Sunday, January 25, 2009

Choosing between VC and Angel Funding

In a recent article in Entrepreneur Magazine, Brad Feld laid out some very helpful advice on how to determine if you are ready to raise venture capital. His points amplify the concepts I laid out in my earlier blog entry explaining the general funding stages an early stage company can go through in its life-cycle.
The main questions Brad recommends you ask yourself are very good ones and are as follows:

The amount of money you're raising in this round: If you're raising less than $1 million, you're likely wasting your time targeting venture capitalists, with two exceptions: 1) you specifically target funds that do seed rounds, or 2) you have a preexisting relationship with a VC firm and want to put together a seed round to get going quickly.

The total amount of money you're looking to raise over the life of your company: If you think you can get your company to a point where it's cash-flow positive on less than $3 million, stick with angels.

The type of company you're building: Venture capitalists love to fund businesses with the potential to be enormous. Angels love this, too, but they're much more willing to fund smaller companies that will presumably require less capital. In addition, most venture capitalists want to fund businesses that have clearly defined economies of scale (such as software companies) vs. ones that scale linearly with some factor (such as service companies).

Your experience: Successful serial entrepreneurs always find it easier to raise money from venture capitalists. If you're a first-time entrepreneur, that doesn't mean you can't raise VC money, but you're going to find it more difficult than an experienced entrepreneur will.

So, what do you do if you find yourself on the angel side of the foregoing questions and yet do not personally know any wealthy financiers? There are several good resources out there you should consider.

First, even if you do not have connections with potential angel investors, it is likely that your professional advisors do. While even the best lawyer cannot make an angel invest in your business, he should at least be able to get your business plan in front of a few of them. Further, by asking your advisor to help you with this, you may receive very good constructive criticism on your business plan that your advisor may otherwise have kept to himself. No professional wants to forward on a business plan that he does not feel good about.

Second, consider whether your local government or university has established an incubator program. For example, in Richmond we have a biotechnology incubator that is co-sponsored by VCU, private companies and state and local government. Typically, these sorts of incubator programs provide extensive support and resources to emerging growth companies. Moreover, they often have formal or informal angel networks that keep tabs on the companies in incubation. Some incubators even offer seed funding as part of the package when you are accepted.

Third, look into whether there are any regional angel networks at which you can present your business plan. These are usually clubs of angel investors that meet monthly or so to hear entrepreneurs present their business plan for potential investment. Oftentimes, in addition to angel investors and VCs interested in seed round financings, these types of organizations include lawyers, accountants and other professionals in their membership. This increases the network of people who are exposed to your business plan, as these professionals often know other investors that might be interested in your sector. In central Virginia, the largest club of this sorts is the Venture Forum, but there are several other informal networks too.

However, the best advice of all is to only raise the money you need and to not raise money until you need it. If you can bootstrap your company to profitability, you will be in a much better place than if you have to bring in outside investors and ultimately lose control of it.

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Dividends and Preferences by Hank Heyming is licensed under a Creative Commons Attribution 3.0 United States License.