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The Changing Venture Funding Landscape

Because of changing dynamics in the venture funding environment,  there is increasing collaboration between Angels and VCs.  This is occurring because of the need for early stage investors to be better positioned to manage high risk,  to add more value when making an investment,  and to expand the options to trigger a liquidity event –  with a high ROI.

This is occurring because Angel investing has been on an upswing since 2003 and it is attracting high-net-worth individuals who want to take a more proactive approach to early-stage investing.  According to Ernst & Young, since 2000,  the number of venture capitalists has declined by 50% while the number of angel groups has more than doubled.

Why have venture capitalist positions declined ?   In the last three years, VCs have had record years for raising capital, totaling over $70 billion.  This has led to VCs being much more averse to seed and start-up stage companies because of the inherent risk and the small amount of capital that is deployed in these types of companies.  Overall, VCs have been trending toward doing larger, later stage deals that have a number of other VCs investing alongside.  This has left the door open for individual investors or Angels to support early stage entrepreneurship.

In conjunction with this, a growing number of Angel investors are becoming more sophisticated at venture investing, understand the need to manage risk,  can contribute operationally to move the venture forward,  and add value with other like-minded successful entrepreneurs to improve the probability of venture success.

The idea of Angel investing is gaining new popularity.  Angel investing has become prevalent by accounting for approximately 40% of seed and start-up capital in the first half of 2007 –  representing the largest single investing group.

As well,  Angel investing has become much more organized and professional over the last few years, according to the Center for Venture Research at the University of New Hampshire.   In the first half of 2007 there were 140,000 active Angel investors in the US who invested in 24,000 entrepreneurial ventures.  The average deal size declined by 4% while the number of investors in each deal increased by 10%.

Angels are well positioned to support entrepreneurship because they are typically a business person who sold or runs a company and is well versed in a variety of business disciplines including – product development, establishing an organization to meet current and new company needs, finance, sales, marketing, mgmt, corporate planning, legal, etc.

Early stage investing is a fairly risky proposition with only a very small percentage of the population considered Angels.   Even more telling is that only a small portion of this group actually makes money !    Because of this,  Angels tend to collaborate with other people (other Angels, VCs, etc.)  when considering an investment.   According to the Kauffman Foundation,  early stage investors have seen a 2.6 times return in three and a half years on their initial capital,  from investment to exit.  That is roughly a 27% internal rate of return (IRR) – which is what private equity funds look at garnering when they make their investments.  Much of the return for an Angel is really based on how many capital deployments have been made over how many different types of industries  (ie:  based on a portfolio of quality venture investments).

In conclusion,  the real difference between Angel investors and their corporate counterparts is the ability to contribute operationally to “ making the numbers “   versus  “ analysis of the numbers afterward “.   However,  an important VC value add is once the business starts to scale,  they can provide much more funding and a whole new set of options to help ramp the business.  Because early stage ventures have these different needs is why Angels and VCs are collaborating more.   And by doing so, a huge benefit is Founders can spend much time on addressing operating issues and a lot less time on funding issues.   For entrepreneurs familiar with the significant challenges of ramping a business,  you are uniquely positioned to appreciate this is a significant value add provided by sophisticated Angels and VCs.  And for new entrepreneurs who aren’t aware, ask one who is !

Andre Peschong, Bridgewater Capital  March 13, 2008