SCHEELA.indd 1JPE-SCHEELA.indd 1 8/5/09 12:38:51 PM8/5/09 12:38:51 PM

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2 BUSINESS ANGEL INVESTING IN AN EMERGING ASIAN ECONOMY FALL 2009

regulate individuals and organizations, and cognitive represents the inf luences that develop through social interaction. Regulatory institutions, especially legal and financial ones, tend be more fully developed and effec-tive in developed countries, especially in comparison to developing countries (Peng [2003] and Ramamurti [2000]). The impact of the lack of institutional support in developing countries is a higher cost of doing business (North [1990] and World Development Report [2002]).

In order to be effective, private equity investors (including both venture capitalists and business angels) require fully developed legal and financial institutions, robust IPO markets, a strong entrepreneurial culture, and developed physical infrastructures (Gompers and Lerner [2001] and La Porta, Lopez-de-Silanes, Shleifer, and Vishny [1997, 1998]). Entrepreneurs are a key factor in economic development and are positively impacted by developed institutions (Boettke and Coyne, [2006]). Bruton, Fried, and Manigart [2005] propose that all three categories of institutional theory can be used to study the development of venture capital worldwide. More specifi-cally, Ahlstrom and Bruton [2006] applied Scott’s frame-work to their study of venture capital in the emerging economies of East Asia. They determined that the legal systems in East Asia (regulatory) are relatively weak; that venture capital associations are having a positive but still limited impact on developing professional standards (nor-mative); and that there is a strong inf luence of overseas Chinese commercial culture (cognitive) in much of East Asia, resulting in a lack of organizational transparency for venture capital investors. Overall, the level of institu-tional development in East Asia is relatively undeveloped, which can have a negative impact on sustained long-term growth ( Johnson, Ostry, and Subramanian [2006]). We believe that business angels, like venture capitalists, will also be challenged to make successful investments in the East Asian emerging economies.

Regulatory institutions provide legal protection for investors and support the development of effective capital markets, and tend to be relatively undeveloped in Asia (Bruton et al. [2005]). However, Asia is not a homo-geneous region in terms of institutional development (Lockett and Wright [2002]) and Bruton et al. [2005] recommend further research, which analyzes significant country differences in institutional development within Asia and the subsequent impact on private equity. More generally, Boettke and Coyne [2006, p. 20] propose that, “Only by understanding the institutional context can we

hope to understand why we observe different behaviors by entrepreneurs … across settings.”

The Philippines is characterized by low rankings in a large number of competitiveness factors, such as financial disclosure and regulation, stock market effec-tiveness, property rights protection, and venture capital, and a high score in corruption (Porter, Sachs, Warner, Cornelius, Levinson, and Schwab [2000]). Basically, the Philippines lacks the required fully developed institu-tions to support an effectively functioning private equity industry. However, venture capital firms have been active in the Philippines since 1988 (The 2003 Guide to Venture Capital in Asia [2002]). We are interested to study the investment and operating strategies developed by business angels in response to the lack of fully developed institu-tions in the Philippines. Our research question is: What is the impact of the lack of fully developed institutions on business angel investing in an emerging economy?

RESEARCH METHODOLOGY

A major challenge in studying business angels is to find them (Mason and Harrison [2002] and Paul, Whittam, and Johnston [2003]) because business angels have been described as being elusive and nearly invisible (Freear, Sohl, and Wetzel [1994]) with a preference of operating in total privacy (Brettel [2003] and Prowse [1998]). This makes it very difficult, if not impossible, to develop a random sample that is representative of the busi-ness angel population (Morrissette [2007] and Paul et al. [2003]). Coviello and Jones [2004] recommend using a judgment sample when it is difficult to identify firms or individuals in the population of interest. We developed a judgment sample in two steps. First, we selected poten-tial business angels from a list of members who attended monthly meetings of investors and entrepreneurs in the Philippines. From this list, we identified individuals who had a history of actively investing in SMEs. Face-to-face interviews are recommended in situations when the data is sensitive, relationships are important (Asia), and the data cannot be effectively collected using a questionnaire (Ahlstrom and Bruton [2006]). In November 2003 and 2004, we interviewed a total of 31 individual investors living in the Philippines. This article focuses on 29 of the investors who met the criteria of being categorized as a business angel investor. These are investors who have significant business experience and net worth, and make substantial investments of their own money in privately


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held, early-stage companies (Freear et al. [1995, 2002], and Roberts et al. [2000]).

We used a structured, face-to-face interview format based on a combination of 32 close-ended and open-ended questions. The structured interview format was initially developed by Gorman and Sahlman [1989] for a study, via a mail questionnaire survey, of U.S. venture capitalists. Because of the exploratory nature of this research due to the formative stage of venture capital in the Philippines and also because of the dif-ficulties of using Western-based questionnaires in an international environment (Adler and Campbell [1989] and Boyacigiller and Adler [1991]), we used the ques-tionnaire to develop in-depth questions for face-to-face, structured interviews. We have previously tested the reliability of the interview questions (Scheela and Nguyen [2001]) and subsequently used this interview format to interview formal venture capitalists in the Philippines (Scheela [2006]) and Vietnam (Scheela and Nguyen [2001, 2004]). Using the recommendations of Coviello and Jones [2004, p. 501], we use the same research methodology in the different countries for both business angels and venture capitalists in order to “estab-lish equivalence in sampling, instrumentation, and data collection procedures.”

All of the interviews took place in the Philippines (24 in Manila and five in Cebu), lasted between 45 minutes and 2 hours, 40 minutes, and averaged one hour, 32 min-utes. Twenty-eight of the business angels are from the Philippines and one is a foreigner who is living in Manila and has significant business experience in the Philippines. Twenty-six investors are men and three are women.

Because this sample is small, judgment-based, and therefore non-random, we analyze the data using descriptive statistics. We used pattern coding (Miles and Huberman [1984]) to transcribe and reduce our field notes (data reduction) so as to identify and describe the most signif icant patterns. We then do a content analysis of the data by constructing both weighted and unweighted frequency distributions based on tabu-lating the different patterns (Yin [1989] and Miles and Huberman [1984]).

RESULTS

Business Angel Profile

Exhibit 1 shows the descriptive statistics (mean, median, and range) for the 29 investors. These business

E X H I B I T 1Business Angel Summary Profile

Source: Interviews [2003, 2004].


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angels are highly educated, as they all have university degrees and 21 have advanced degrees. All 29 inves-tors have previous work experience, and they have been investing in companies/deals for an average of 18 years.

The average or mean amount of investment funds managed per investor is not applicable because one investor is a significant outlier with a U.S.$300 mil-lion investment fund. This results in a distorted average investment fund of U.S.$13.77 million per investor for the 29 business angels. However, only one business angel has developed an investment fund that is larger than the average and 28 investors have funds that are significantly less than the average amount. In this situ-ation using the median amount invested per investor provides a more accurate description. The median total amount invested per business angel is U.S.$1.8 million. In terms of how much each business angel invests per investment, the median investment range per investment for is U.S.$100,000–250,000.

Most of the business angels invest with partners, resulting in an average of three co-investors for each investment. In total, the 29 business angels have invested in 238 companies, which are comprised of 203 early-stage companies and 19 growth-stage companies. To date, each investor has made, on average, a cumulative total of over eight investments with a median number of six investments per business angel. Because of the wide range of investments per investor (2–30), the median is probably a more realistic descriptor of the number of total investments per business angel.

Business angels overwhelmingly source their investment funds from personal savings and tend to focus their investments on investee companies operating in the Philippines and preferably in Manila. However, seven business angels are open to investing in companies oper-ating outside of the Philippines. In terms of using an investment strategy, 25 investors acknowledged that they have formulated a strategy, which they use to identify and invest in companies, while four investors are simply open to a broad range of investment opportunities.

Twenty-four of the business angels are active, hands-on investors, who average five board seats per investor, while five investors consider themselves to be passive investors. The latter do not fully fit the definition of a business angel, because of their lack of involvement with their investee companies. This is surprising consid-ering that all 29 business angels are both highly educated in business and have significant business experience.

Investments are typically held for approximately eight years, with the exit strategy being primarily a trade sale to a third party. IPOs, while technically pos-sible, are not perceived as a viable exit, especially in the Philippines, because of the lack of a fully developed securities market.

We asked each investor to identify his/her pre-ferred industry for investing and to also identify the key characteristics that made the industry(s) attractive. Exhibit 2 shows the cumulative responses to these two separate questions. Clearly, there is a wide range of pre-ferred industries for investing, with real estate and busi-ness services being the most preferred, followed closely by technology services, agribusiness, and trading/retail. Combining all service industry preferences (technology, financial, and business) results in a frequency of 20 cita-tions, which strongly supports a significant interest in investing in early-stage service businesses (Exhibit 1). Industry attractiveness criteria are even more dispersed than industry preferences. It appears that business angels have a very clear understanding of the most significant criteria that make an industry attractive within their preferred industries. The five business angels, who do not have a specific investment strategy, have developed a framework for making investments in a wide variety of investee companies that have the potential to generate significant investment returns.

Investment Performance

Each business angel was asked to evaluate invest-ment performance on two levels. First, they evaluated their respective investee company performance based on actual performance-to-date versus expected performance at the time of the initial investment (below expectations, average, or above expectations). Second, they evaluated the overall performance of their aggregate investment funds-to-date (below expectations, average, or above expectations). The results are summarized in Exhibit 3.

Investment performance on both levels is gener-ally positive. According to the business angels, 63% of their investee companies are performing at average or above expectations. This positive performance evalua-tion is even more significant because one investor eval-uates 22 of his/her investments as performing below expectations, which comprises almost one-third of the below-expectations performers. Therefore, a better indi-cator of investor performance is the performance of the


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27 aggregate investment funds (two investors’ funds are too early to analyze), where almost 80% (79.3%) of the business angels evaluate their overall investment perfor-mance as meeting expectations (average) or above expec-tations. Thus, the investment track record, as reported by the business angels, is very significantly positive.

Value Added by Business Angels

Each business angel was asked to analyze a list of value-added activities that we developed from previous studies of private equity investors, primarily venture capitalists in emerging Asian economies (Scheela [2006] and Scheela and Nguyen [2004]). From this list, we asked each business angel to identify the most significant value-added activities (their top three to five activities) that he/she contributed to his/her investee companies. They were also asked to include activities that were not on the master list. Exhibit 4 shows the priority ranking of the most significant value-added activities.

E X H I B I T 2Investment Strategies


E X H I B I T 3Investment Performance Summary

Note: *43 companies are not included because of exits or very recent investments.



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Providing strategic planning expertise to investee companies is clearly the most significant value-added activity, followed by management recruitment and mon-itoring financial performance. Expanding the ranking to the top five value-added activities includes introduction to customers and providing additional financing, with help form and manage the board in fairly close sixth place. Collectively, this shows that the 25 business angels who are active and very active investors provide a wide range of critical value-added activities to their investee companies on an ongoing basis.

Characteristics and Challenges of Business Angel Investing in the Philippines

Each business angel was asked to identify and explain the major characteristics of business angel investing in the Philippines. Secondly, we asked each investor to talk about the major challenges facing

business angels in the Philippines. The results are shown in Exhibits 5 and 6.

In general, business angels characterize the invest-ment climate in the Philippines as being poor because of the lack of both good investments and quality foreign investors, which have resulted from high levels of cur-rency, economic, legal, and political risk. Government corruption is a significant problem that further damages the investment climate. The combination of these two characteristics (poor climate and corruption) may have resulted in the lack of ethical and professional behavior of both investors and entrepreneurs, which were identi-fied by the business angels as the fourth-most-significant characteristic. Because of the lack of fully developed institutions to support a transparent investment climate, informal networking among investors is the primary method of investing. Not surprisingly, difficulty in com-pleting deals in this type of investment climate is also a characteristic of business angel investing.

Business angels characterize themselves as making relatively small investments in early-stage companies. While there is a risk-adverse mentality for investors and entrepreneurs in general, Filipino-Chinese investors and entrepreneurs are the major risk takers. Unfortunately, it is perceived that the Philippines lacks a sufficient number of business angels.

The challenges shown in Exhibit 6 ref lect the characteristics analyzed from Exhibit 5. Because of a very poor investment climate and lack of transparency in the Philippines, business angels have difficulties in finding the right people (entrepreneurs, co-investors, and managers) in order to do deals. This challenge is further increased because it is also difficult to convince foreign investors to enter the Philippines because of the small country market, currency risk of the peso, political instability, and government red tape and corruption. Consequently, it is important for business angels to be patient investors and conduct in-depth due diligence for each potential investment.

Recommendations to Improve Investing

Each business angel was asked to make recom-mendations on how to improve business angel investing in small companies in the Philippines. Exhibit 7 shows the frequency of the major recommendations. Basically, there are two sets of recommendations.

E X H I B I T 4Priority of Value-Added Activities

Note: *Scale: Activity rank Weight 1 3 2 2 3 & lower 1Source: Interviews [2003, 2004].


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E X H I B I T 5Characteristics of Angels Investing in the Philippines



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First, create a business angel club for investing pur-poses. This was the dominant recommendation: spe-cifically to form an organization in order to enhance and streamline the investment process and to educate entrepreneurs about private equity investing. According to many of these business angels, this club should pro-vide a forum for entrepreneurs to present business plans to potential investors and, more specif ically, provide specific services to enhance the investment process for club members. Services could include: screening the

entrepreneurs/business plans before they are presented, publishing the minutes of club meetings, developing a database of deal-making activities, creating a website that lists possible investments, and educating both entre-preneurs and investors about the investment process.

The second major recommendation is to develop more effective institutions to enhance the investment climate in the Philippines. This includes reducing political and legal risks, which should result in both more investments in SMEs and more foreign direct

E X H I B I T 6Challenges of Angel Investing in the Philippines



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investment (FDI) in the Philippines in general. Also, financial institutions need to be improved in order to increase bank support for SMEs and to improve IPO exit strategies in the Philippines by reducing the current listing requirements for SMEs. According to the business angels, this second set of recommendations could also be a significant responsibility of a business angels club, whereby recommendations on institutional development

and listing requirements are generated and formally pro-posed to the government.

SUMMARY OF RESULTS

This study has documented that the Philippines is a difficult country for business angel investing primarily because of the difficult investment climate that results

E X H I B I T 7Recommendations for Angel Investing



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from the absence of effective institutions. This finding directly addresses our research question (“What is the impact of the lack of fully developed institutions on business angel investing in an emerging economy?”) by validating that the lack of fully developed institutions makes it very challenging for business angel investors to both find and make investments. Using Ahlstrom and Bruton’s [2006] application of Scott’s [1995] institutional levels to analyze venture capital in East Asia, we can see that business angels also face similar challenges. Busi-ness angels clearly identify the lack of political, legal, and financial institutions (regulatory) as a major chal-lenge. While many Asian countries have formed venture capital associations (The 2003 Guide to Venture Capital in Asia [2002]), which can be used to develop professional investing standards (normative), no East Asian emerging country has developed a formal business angel club. The lack of fully developed institutions is evident on all three levels of institutional theory.

The lack of institutions has resulted in busi-ness angels developing a co-investment strategy com-bined with hands-on monitoring, which has resulted in generally positive investment returns in spite of the challenging investment climate. All 29 investors have effectively developed comprehensive informal networks whereby they have primarily co-invested in 238 compa-nies, which are overwhelmingly early-stage ventures. In spite of the lack of institutional support and the difficul-ties of finding good deals, almost 80% of the business angels in this study consider themselves to be successful investors as measured by meeting or exceeding their investment expectations. In summary, business angels operating in an emerging Asian economy character-ized by the lack of institutional support were able to develop effective investment strategies resulting in posi-tive financial returns.

DISCUSSION

Even though the results of this study are very preliminary and business angels operating in Asia have been significantly understudied, there does not appear to be an overall Asian business angel model, which is not surprising given the significant differences in both eco-nomic and institutional development in Asian countries in the three countries studied to date: Japan, Singapore, and the Philippines (Porter et al. [2000]). Business angels in Singapore tend to do bigger deals than angels in both

Japan and the Philippines and relate more to Western business investing practices than do Japanese business angels (Hindle and Lee [2002]). While Japanese busi-ness angels are becoming increasingly active, they are significantly different from U.S. angels in that the Japa-nese tend to be less significant investors because Japa-nese entrepreneurs, who are potential angel investors, generally have not yet accumulated significant wealth compared to the U.S. entrepreneurs/business angels (Katsuna and Harada [2004] and Tashiro [1999]).

An investment strategy that may be common among both business angels and venture capitalists in Asian emerging economies is networking. Ahlstom and Bruton [2006, p. 312] found that venture capitalists in East Asia “… generally used networks to substitute for formal institutions such as the rule of law….” Business angels in the Philippines also networked with other investors to find deals, conduct due diligince, and reduce investment risk because of the lack of legal protection for minority shareholders.

Even though the Philippines’ investment climate is significantly different from that in the United States (Porter et al. [2000]), which makes business angel investing more challenging in the Philippines, there are more similarities than differences between business angels in the two countries. While U.S. angels tend to focus more on high-technology investments (Freear et al. [1994] and Wetzel [1983]), angels from both coun-tries invest primarily in early-stage companies, co-invest (Freear et al. [1994]), and play a hands-on role as active investors. That is, angels from both countries provide signif icant value to their investee companies beyond providing equity. According to Morrissette [2007], the average deal size for U.S. business angels is U.S.$50,000–75,000, which is considerably less than the median deal size in our sample of U.S.$100–250,000. U.S. business angels tend to be male, highly educated, wealthy, and successful entrepreneurs (Morrissette [2007]). The busi-ness angels in our judgment sample also fit this profile. Many of the business angels in this study were still active entrepreneurs, sometimes with their investee companies. This is also common in the United States, where the “distinction between entrepreneur and investor is often rather blurry” (Morrissette [2007, p. 59]).

Philippines, American (Wetzel [1983]), and British (Harrison and Mason [1992] and Mason [2006]) business angels are collectively dissatisfied with the lack of good deal f low because of ineff icient channels of


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communications with entrepreneurs who are seeking funding. Angels in all three countries perceive a lack of effective and eff icient communications as a major challenge in making investments in early-stage compa-nies. Apparently, the fully developed institutions in the U.S. and U.K. do not significantly improve deal f lows for business angels. Specif ically, in this study, busi-ness angels overwhelmingly support the formation of a business angel club in order to improve the investment search process whereby entrepreneurs seeking equity can be both identif ied and analyzed. In the United States, business angel clubs not only provide a com-munication and analytical venue between angels and entrepreneurs (Freear et al. [1994]), but clubs can also provide valuable training for potential but latent angels (Aernoudt [2005] and San Jose et al. [2005]). Philippine business angels also support a training role for a club and a policy role for providing guidance to the govern-ment in developing effective institutions to increase the impact of private equity funding on economic devel-opment for SMEs. The latter f inding appears to be unique to business angels in the Philippines. However, it appears that business angel clubs have not yet made a formal appearance in the emerging economies of South East Asia.

Finally, while many business angels in developed countries co-invest with other investors, a co-investing strategy appears to be especially important for business angels in the Philippines because of the high levels of currency, political, economic, and market risks. This reinforces previous research supporting networking as a crucial and effective strategy in developing coun-tries lacking fully developed institutions (Ahlstrom and Bruton [2006] and Peng and Heath [1996]).

FURTHER RESEARCH

This study is a first step in analyzing business angels in the Philippines; of course, much more research needs to be done. Sampling is always a problem in studying relatively reclusive and unorganized private equity investors such as business angels (Mason and Harrison [2002], Morrissette [2007], and Sohl [2003b]) and may represent the “single biggest obstacle to research in this field” (Freear, Sohl, and Wetzel [1997, p. 48]).

In Asia, it is especially challenging to conduct postal surveys of angel investors (Hindle and Lee [2002]) and, especially in developing countries, face-to-

face interviews are much more effective (Ahlstrom and Bruton [2006], Scheela [2005], and Scheela and Nguyen [2004]). Given our non-random and small sample, gen-eralizing to business angels in other emerging Asian countries, or even to other angels in the Philippines is problematic. Further field research is needed to increase the database in the Philippines and Asia. More spe-cifically, it will be very useful to develop longitudinal studies (Ahlstrom and Bruton [2006] and Sohl [2003a, 2003b]) of both business angels and the formation and operation of business angel clubs. How will the invest-ment strategies of business angels change as the level of institutional support improves in emerging econ-omies? Ahlstrom and Bruton [2006] posit that with improving institutions, the need for venture capitalists to network to compensate for the lack of institutional will lesson. Ahlstrom and Bruton [2006, p. 314] expect that venture capitalists in emerging economies “will grow to act more like those in more developed markets” because of improving institutions. This can also result in increasing brain circulation whereby Asian venture capitalists, who are educated and trained in the United States, are returning to set up funds in their home coun-tries, especially in Taiwan and to some degree in China (Saxenian [2006]). Will this also be true for business angels in dynamic emerging economies? So far, there has been limited movement of U.S.-based Filipino busi-ness angels returning to the Philippines to finance deals. Possibly, as more effective institutions are developed in the Philippines, brain circulation will increase and the need for business angel networking will decrease because of improving regulatory and normative insti-tutions. However, Morrissetti’s [2007] profile of U.S. business angels shows that networking is still very important in a developed economy in terms of both sourcing deals and co-investing. So, it may be that busi-ness angel networking is less affected by institutional development than are venture capitalist’s investment strategies. Longitudinal research is needed to analyze the impact of developing institutions on business angels’ investment strategies in emerging economies.

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Angel Investing in an Emerging Asian Economy by Bill Scheela and Ed Isidro

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