The U.S. Economy Needs a Host of Angel Investors

Wall Street needs fixing. The U.S. job-creation engine continues to sputter. Growth remains subpar. Perhaps it's time to call in the angels.

No, not Gabriel & Co. Let me explain.

The big focus in Washington right now is regulatory reform of the banking system. The effort is gaining momentum following the Securities & Exchange Commission's civil fraud charges against Goldman Sachs Group (GS) on Apr. 16. There's no question that an overhaul is needed. Without better regulation, the existing "too-big-to-fail" policy all but guarantees that financiers will eventually drive the economy back to the brink of collapse. The money crowd has learned that profits at globally interconnected financial firms remain privatized, even as their future losses have been socialized.

Still, it's disturbing that the focus on preventing another round of bailouts has obscured a more fundamental problem: how to better encourage further savings and investment in the economy's entrepreneurial, innovative, knowledge sectors—away from the trillions in synthetic securities, derivatives, and other engines of speculative finance that mostly wind up lining the pockets of predatory middlemen.

"Our economic system needs to stop channeling funds into super-risky, highly leveraged, and speculative areas," writes Richard Florida in The Great Reset: How New Ways of Living and Working Drive Post-Crash Prosperity. "Instead we must return to the original vision and purpose of the financial markets: supporting innovation and the growth of the real economy," adds Florida, director of the Martin Prosperity Institute at the University of Toronto's Rotman School of Business.

One way to accomplish this basic shift in purpose is to encourage angel investors. These are mostly entrepreneurs and former entrepreneurs who invest in bootstrap companies too young and raw to attract attention and money from professional venture capitalists. Unlike venture capitalists that manage funds of money raised largely from such institutional investors as pension funds, angels risk their own money.

angels helped Apple, Amazon, Google

Angels are in the vanguard of financing entrepreneurship and innovation and when an investment pays off, venture capitalists come in to further build up the company. Angels fund real companies. They don't create collateralized debt obligations. (Some would argue that those complex financial instruments were the handiwork of the angels' opposite numbers.)

A number of well-known companies got their start with angel money. An Intel (INTC) executive and shareholder put $91,000 in seed money into fledgling Apple (AAPL). A dozen angels invested $1.2 million into (AMZN) after founder Jeff Bezos was turned down by venture funds. Perhaps the most famous angel stake in recent years was the $100,000 that Sun Microsystems founder Andrew Bechtolsheim invested in Google (GOOG). The money let founders Larry Page and Sergey Brin move out of their Stanford University dorm rooms and market their search engine product. Many of Google's newly minted millionaires are now trying their hands at angel investing.

"It's entrepreneurs looking to play with house money, make some more money, and help out other entrepreneurs," says Gary Smaby, a Minneapolis-based venture capitalist and sometime angel.

To be sure, angel investing cooled off somewhat with the downturn in the economy. Last year, some 259,480 angels invested $17.6 billion in 57,225 entrepreneurial ventures, according to the University of New Hampshire's Center for Venture Research. The number of ventures held steady, compared to the previous year. Funding levels were down 8.3% percent but that's a heartening number when you consider that the recent downturn in the U.S. was the worst since the 1930s.

A bigger problem is that a section of the reform bill from Senator Chris Dodd (D.-Conn.) has three provisions that, taken altogether, could dampen angel investing far more than the Great Recession did. Currently, fledgling companies can raise money from accredited investors—high-net-worth individuals—without regulatory approval. The Dodd bill would require money-raising startups to register with the SEC, which would get 120 days to review the filing. The wealth and income baselines for angels would also double. The bill proposes revoking the rule that allows angels to follow federal regulations, rather than various state rules, in funding companies.

angel communities abound in the U.S.

The U.S. needs a greater number of successful angels to reinvest money and entrepreneurial talent in new ideas and new companies, not fewer. Angels have a knack for backing the types of companies that create additional jobs. And the angel community has been growing. Typically angels have hooked up with entrepreneurs through ad-hoc social networks—friendships created with other entrepreneurs over the years, perhaps at the country club or local philanthropic events. Since the late 1990s, however, there has been a proliferation of formal angel groups that screen investments and pool money on local or regional levels.

"You would be hard-pressed to find a major metropolitan area without a good, robust angel community," says Susan Preston, general partner for the CalCEF Clean Energy Angel Fund, as well as CalCEF Clean Energy Angel Network.

The anti-angel section of the Dodd bill constitutes a step in the wrong direction. Left alone, the pool of angel investors will likely grow. Angel investing has moved from the fringes of entrepreneurial society to the mainstream over the past two decades or so. For angels, the high-risk endeavor is social, fun, competitive, and potentially lucrative. What's not to like from an entrepreneurial point of view?

Even more could be done. For instance, many immigrants are well-educated in such tech-related subjects as math, engineering, and the sciences. Less appreciated is how many of these well-educated immigrants are attracted to entrepreneurial enterprises and later become angel investors themselves. That's why moves to make it easier for educated immigrants to stay permanently in the U.S. may not only provide a short-term job-creating boost, but also increase the startup financing funding pool over the long term.

With an unemployment rate at 9.7% and an increasingly competitive global economy, America needs its angels more than ever.