In the technology startup world, angels and VCs have at best been seen as different camps, with separate perspectives, and even being at odds with each other many times. One is from Venus, the other’s from Mars. One tends to be a cocky MBA, the other’s an entrepreneur with real operational experience. 
One pounds spreadsheets all day, the other’s a cowboy. As a minimum, they certainly don’t have a record of working closely together. They can compete for deal flow, they often distrust each another, and it’s frequently heard that angel investments can foul up the chance for later VC rounds because of unrealistic valuations or poor cap structure, or whatever.
There was a time when "venture capital" was synonymous with seed-stage investing. But, with the trend in recent years toward larger and larger funds, some approaching $1 billion, "You don’t have to do much math to realize that such firms are forced to make bigger and bigger investments to generate adequate returns for their limited partners," says Sramana Mitra in her recent column in Forbes: The Real VCs of Silicon Valley. (Mitra is an experienced technology entrepreneur and strategy consultant in Silicon Valley.) An excerpt from the column:
"…if you are an entrepreneur, especially a first-time entrepreneur,
you need to look for the ‘real’ VCs who are willing to take risks and
invest their time in mentoring you, not those big names that the term
venture capital normally conjures."
And who does Mitra say those real VCs are?
"So-called ‘angels.’ While VCs primarily invest other people’s money,
angels invest their own. An entrepreneur working on a fledgling idea
needs investors who not only provide valuable business advice but also
connect the dots to make business development partnerships happen, help
recruit key team members and help move the venture from concept to a
fundable company. Angels tend to have the operational background
necessary to play such a role."
Angels investing is no small phenomenon. One study found that that angels invested $25.6 billion in
2006 in the U.S. in 251,000 mostly early-stage deals (for an average investment of
about $100,000).
In her piece, Mitra seriously questions whether and how the gap created by VCs moving to larger and larger investments is being filled. Her closing line: "In capitalism, gaps generally get spotted and filled. This one–and the entrepreneurs in it–is still waiting."
Clarion Call
Mitra’s point comes early in her column: "we need to create a sort of microequity program for start-ups." It’s getting to be a common refrain; angels are clearly being expected to pick up more of the slack, as VCs leave early-stage investing behind and entrepreneurs get increasingly frustrated. Yet positive things are starting to happen, with more and more sophisticated, managed angel groups forming (or becoming more formalized), all across the country.
Note: this is not just a Silicon Valley phenomenon. That may be the epicenter of the VC industry, and where most of their money is invested, but not so for angel investors. Their is no epicenter. Sure, there are some notable angel groups in the Valley. But the distribution of these groups is much more even across the country. If anything, the Midwest rules. The Angel Capital Association is located in, are you ready? …Kansas. Of the organization’s approximately 150 member groups (see their directory), it’s the Midwest region that has the largest number of such groups (40), by a wide margin. So, yes, it’s fair to say that angel investing is more a heartland thing.
Reactions from Both Sides
Seeing the column in Forbes inspired me to do another blog post on angel investing. (See this category of my blog for lots more I’ve written on the topic; I also did a recent post on the new blog Minnov8.) After reading the Forbes piece, I reached out to three of my contacts whom I thought would have something to say in reaction. First, from the angel side:
"I really think that linking the angel and VC markets really hurts both models," said Pete Birkeland, CFO of angel network management firm RAIN Source Capital, St. Paul. "The VCs get hammered for not investing early enough, and the angels get hammered for scattershot investing. These are two complementary but distinct activities. They’re both needed to continue to grow companies and innovate. As we run our angel groups, we want to be able to look at opportunities that are early and risky, and invest in those that have a potential for a return. That return may be 3-5x, and we may be able to live on a seven-year horizon — that (scenario) wouldn’t even get past a first screen by a VC. We need an ‘angel manifesto’ that breaks us away from VCs, and the mindset that we have to all become VCs. However, with the view of limited partners and the dollars involved, it’s tough to escape the gravitational pull of the VC model."
And from an individual angel: "Founders, especially those without prior startup experience, need strong advisors, even operational advisors," said Doug Henrich, a former Microsoft executive and angel investor now living in the Twin Cities. "For an angel to be successful, I feel he or she needs to be active in the startup. The money of course is needed, but the experience and counsel are more valuable in successful startups. The experience has to come from somewhere…I wonder how large VCs can make money in the software space these days." I read that last comment of Henrich’s to mean that, for software startups, angel investors are naturally a better fit — that such firms need the type of mentoring that comes from angels in their early stages. In other words, VCs’ big money isn’t the answer; it doesn’t tend to produce the desired result.
One Big Sign of Hope
From the VC side, I very much wanted to get a comment from a firm I know well — one that started in Minneapolis, still has close ties here, but has been headquartered in Palo Alto for several years: Crescendo Ventures. 
David Spreng is the Managing General Partner of the firm, and has been on the board of the NVCA (National Venture Capital Association) since 2005. He recently launched a great blog called "Lightbulb," and here’s his About page there. But the most interesting thing is that David was recently tapped by the NVCA board to be the organization’s liaison to the angel community. That, to me, is very cool — a sure sign the two sides will be coming closer together in the future.
David was jumping on a plane when he I caught him, but pointed me to a recent blog post of his titled Angels and VCs Find Common Ground. In it, he reprints an article he co-wrote a couple of months ago with a board member of the Angel Capital Association. I had heard wind of this article before, and told him I bet I could get some good insights of his from it. I was right. I encourage you to read the full article, but here’s an excerpt:
While both angel groups and VCs have issues to improve in our relationships and processes, establishing strong relationships with quality angel groups can be extremely valuable to a venture firm’s deal flow and ultimate returns.
At $250,000 to $1 million, the average size round for an angel group is often below what most venture capitalists would consider investing in a Series A round. However, respected angel groups may well have the next generation of promising early stage companies that a venture capitalist is not ready to invest in but also doesn’t want to lose track of.
The ACA and the NVCA are both committed to working together to improve the relationships between angel groups and venture capitalists by sharing best practices and enhancing communications between the two associations.
Transitions from angel groups to venture capitalists should be seamless and considered a valued relationship for all the stakeholders, including entrepreneurs, co-investors and limited partners.
As I said, signs of hope. And it can all only be good for you entrepreneurs out there.
UPDATE (4/11/08): Well, maybe not as much hope as I thought. Just saw Sramana Mitra’s new column this morning in Forbes: Fund Envy: Venture funds are getting bigger all the time. This is bad news for aspiring entrepreneurs. Yes, she says, taking a poke at the name of a well-known VC’s blog, "Greed, indeed, is infectious."
Angel investors are banding into networks at an increasing rate, especially in the Upper Midwest, and they’re getting a lot more savvy, I learned at a conference sponsored by 
They appear to be out in front of a trend, meeting the market need to fill the infamous “gap” between very early-stage funding and traditional VC funding. It’s a gap many entrepreneurs have been more than frustrated with in recent years as they attempt to attract capital to get their ventures off the ground. And it’s the angels — increasingly smart bands of these angels — that are stepping up to fill that gap.
Miller said that Midwest Wireless began in 1990 with a handful of employees and a single tower in New Ulm, MN [one of my favorite towns, where the oldest brewery in the state, Schell’s Beer, still flourishes]. By the end of the ’90s, the company had 4700 towers. It made its first acquisition in 1996, a wireless company in Rochester, MN. By the year 2000, it had 234 employees and 110,000 customers and made another acquisition — this one for $165M — which expanded the company’s service area into Iowa and Western Wisconsin. By 2003, Midwest Wireless made a big bet: it switched over to CDMA technology, which Miller implied was a big challenge for the fledgling firm, but one they survived. By the end of 2003, his firm had grown to 507 employees and 356,000 customers, revenues had expanded to $179M, and it had made a second Iowa acquisition by the end of that year. Fast forward to the end of 2005, when the company had reached 636 employees and 440,000 customers, and $264M in revenues.
Rich Karlgaard of Forbes. [Or as Guy Kawasaki, another friend and business partner, calls him, “Brother Rich.”]
One industry where this is happening is newspapers, with the stock of the New York Times, for example, at half what it was in 2002. Why is the industry in trouble? “Craig’s List is one reason,” he said, “a company with 23 employees.” He noted that McKinsey said the topple rate will triple again, and he gave some reasons why this volatility will stay with us. “The backside of Moore’s Law is the part that’s important. As performance increases, prices drop 30% a year. Suddenly, hundreds of millions more people can afford technology every year.” He also cited the example of Google bootstrapping its way early on, with the founders not taking equity investment but instead maxing out their credit cards. 
Read more about that in 
“It’s growing at 70% year-over-year, and will have more ad revenue than the magazine by the end of 2007.” He said that’s what got Elevation Partners interested. “In the media business, as revenues double, valuation triples.” Forbes has very definitely become a global franchise. It’s seeing most of its growth on the Internet, and most of that growth is non-U.S. “But we’ll never give up on the magazine,” he said.
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