WORKING PAPER 3
Before conducting an initial public offering, the equity of a firm is held by a combination of investors including venture capitalists, managers of the firm, and angel investors (private individualinvestors). The literature has examined the influence of venture capitalist stock holdings andmanagement stock holdings on IPO firm valuation, underpricing, and long term performance andthe role of these investors in the initial public offering.
Pre-IPO investors often have seats on the board of directors and should have considerable power in setting the offer price for the IPO firm(Lerner (1995)). As such, these investors will be able to make decisions that will ultimatelyinfluence the underpricing of the IPO firm, arguably the largest cost of the IPO to the firm going public. But there is one class of investor that has received almost no consideration in the empiricalIPO literature, the individual angel investor. This omission is particularly surprising when Sahlman(1990) and Sohl (2003) estimate the aggregate volume of angel investments to be ten times thenumber of venture capital investments and the finance literature has generally recognized thedeficiency of research in this area (Lerner (1998).
The paper attempts to fill this void in theliterature, examining the role of angel investors in the process of bringing firms into the publicmarkets.Angel investors are important for several reasons. First, they often make investments instart-up firms at dollar amounts far smaller than one would tend to find for venture investors (Sohl,1999, 2007). Such early stage investments are likely to have a large influence not only on thesuccess of the firm, but also on its management, governance, and operations. Second, angelinvestors do not have the agency problems inherent in venture capital investments. Angels investtheir own money where venture capitalists are money managers and invest capital provided by their limited partners. This fundamentally changes the incentives of the venture capitalists. Pre-IPOinvestors are concerned about the liquidity provided to their investment by taking the firm publicand the return on their investment.
Where angels are concerned most about the return of their