The Funny Math of the Angel – Venture Capital Financing Gap


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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.

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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.