05 Jun The Shifting Investor Landscape: VCs and Angels
It is crucial that entrepreneurs understand the dynamics of the early stage investing market. In this piece we will highlight some interesting developments among two major types of investors, venture capitalists and angel investors in the always shifting investor landscape.
The Past: Angels and VCs up until the 1990s
Going back 20 years, early stage investors fell into two simple and distinct categories. There were angel investors, who would invest their own money to fund early stage companies; they were often wealthy, independent businessmen. And there were venture capitalists, who were professional investors who invested other people’s money from Limited Partnerships, large funds raised primarily from institutional investors (pensions, endowments, etc).
Historically, the primary challenge for both of these groups was finding new companies to invest in, which is often referred to as “deal flow.” Due to this general scarcity of private deals, the funding process moved quickly.
Angel investors in particular made fast decisions, relying on their personal expertise and generally acting alone. Without any restrictions or investors to answer to, angels could invest in any type of business they choose.
Conversely venture capitalists operated within a firm structure, working in teams with reporting lines to senior partners and the limited partners (investors). A large part of their time was occupied by raising the funds from institutional investors. This more formal structure, compared to angels, often involved criteria or mandates from the limited partners that required venture capitalists to invest only in certain sectors, stage, and types of securities. Not surprisingly, this led to longer and more involved funding cycles, which also lead to generally larger investment sizes per deal. The pressure from fundraising and supporting firms of professional investors resulted in venture capitalists seeking higher-return (but also higher-risk) opportunities, also known as homeruns and grand slams.
Venture capitalists and angel investors remain the two largest types of early stage investors but the distinctions between them, or at least their behavior, have blurred. Rather than a scarcity of deals, today’s early stage investors face a high volume of deals but a challenge screening and finding the high-quality deals.
Today’s angel investors still invest their own money, they still rely on their expertise, and they still make decisions slightly faster than venture capitalists. However today’s angel investors increasingly operate in teams or networks, called angel groups, to pool of their resources and investments. As a result, they increasingly seek the same high-risk high-return opportunities as venture capital. Not surprisingly, these groups have adopted the screening and vetting procedures similar to venture capitalists, and the deal size has also increased. The experience for entrepreneurs seeking capital from these angel groups resembles the experience of seeking venture capital.
Venture capital investing has also changed, although not as radically. Read our separate post on understanding VCs but to summarize: there has been a consolidation and thinning of the VC market and they have shifted most of their funding to later stage companies. Even more recently, VCs have re-emphasized seed funding, but again only for companies with outsized return potential.
Bias towards startups with grand slam potential
The public dialogue on early stage investing certainly reflects these changes, especially the bias towards high-risk, high-return startups. Just think how much media attention there is on the next Facebook, LinkedIn, SnapChat or you name it. Unless your idea is big enough, you may struggle to find an audience. This has left a major gap in the funding of companies whose potential market size is less than huge.