primarily on the initial stage of the company. "Venture capital is largely dependent on the positioning of capital, sometimes investing in the initial stages, sometimes in the mid-term and sometimes in later periods," said Fang Xingdong, President of Chinalabs. Fang believes that most of the capital from angel investments belongs to individuals who are, therefore, only responsible for themselves. VCs, on the other hand, involve far greater responsibility being placed on the fund manager. "The 'angels' work like nannies, while VC managers perform more of a coaching role. For VC managers, even though they work directly with company management, success depends on the independent growth of the company."

Due to the small amount of capital involved, angel investors generally finance companies only in their initial stages. When companies develop to the point of requiring a second round of financing, VCs with larger capital usually step in. In this situation, however, VCs normally demand that angel investors give up their "liquidation preference" (liquidation preference shareholders are entitled to receive their investment back plus any accrued and unpaid dividends). Angel investors are then faced with two choices: one is to make an additional investment; the other is to give up their liquidation preference. Both choices can lead to the loss of their entire investment.

Consequently, dealing with VCs becomes the key to ensuring returns for angel investors. According to Ni Zhengdong, Chairman and CEO of Zero2ipo Group, in an emerging market, a win-win situation is far more preferable, so angel investors prefer to partner with VCs.

"This leads to a win-win situation between the founders and investors," Ni said. "A single-sided win often means failure. We do not compete with VCs, we prefer to seek cooperation. Our investment taking place prior to that of the VCs does not mean we are competing with them. We prefer to partner with VCs and proceed under their leadership."

As potentially profitable as they are, angel investments frequently end in tears. If VCs have a 20 percent chance of success, then angel investments only have around a 5 percent chance. Angel investors bear great risk as their investments only become profitable if the company achieves a return of 10 to 20 times their investment. In an attempt to minimize risks, angel investors often choose to invest with a partner rather than investing on their own.

IPO-the primary exit method

Even though due diligence and procedures for angel investments are simpler than those of VCs, it still takes many significant steps to complete the process of project selection.

The first stage is the search for projects. Similar to the information sources that VCs utilize, angel investors use direct contact with company founders; introductions by "angel teams" and business partners; recommendations by venture capitalists; and background records from lawyers, accountants, consultants and investment banks.

After having identified satisfactory investment projects, angel investors carry out due diligence and project evaluation, including team capabilities, business prospects and profit modeling.

If the angel investor and his counterpart agree on the macro direction, the two parties begin negotiating the clauses of the investment agreement. This is the key to completing the deal, which not only ensures maximum profit for both parties, but also guarantees the rights of investors and protects them from any ethical risks. The two parties must agree on all clauses in the agreement to avoid any future disputes. The major clauses include:

· Securities type arrangement. The following three securities are normally applied to the seed stage: common stock, convertible securities and preferred stock to which many rights can be attached;

· Anti-dilution clauses and protective clauses. Anti-dilution clauses are normally standardized, with the aim of protecting the angel investor in the case of a stock split, stock distribution or capital reorganization;

· Ownership percentage and control;

· Key personnel and incentive clauses;

· Exit mechanism or liquidation agreement.

"Angels" are not philanthropists. In order to seek maximum returns, they generally play a role in operation management of the enterprise in its initial stage.

Angel investors are constantly pursuing the best exit strategy by discussing enterprise development planning with entrepreneurs and finding experienced venture capitalists to partner with through networking. Exiting is the last stage of angel investment operations and exit methods include IPO, acquisition, management buyout and liquidation, of which IPO and acquisition are the most popular. Compared to developed countries, the acquisition system in China is far from mature, and as a result, IPO has become the primary method of exiting for angel investments.