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Angel Financing: Trends for Today's Entrepreneurs

William H. (Bill) Payne, Senior Program Consultant, Kauffman Foundation

Angel investors have long been a primary source of financing for companies at the seed and start-up stages. However, in the recent past, as venture capitalists have backed away from funding enterprises at these early stages, angels have become recognized as the primary source of funding at this stage of company development. What’s more, having in the past largely operated individually and behind the scenes, they are now banding together in groups, enabling them to share information about companies worthy of funding and pool their collective resources.

These developments have significant ramifications for today’s entrepreneurs. While founders must still toil diligently to present to investors a business plan that signifies a clear competitive advantage for their product or service, the fact remains that they now have easier access to angels. A group with which I am involved as an entrepreneur-in-residence at the Ewing Marion Kauffman Foundation (which sponsors the EntreWorld Web site), called the Angel Capital Association, has even endeavored to join together some 60 angel groups in order to facilitate the sharing of information.

As a former entrepreneur and now an angel investor for many years, I have observed these trends with great interest. A look at the forces driving these trends might help entrepreneurs understand this altered financing environment – and thus more intelligently pursue the financing they need for their companies.

Financing Trends

At its heart, the recognition that angels are the primary source of seed and start-up financing can be traced to recent trends in financing on the part of venture capitalists – that had once been heavily involved in funding start-up companies.

  • Venture Capitalists Invest at Later Stages

In the past eight years, from 1995 to 2003, venture capitalists have been making more investments in companies at the expansion and later stage and far fewer in those at the seed and start-up stages. In fact, VC funding for fledglings has dropped precipitously since the mid 1990s, with fewer than 200 companies a year receiving VC funding during the past three years .

Let’s look at the numbers that underlie this development. Today, nearly half of all venture capital is invested in funds with at least $1 billion in assets under management, whereas, in 1995, no venture capitalists were managing assets of that amount, according to Venture One, a research group that tracks the industry. During this period, the total amount of venture capital has increased tenfold, while the number of principals managing such funds has not increased proportionately. With more money to invest and fewer venture capitalists for each dollar under management, the average round of venture investment has more than doubled to $7 million in 2003 from $3 million in 1995.

With venture capitalists committing more money to each investment, they have tended to invest in more mature enterprises, those that have demonstrated the value of their products or services and seek additional funding for expansion. Indeed, whereas the average VC investment in a seed or start-up company is now $2 million to $3 million, later investments in these same companies are substantially larger. Specifically, in 2003, the average early stage investment was $4.5 million compared with $7.3 million at the expansion stage. For entrepreneurs launching new companies, the numbers make an undeniable point: VCs aren’t the investors to be approaching in the seed and start-up stages.

  • Angel Investors Solidify Their Hold on Seed and Start-up Stage Investments

While the data for angel investing isn’t as definitive, these individual investors have put $15 million to $30 million a year into new companies in the past decade, with rounds averaging $250,000 to $750,000, according to the Center for Venture Research (CVR) at the University of New Hampshire. Some 30,000 to 50,000 companies a year have been recipients of funding from angels during this period.

Significantly, more than half of all angel dollars have been invested in seed and start-up companies, with the bulk of the balance going to existing portfolio companies at later stages of development. In 2003 alone, angels invested $18 billion in 35,000 companies, according to CVR. Of that total, they put 60 percent, or $11 billion, into an estimated 20,000 companies at the seed or start-up stage. That compares with VCs’ investments of only $400 million into 181 fledglings during the same period. The comparison is as startling as the message is clear: angels continue to solidify their hold on the funding of start-up companies.

Group Dynamics

Some angel investors have created a new model, banding together in groups, or networks, in an effort to seek out and adopt best practices, improve due diligence, and utilize standardized term sheets. In 2003, some 200 such groups were in operation, compared with less than 20 in 1996, according to estimates by the Kauffman Foundation and also by CVR. Indeed, Kauffman’s latest effort to consolidate the groups into the Angel Capital Association represents an acknowledgement of the value of refining investing techniques, adopting robust processes, and sharing information about deals among fellow investors.

In addition to joining networks, angels and networks of angels have become willing to syndicate deals among themselves and also in collaboration with venture capitalists. Indeed, the sophistication of mature angel groups hasn’t gone unnoticed by venture capitalists, especially those that still consider investments in early-stage companies. In the case of Tech Coast Angels, a network of angel investors in Southern California, for example, more than 20 venture associates routinely scrub deals and invest alongside the group’s members. Venture capitalists appreciate the robust process adopted by angel organizations and recognize that angels serve as critical mentors and board members for start-up companies. In addition, by investing alongside angels, the venture capitalists set the stage for leading subsequent larger investment rounds.

Benefits for Entrepreneurs

For the entrepreneur, these recent trends in the funding environment contain enormous advantages. Angel groups tend to publicize their application processes, making access easy for entrepreneurs who no longer need to find angel investors one at a time. For those that survive the rigorous screening process adopted by the Tech Coast Angels, to take one example, entrepreneurs are able to make their case to upwards of 200 potential investors.

Finally, given the cooperation between angel groups and seed VCs, and also among the angel groups, including the willingness to syndicate, that netherworld of the $2 million to $5 million investment is finally being addressed. Entrepreneurs will be increasingly able to secure funding for these amounts.

In sum, the news is good on the financing front for entrepreneurs seeking dollars for seed and start-up enterprises. The challenge for these founders will be to thoroughly understand today’s angel investing environment and to position their companies to take full advantage of these exciting developments.

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