With a flourishing startup environment in our own backyard, there certainly appears to be no lack of ideas or innovation from the entrepreneurial standpoint. The question is then, why do we continually hear from investors that there are not enough high quality investment opportunities for them to pursue?
The numbers indicate that the investors we hear from are not alone in their claims. The amount of investment dollars going towards seed funding of startups dropped 7% for the fiscal year of 2012 compared to 2011. Simultaneously, the total amount of investment overall was up 1.8%. This indicates a recent pullback from investors, not in terms of how much money they give, but whom they give it to and when. While there still exists a vast amount of support and resources for startup businesses in general, investors have been becoming more selective.
This presents an interesting situation as the narrative around the reason for this shift could fall in favor of investors pointing to lack of return and a necessary pullback of risky investment practices. Entrepreneurs, feeling the pressures of a Series A crunch, could assert that there sometimes exists a lack of faith in their early stage businesses, citing pressures to monetize too quickly and become profitable before their idea or product has been given the support it needs to become viable and catch on in the overall market.
We assert that both entrepreneurs and investors alike have valid points in this regard, and that there are a few primary reasons for the Series A crunch and the funding gap. We also think it is important to look at the causes and find a solution for the collective benefit of the startup community as a whole.
So are startups underperforming in 2012 versus 2011, or have VCs grown too risk-averse? After researching the market over the past 12 months, talking to thousands of startups and hundreds of angel and venture capital investors, we contend that VCs are simply looking at businesses from a different perspective than angel investors and startups themselves. A thorough understanding of the different ways in which VC’s are now evaluating businesses can help angel investors in pursuing worthwhile opportunities that might be overlooked by VC’s, particularly in early stage investments.
In general, there are three main risks investors evaluate: the team risk, the technology risk, and the market risk. VCs prefer great teams with ample experience and a demonstrated exit strategy. However, investors would contend that this is demonstrated in first 12-24 months of their startup’s growth. At Inismo, we believe in the inherent value of a high quality entrepreneurial team, and that is why we help investors evaluate these factors using our proprietary startup assessment tools. Angel investors are far more likely to invest in startups where they believe in the team behind the business. We help investors to build that confidence, or heed warning where necessary.
The technology risk, in our view, is the primary risk VCs are willing to take: “Does the entrepreneur spend the capital to develop technology and bring it to the market or not?” This determination of course coincides directly with overall market risk and the burden taken upon investors by injecting their capital into unproven products and technology. The possible return from investment in new technologies is potentially very lucrative. One must make decisions in this regard on a case-by-case basis given the best possible information and intelligence. That’s why it is necessary for angel investors to think and act like VCs, especially when they face a Series A financing round to exit.
Our next featured Inivice column, “Why VC’s are successful and Angel Investors Need to be” addresses ways in which Angel Investors can better evaluate startups by analyzing which tools VC’s are using and how it affects their track record.