or decades, the venture capital industry has been a critical driver of our modern, innovation-driven economy. It has financed many of the companies that have redefined how we live, work, and play including Google, Microsoft and Netflix.
However, there are big changes on the horizon in the world of entrepreneurial finance. These changes will take centralized control over entrepreneurial finance out of the hands of a small group of venture capitalists and democratize the process.
And these changes are being led by Angel investors.
It is increasingly evident that the venture capital model is flawed. The industry is characterized by over concentration. 78% of all VC money is invested in just three states: California, Massachusetts and New York. This figure represents 50% of the worldwide venture capital being invested outside of the United States. The geographic over concentration is stunning.
There is also mounting evidence that traditional VCs are abandoning early-stage investing and putting more focus on mature companies. This is demonstrated by the fact that in 2020, $100 billion, or two-thirds, of total US VC deal value was allocated to late-stage companies.
Early-stage companies are increasingly starved for capital and are therefore being forced to look beyond VCs for funding. Although the venture capital industry has captured the popular imagination due to the massive successes of a select few investments, it should be noted that only 1% of small businesses are funded by VCs.
Angel investors on the other hand will invest in as many as 30% of the opportunities presented to them.
The venture capital industry is also painfully homogeneous. A database that includes every venture capital organization since 1990 indicates that only 8% of VC investors are women, 2% are Latinx, and less than 1% are Black.
The same skewed figures are evident in the recipients of venture capital. Between 2015 and 2020, an October 7th Crunchbase report on 970 Black and Latinx-founded companies revealed that just 2.4% of total venture funding went to Black and Latinx founders.
Unsurprisingly, the fact that the vast majority of VCs are White males and the lack of investment in startups founded by underrepresented minorities and females are closely correlated. Clearly, this lack of diversity is part of the reason that 95% of VCs aren’t returning enough money to justify the risk, fees and illiquidity of their investments.
In response to these challenges, angel investors are taking the lead in building their own professional networks to redefine entrepreneurial finance. Rather than look only to venture capitalists to finance their businesses, startups can now appeal to organizations of affiliated angel investors such as the Brown Angel Group, Columbia Angels, Wharton Alumni Angels and MIT Alumni Angels—to name a few. Oftentimes these angel investors have strong institutional support as MIT Alumni Angels is a part of a university-wide innovation initiative designed to maintain the school’s status as an “entrepreneurial university.”
The rise of alternative models of entrepreneurial finance like equity crowdfunding has been catalyzed by the willingness of angel investors to provide the seed capital that the early-stage businesses on these platforms need to gain traction. The April 5, 2012 passage of the Jumpstart Our Business Startups (JOBS) Act established the equity crowding industry in the US. The JOBS Act changed US securities laws so as to allow entrepreneurs to raise capital over the Internet.
Initially, only accredited investors were allowed to invest, but in June 2015, Title IV (Regulation A+), another part of the JOBS Act, went into effect and this permitted the crowdsourcing of capital from non-accredited investors by larger companies.
Finally, in May 2016, Title III (Regulation Crowdfunding) of the JOBS Act became law and this facilitated the dramatic growth of equity crowdfunding platforms by allowing early-stage startups to solicit offerings of up to $1 million within 12 months from either accredited or non-accredited investors.
Equity crowdfunding is distinct from venture capital not only in its use of the Internet but also in that the equity stake surrendered is usually much smaller than that taken by a typical VC. Another massive advantage for entrepreneurs is that it takes networking to a whole new level. The Internet allows the entrepreneur to market their startup to a much broader population of investors—particularly angel investors who are more prone to invest in startups requiring less capital than VCs are.
Like angel investing, equity crowdfunding is best suited for startups who need a smaller investment of seed capital in the usual range of $15,000 to $500,000 or perhaps as much as $1,000,000 as VCs typically do not consider making investments of less than $2,000,000 and as has been highlighted previously, traditional VCs are increasingly focused on late-stage investing at the expense of providing seed capital. Due to these realities, equity crowdfunding fueled by the support of angel investors is increasingly filling an important market gap in entrepreneurial finance.
Since 2016, equity crowdfunding has exploded in the United States with platforms like Wefunder, SeedInvest, Republic, StartEngine and Microventures popping up on the scene. The data indicates that $748,562,363 has been raised on those platforms since May 2016 with the involvement of 991,659 investors, the vast majority of whom are angel investors. As the data shows, small contributions by many angel investors can have a huge impact.
Wefunder takes pride in its connection to the angel investing community. A salient indicator of Wefunder’s success in achieving its mission to democratize finance is that it has signed up 1,360,841 angel investors to its platform. The company contends that its overall approach is effective as it argues that results indicate that it has higher returns than the top quarter of venture capital firms. Likewise, in September2014, SeedInvest announced a partnership with angel investing website Gust, which has created one of the world’s largest angel investor databases.
If equity crowdfunding platforms are the innovative infrastructure catalyzing the democratization of entrepreneurial finance, angel investors are the active agents of this emerging democratic revolution. While VCs typically come from a very narrow background—Harvard/Stanford/Wharton MBA; McKinsey/Bain/BCG consulting experience; alumni of an elite private university—angel investors come from far more diverse backgrounds.
Oftentimes, their status and wealth has been acquired not from credentials but from demonstrated skill in building a real business. As such they usually bring a unique blend of practical insight coupled with boldness to their investing approach that is rooted in their passion for entrepreneurship beyond just seeking investment returns.
Unlike VCs who are increasing focused on late-stage investments, angel investors are often willing to provide the seed capital and expertise that nascent entrepreneurs require. This is why, as financiers and agents of tacit business knowledge, angel investors are the driving force behind many of the leading equity crowdfunding platforms.
Led by angel investors, their networks and their growing impact on equity crowdfunding platforms as well as discontent over the flaws of the VC industry, entrepreneurial finance is at a crossroads. How will venture capitalists respond?
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