It is traditionally thought that angel investment precedes venture capital funding for new technology companies. That is traditionally, it is thought that the sequence of investment for most companies is 1) friends and family, 2) angel capital, and then 3) venture capital funding. This was never actually true for most companies because most companies never qualified for venture capital funding. It is even less true today because angel networks and venture capital firms are tending different flocks – i.e. they are funding different groups and types of companies by and large. The reason is that venture capital firms have grown in size over the years. According to the U.S. National Venture Capital Association, the average VC firm has grown from about $50 million in 1990 to about $350 million in 2005 and larger now. The reason for this is that VC’s by definition are re-investing funds provided primarily by institutions (such as corporate investment funds, pension funds, university endowments, and very wealthy families.)
As a result of this growth in fund size, the amount of money VC’s must deploy has increased in size, so that as a rule of thumb, minimum venture capital funding investments are $5,000,000 to $10,000,000 and above. In fact, according to the U.S. National Venture Capital Association again, the average amount of capital deployed per company over all rounds of financing rose past $30 million in 2005 and larger now. (There are exceptions in early stage venture capital and startup venture capital.) In contrast, typical angel investors are investing their own funds as individuals. So angels have much less money to deploy per company. This doesn’t yet explain why angel investors and VC investors are in most cases investing in different kinds of companies, rather than providing funds in sequence for the same companies. This will become clear below.
To better understand the difference between VC’s and angel investments, members of angel networks typically deploy (in aggregate) under $1,000,000 per company in the first round, with possibly another $1,000,000 to $2,000,000 in a subsequent round. Since a following VC round is likely to be much larger than an earlier angel investment round, the chances are the original angel investment would be diluted excessively. Dilution is the key problem for angel investors. They do not want their equity position of a company to be so small that they cannot influence the direction and strategy of the company. Even worse than loss of influence, when a large VC round occurs, the VC investor can simply declare that the earlier angel round of investment is diluted to an even greater degree than the proportionate amount of money invested, thus reducing the angel’s return on investment. For these reasons, angel networks increasingly prefer angel investment opportunities that do not require a follow-on round of venture capital funding.
Another difference between the two communities of investors (angels and VCs) is that VC’s usually prefer a 7 to 10 year exit to conform to the life expectancy of their funds, whereas angels increasingly seek an early exit of 3 to 5 years. The tendency to prefer an early exit for angel capital is accelerating. See the widely references book Early exits: Exit Strategies for Entrepreneurs and Angel investors (But Maybe Not Venture Capitalists) by Basil Peters. For the above reasons, the interests of angel capital and venture capital funding are diverging. Angels and VC’s are investing in different companies rather than sequentially backing the same companies. There are exceptions of course.
What this means is that angel network investments are rarely followed by venture capital investments. When angel investors in a typical angel network invest, if a follow-on round is needed, they will usually seek to syndicate the deal themselves, turning to their own network of angel investors. For this reason, if you are seeking angel capital investment from an angel network, you are most likely to be successful if you structure your business plan so that a follow-on round of venture capital investment above $2,000,000 is not needed.
There is one exception, and that is if your company is truly venture-capital bound, but it needs to get started with $1,000,000 to $5,000,000 of angel capital. In this case, you may want to start with an angel network, but your best bet would be individual high-end investment angels rather than an angel network. An individual investment angel of this kind would be a very wealthy individual with experience in the same domain as your company. You may be able to find such an individual investment angel who will back your startup with his own funds, understanding that a VC round will follow. Such individual investment angels invest typically on their own. The key to finding such an individual investment angel is to look for the large winners in the same business domain as your business idea.