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Tracking the flight of angel investors

As venture capitalists spend less on early-stage start-ups, entrepreneurs are asking for money from private investors, commonly known as "angels," whose identities and roles are ever-changing.

    The first quarter 2000 venture capital investment numbers have just been released, and once again, they're astonishing: Roughly $1 billion a week were invested in venture-backed companies in over a thousand financing rounds.

    But while the number of deals almost doubled compared to the same time last year, only 26 of those deals, or 2.5 percent, were seed rounds. This is a significant decline from last year, when such deals accounted for 8 percent of the financing activity.

    Seed rounds are initial rounds invested in companies at very early stages of development, typically with only the founders and product developers--such as engineers or molecular biologists--on board, and without a complete management team in place. Just two or three years ago, seed rounds averaged $1 million or less. But like the rest of the market, they have expanded and currently top out at about $2.5 million.

    Unlike other venture financing rounds, however, their growth has not been phenomenal. Moreover, their share of the venture capital pie is shrinking.

    Are venture capitalists less interested in truly emerging technologies and new ideas? Do they have less time and more money to invest, making seed financings an indulgence?

    Granted, later-stage totals are getting a boost from various sources outside of venture capital proper. Buyout and other private equity firms are contributing via new venture capital funds, and corporations are increasingly involved in venture funding. Nevertheless, whether by design or through administrative optimization, venture capitalists are spending more on later-stage companies at the expense of very early-stage start-ups.

    But not to worry--these venture orphans are finding willing caretakers to attend to their early needs. The comparative dearth of venture capital has created an opportunity for new players to become involved in early-stage ventures, and increasingly seed-stage rounds are being financed by private investors commonly known as "angels."

    Who are these angels, what drives them, and how do they operate? No single definition can encompass the wide variety of individuals and entities that engage in angel investing. The original angels were wealthy people who saved Broadway plays from certain demise with cash infusions at the last dramatic moment. The term was later applied to those who lent their "patient money" to entrepreneurs whose ideas interested them--the boat owner who gave the "Juice Guys" at Nantucket Nectars their first financing, for example. These wealthy individuals contributed funds in arrangements with few terms and conditions.

    As time went on and the entrepreneurial scene became more complex, some angels grew more savvy and often replaced loans with equity positions in the companies they financed. And as anecdotes proliferated about the successful investments of individuals such as Paul Allen and groups such as Northern California's Band of Angels, these celestial investments became more common and more formal. To mitigate the risk involved in early-stage investing with limited funds, many angels have armed themselves with term sheets and attorneys, just like traditional venture capital investors.

    Estimates of the number of angel investors now range from the hundreds of thousands to the millions, and with growth in numbers comes variance. Just as the venture capital community has expanded to include corporate and other private equity investors, the angel community has grown and evolved as well. But while corporations and professional venture capital firms are easy to identify, angels are more elusive. Most entrepreneurs don't get their initial round of financing from Paul Allen or Hans Severiens. In fact, after the credit cards are maxed out, the first stop is almost always friends and family. Does that make Uncle Harry an angel?

    It sure does. As they are now defined, angels include relatives, groups of friends, notoriously successful former entrepreneurs, and organized groups of individuals with admission criteria, business-plan submission rules and stages of due diligence. And as the definition grows broader, tracking these investors with any kind of reliability is increasingly difficult. I've joked that short of conducting a door-to-door survey in Atherton (the Northern California suburb that is home to many a Silicon Valley millionaire), it is virtually impossible to tally the number of angels.

    In fact, you'd have to go a lot farther afield than Silicon Valley, because angels and angel groups are spread throughout the country, and often operate behind the scenes to promote local entrepreneurship. Further complicating things are regional idiosyncrasies. Whereas on the West Coast angels are often successful entrepreneurs whom themselves reaped the benefits of angel and venture capital investment, East Coast angels are often universities that also serve as incubators.

    The constant metamorphosis of the angel space presents a formidable challenge for research organizations such as my own and for other industry-watchers, but it is well worth the effort. Angel investors are providing a much-needed service and playing a vital role in the nation's entrepreneurial development, and their evolution is far from over.