As the Startup Funding Model Evolves, Angels are Winning

In the race to attract attention from startups and entrepreneurs, angel investors appear to be winning, and that’s accelerating an ongoing shift in the venture capital market — what some would argue is an evolution of the startup-funding model. A new survey from Dorsey & Whitney (PDF), a Silicon Valley law firm that specializes in advising startups, shows that startups are increasingly turning to angels, not just for their initial rounds of funding but for subsequent rounds as well. Meanwhile, the most recent data on the VC industry shows that traditional venture funds have only raised $9 billion so far this year, a significant drop from the amount raised in previous years. Insiders have been arguing for some time that the VC business needed to get smaller, and it appears to be doing that in more ways than one.

The latest figures from the National Venture Capital Association show that the amount raised by traditional funds in the first three quarters of 2010 is just a little over half the $16 billion they accumulated in all of 2009, and dramatically lower than the $28 billion that was raised in 2008, or the $35 billion that traditional funds managed to pull in during 2007. NVCA President Mark Heesen said the industry was “experiencing a period of time in which venture capital investment is consistently outpacing fundraising, creating an industry that will be considerably smaller in the next decade.”

Meanwhile, as startups require smaller rounds in order to get moving — and are more likely to get acquired than building up to a giant IPO — angels are coming to the forefront, according to the survey from Dorsey & Whitney. The survey showed that angels accounted for 59 percent of the funding for startups in the past 12 months, and almost 70 percent of startups said they would be looking for funding from angels for their next round.

Startups who were surveyed said that they turned to angels in part because of a perception that angels understand the needs of startups better, that they have operating experience, and that they can get a deal done quickly. “The two factors that stood out in the survey were that the investor understood the funding needs of the startup — they didn’t push them to take more or less than they needed — and the speed of the deal,” said Dorsey & Whitney partner Ted Hollifield. “Those are parameters that angels tend to do very well on.”

Startups also said they preferred to get financial backing from someone who was a specialist in the space they were hoping to operate in, as well as someone who had operating experience, and were “not particularly interested in brand names” (a point that many of those jockeying for attention during the recent AngelGate furor might want to consider). The survey also suggested that there may not be a lot of truth to the axiom that startups seek initial funding from angels, then move to traditional VCs for subsequent rounds. Hollifield said that the increase in numbers of startups who were looking to traditional funds rather than angels for their second round was “not particularly significant.”

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Post and thumbnail photos courtesy of Flickr user Vinnie Lauria