Thoughts on startups by investors that
fund them & entrepreneurs that run them

Startup Capital: Feast or Famine?

For years there has been a pervasive opinion across the entrepreneurial landscape that the US has a shortage of capital required to startup and grow new ventures. It is suggested that companies cannot find the cash necessary to start new and exciting ventures. Furthermore during this economic downturn, we’ve heard a crescendo of voices lamenting the lack of startup funding, as communities finally recognize that new companies are the key source of job creation in this country. But, what evidence do we have of this shortage of capital?

New Company Formation – According to the Kauffman Foundation, entrepreneurs start about 700,000 companies per year in the US. Dr. Carl Schramm, Kauffman CEO, recently said that startup formation is stagnant or even decreasing in the US in the second half of 2011. So, we are clearly not experiencing an upsurge in new company formation today.

Sources of Capital for Startup Entrepreneurs – The primary sources of cash for new companies are (1) self (the entrepreneurs’ resources), (2) government grants, (3) friends and family, (4) angel investors and Super Angels, (5) venture capitalists and (6) strategic investors. We have no measure of the changes in available capital resources from entrepreneurs and their friends and family, but we have no reason to believe they have changed radically over the past few years. Strategic investors tend to be later stage sources, and will not be addressed here. Let’s take a closer look at trends in government grants, angel investment and venture capital financings.
Several sources (including Startup by Elizabeth Edwards) estimate that $2-3 billion per year is awarded to very early stage companies by federal government grants (mostly SBIRs). At $100,000 or so per grant, perhaps 2-3000 pre-seed and seed/startup companies receive SBIRs and other government grants per year. Furthermore, total federal grants to very early stage companies have been increasing over the past few years.
According to the Center for Venture Research, The Angel Investor Market in 2010 was about $20 billion and funded about 60,000 companies, with about one-third of that capital committed to seed/startup stage companies. Total angel funding in 2010 was up somewhat, but has ranged from $15 to $20 billion for several years. The fraction of angel capital committed to follow-on and later stage investing has increased over the past five years. But the number of seed/startup stage companies receiving angel capital has been rather steady at 20,000 to 25,000 companies per year.
The Angel Resource Institute recently published the first definitive study, to my knowledge, of Super Angels. While the authors made no attempt to estimate the total impact of Super Angels and their Micro-VC funds, I will attempt to do so. It appears to me that there are about 100 Super Angels in the US. On average, they are investing $1 million or more per year into perhaps five companies each, most of which are seed/startup stage companies. So, we think about 500 seed/startup companies are receiving at total of $100-200 million annually from Super Angels.
According the MoneyTree© about 2% of venture capital has been invested in seed/startup stage companies (perhaps 400 companies per year) in each of the past five years, with no obvious trend towards a decreased commitment to this stage. There is anecdotal information suggesting that VC investment (perhaps outside the MoneyTree© survey) in the earliest stage companies is increasing somewhat today.
In summary, it would appear to me that 25,000 or more companies are successful in raising seed/startup capital in the US annually. Furthermore, with the recent activity of the Super Angels and trends in government grants, angel financings and VC investment, one could conclude that the total US volume of seed/startup investment is increasing.

We have an additional indication of “money chasing deals” (a lack of fundable startups, not a shortage of startup capital) as measured by the competitive environment in the more active US entrepreneurial communities. A recent informal survey of angel groups indicated that valuations are highest in Silicon Valley, New York City and Boston, which are arguably the most entrepreneurially active communities in the US. Furthermore, the survey indicated that seed/startup valuations all over the US have risen in the past year, and especially in these three markets. As we know from elementary economics, scarcity is one cause of increasing prices – in this case, lots of seed/startup capital looking for investment opportunities with too few qualified entrepreneurs.

It is pretty clear to this observer that the formation of companies is rather steady and the capital available to fund those companies is increasing. There does not appear to be a scarcity of capital for seed/startup stage companies that can qualify for funding. Could it be that shortage of capital is only being reported by those entrepreneurs whose ventures do not qualify for seed/startup financing?

 

All opinions expressed are those of the author,  and do not necessarily represent those of Gust.

Written by Bill Payne

user Bill Payne Angel Investor ,
Frontier Angel Fund

Bill Payne has been actively involved in angel investing since 1980. He has funded over 50 companies and mentored over 100. He is a founding member of four angel organizations: Aztec Venture Network, Tech Coast Angels, Vegas Valley Angels, and Frontier Angel Fund.

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Comments

4 thoughts on “Startup Capital: Feast or Famine?”

  1. Matt Sharper says:

    they don’t differ they are both business’s

  2. ScottjHoward says:

    My firm runs a small project grant that is typically applied to early stage / seed companies. We have not lack of demand, but do struggle to identify ‘good deals’ more specifically ‘good teams’ that qualify. Operating in the space over the last 3 years on both sides of the equation, my opinion veers towards the lack of quality deals versus lack of capital. We are working to apply our resources at the development of higher quality deal flow by becoming more active with solid entrepreneurs and talent at the earliest stages. This means providing direction and opportunity towards commercial problems that can tie to revenue generating innovations. 

  3. Rick Ritter says:

    Bill,
    As someone who works daily with early stage businesses I would have to disagree a bit with your conclusions.  I think you are probably right when your thinking is applied to “web” related businesses (apps, operating software, services, etc.).  I do think there is a shortage of early stage capital in other business segments, especially for companies that take longer to get to scale (outdoor clothing and products, consumer products, health, etc.)  Any thing that takes a longer time horizon, almost regardless of potential size.

  4. Bill Payne says:

    Hi Rick- Thanks for sharing your thoughts.  I don’t know if I can provide definitive data to dispute your conclusions, but if you look at the distribution of angel capital across the spectrum of deals, angels fund deals in all sectors (very broad:  no tech to high tech, healthcare to consumer products).  We expect home runs to take 6-8 years to mature.  We don’t simply look for companies that can grow and exit quickly.  I will add that most angels tend to invest only when some customer validation is available.  Perhaps you are concerned for a lack of pre-seed capital which I addressed in my recent Funding Gap post.  Bill