The Funny Math of the Angel – Venture Capital Financing Gap

angel venture capital financing gap mythMuch of the writing on angel investing suggests that angels fill the gap between the low amounts invested by friends-and-family, and the large amounts invested by venture capitalists. But is that true?

The story goes something like this: that business angels fill the financing gap between the $100,000 maximum seed stage investment that friends and family are said to be willing to provide … and the $5 million expansion stage investment that venture capitalists are thought to be willing to offer. Further, as the story goes, friends and family don’t have enough money to invest beyond $100,000.  The cost of making venture capital investments leads venture capitalists to avoid investments less than several million dollars.  Therefore, companies needing between $100,000 and $5 million go to business angels.

Although this gap-filling story of the role of business angels presents a nice perspective on them, it takes some funny math for it to really be true.

In my book Fool’s Gold: The Truth Behind Angel Investing in AmericaI point out how the above math doesn’t compute.

If angels are filling a gap between friends and family and venture capitalists, then the maximum number of firms that are founded each year for whom angel capital could fill a gap between friends-and-family money and venture capital cannot be larger than the total number of companies that receive non-seed stage venture capital, which, tends to average fewer than 3,000 businesses per year.

Moreover, for angels to fill a financing gap between $100,000 and $5 million, then angels need to put that amount of money into businesses. However, most observers have found that very few angels do this, with the typical angel putting in $10,000 and the average angel investing $77,000.

Even most angel groups don’t put enough money in their portfolio companies to plug the financing gap. Data from the Angel Capital Association’s annual survey of angel groups shows that the average group invests about $242,000 in each portfolio company, and a very small percentage of those groups invest between $500,000 and $2 million in a company, let alone invest between $2 million and $5 million. Even the oldest, and what some say is the best angel group, the Band of Angels in Silicon Valley, averages investing about $600,000 per portfolio company.

In short, the numbers just don’t work for the financing gap explanation for angel investing. Angel investing tends to be a different type of funding that an entrepreneur chooses, rather than a bridge to venture capital.

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About the Author: Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool’s Gold: The Truth Behind Angel Investing in America; Illusions of Entrepreneurship: The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By; Finding Fertile Ground: Identifying Extraordinary Opportunities for New Ventures; Technology Strategy for Managers and Entrepreneurs; and From Ice Cream to the Internet: Using Franchising to Drive the Growth and Profits of Your Company.

14 Comments ▼

Scott Shane


Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

14 Reactions

  1. Hi Scott,
    I always enjoy your posts and appreciate your insights. I am now going to have get a copy of your latest book, too! I have been an angel investor (as i am in the case of Shiftboard linked here in this comment), plus I’ve raised money from angels for a software startup of my own years back. Without your post and shared knowledge, I would have kept believing that a savvy startup, in this web 2.0 world we live in, could raise angel funding and get completely profitable. And i guess it is possible, for the right startup with the right concept, but this dose of reality helps me to evaluate startup ventures in a new light — a much more practical and healthy light. Thank you!
    TJ

  2. TJ, just thought I’d mention that Scott is on vacation over the holidays, without Internet access, or I’m sure he’d respond.

    Anita

  3. I would have to agree with you here, Scott, it doesn’t fill the gap and, as you stated, the typical investment is around $10k. Your posts always shed light into this topic for me and each one really helps me to get a clearer, more defined perspective of it entirely.

  4. As they say at the Underground / Metro: “Mind the gap!” ;)

    I am interested in getting in touch with a small business / start-up angel for an idea I have chewed for several years. It has to do with celebrations and it includes all individuals with a name! :) It is a tradition that is not common in North America yet. It is celebrated here in Scandinavia and in some other European countries.

    I need to get in touch with a creator of widget for e.g., Facebook, Netvibes, Srapplet. A web / blog designer. Someone with insight in the greeting cards, calendar, event industry. And someone with connections in the printing on stuff, e.g. pens, t-shirts and other gifts.

  5. Thanks Scott, good point, and by the way, I really like the book too. My sense on this is that part of the problem is that we’ve got some blurry borders between the different categories: distinguishing between angel and friends and family isn’t always easy, some VCs sometimes operate down in the areas that we’d normally think of as angel areas, and some angel investors appear temporarily and operate ad-hoc on a specific investment, then disappear later. Tim.

  6. Interesting statistics. As I am learning from your articles, business funding can be a challenging situation. I can certainly understand that a friend or family member can only contribute so much but I had assumed that angels would take up the remaining gap. Clearly I could learn a lot more by reading your book.

  7. I saw this post on Linked In and decided to click. I thought it was funny as I’ve had similar debates with professional Angels.

    See: http://www.matr.net/article-29148.html (read comments below article) – was syndicated to national angel association too I think to help educate others, entrepreneurs and angels alike.

    Care to send me an autographed copy? See: http://www.mikesparr.com/2008/12/01/read-guy-kawasakis-new-book-reality-check/ (wishful thinking of course but I’m happy to promote your book) ;-)

    Great post!

    Mike

  8. Good article. Interesting to see the stats; kind of surprising (typical angel investing $10,000) – I would have expected a lot higher number. It would be even more interesting to see the stats at the end of next year – funds seem to be drying up in a lot of areas these days.

  9. @Kris: I thought the number would be higher too, maybe $25,000. In one of my companies, we raised $75k from one angel and we thought that would be the average.

    I don’t see funds drying up so much, though. But i live in the west, in Seattle, and while i will admit to hearing people talk about tightening the belt; people are still interested in smart startups. But i guess i should step back for a second as you’re probably right, Kris — people are spending slowly in almost everything else in life.

    Just seems like i have heard of a number of folks saying that the time to buy is now…. If one can just get over the media fear factor, perhaps it is possible!

  10. Great finding your post Scott. Glad you are sharing your insights this way too. Loved having you on the show a few weeks ago. For anyone wanting to hear Scott’s interview on the SPEC Talk Radio Show, please go to http://kugarand.podomatic.com/entry/2008-12-14T18_45_59-08_00 More info about investors groups and motivations of investors to join those groups can be found on my post from November aand the associated podcast http://tinyurl.com/9y95wo at myvirtualangelworld.com Follow me on Twitter karen_rands

  11. I’m not so sure about this because I think one company will typically go to several angels not just one. But my experience is based on Angel Forums like Band of Angels. My strong suspicion is that non-Forum angels smell and act just like early stage seed friends and family – a little money to invest but they do it with more professional evaluations.

    As someone in the process of securing angel financing I’ll be sure to find out soon enough!

  12. Well said. “Even the oldest, and what some say is the best angel group, the Band of Angels in Silicon Valley, averages investing about $600,000 per portfolio company.”

  13. just thought I’d mention that Scott is on vacation over the holidays, without Internet access, or I’m sure he’d respond

  14. Ikon Marketing Group

    Nice Article. Never thought of it like that.

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