US VC Trends are Driving Angel Groups Towards more Angel-only Deals

January 19 2010 No Commented

US VC Trends are Driving Angel Groups Towards more Angel-only Deals

In an earlier post, I reported that angels in some US groups are investing in more angel-only deals, that is, startups for which less than $1 million in funding will provide sufficient runway to achieve positive cash flow.  Angels are electing to seek out and invest is such deals because venture capital in the range of $1 to $5 million is less available than in the past.  As I pointed out earlier, the world of venture capital in the US is changing rapidly – and not for the better.  VCs are funding fewer deals with a higher fraction as later stage deals.   US VCs are investing larger sums in total in each venture and waiting longer, hoping for larger exits.

Why are VCs moving away from angels, that is investing much larger sums in later stage deals and exacerbating the capital gap between deals that angels typically fund and the size of deals VCs are willing to make as their earliest investments?

  • The size of new VC funds in the US has increased substantially in the past decade.
  • Larger funds almost always invest more in each deal, up from $2-3 million in the ‘90s to $7-8 million today
  • Startup deals can typically only justify equity investments of $1 million or less at the seed stage.  In order to invest more per deal, VCs have moved to later and later stage deals.
  • Almost all angel first round deals are funded with US$200K to $1 million.  This amount has remained rather constant over the past two decades.
  • The US VC trend towards high average round size and later stage investing has created an important capital gap in the US between $1.5 million and $5 million.   Very few investors are available to fund deals in this gap, leaving angel-funded entrepreneurs who need, say $3 million, with very few options for raising money.

Furthermore, the number of VCs, as measured by the US National Venture Capital Association is decreasing.

  • The total number of VCs in the US peaked at about 1000 shortly after the Internet bust in 2001.  Because returns were poor, many VCs were unable to raise new funds.
  • Many of the 700 or so remaining VCs in the US (as measured by the NVCA) are not investing in new deals (because they do not have new funds to invest) and are only managing their portfolio companies until exit and will then disband.
  • Some have estimated that the number of US VCs will decrease to less than 400 in the next few years.
  • Fewer VCs investing in larger deals only increases the difficulty of finding funding in the gap.

These US trends have led many angel groups to focus more frequently on angel-only deals, those deals not requiring large amounts of capital to sustain and grow their businesses.

NOTE: I am describing a trend in angel investing.  One should not conclude there are no VCs investing in the gap, just that there is less capital available in the gap than a decade ago.  Nor should one conclude that US angels will not invest in deals which anticipate VC follow-on investment or that those deals will not find such follow-on capital.  It is my observation that angels who have primarily sought to invest in deals that would eventually be of interest to VCs are deciding to broaden their portfolios by investing in more angel-only deals.
It’s a GREAT time to be an angel.  Find a group and jump in!

Bill Payne is the 2010 BNZ University of Auckland Business School Entrepreneur In Residence.