ANGEL INVESTING 101- – An Introduction to Angel and Venture Capital Investing
By Michael Gruber
Note: This article was originally written and published for DailyDAC as the first installment in a series of articles.
Intro to Angel and Venture Capital Investing
The small business is the backbone of our economy. In the US, small businesses (less than 500 employees) accounts for around half the GDP and more than half the employment, and represent 99.7 percent of all employer firms. Most of these businesses remain less than 10 people, many never reach profitability, and a good portion disappears within two years. That being said, the promise to create the next Google, Cisco, or FedEx is the passionate quest for many willing to walk in the shoes of a founder.
It is the founder of those businesses, the entrepreneur, who usually at great risk (financial, career wise, and other), will take an idea, and with passion embark on the wonderful journey of new venture creation. The word entrepreneur is actually a French word, and literally means “to undertake” (some task). The World English Dictionary defines it as “the owner or manager of a business enterprise who, by risk and initiative (my emphasis), attempts to make profits.” Company founding is not for those weak at heart and lacking in conviction and passion. The ups and downs can be worse than a rollercoaster, and businesses often change their business model several times out of necessity just to survive.
The very nature of the risk-taking nature is a discussion all of its own, and we won’t be spending much time on topic of whether someone is born an entrepreneur or can develop or be taught to be one. An even larger ongoing debate about surrounds the investment decision on “whether to bet on the jockey or the horse”… meaning whether an investment should be made into a company based on the team or the idea. This question will be addressed across the series, and with this decision potentially changing across the business cycle of an enterprise.
Regardless of the company, financing is critical to not only the launch of the company, but for sustaining the company’s operations while a product or service is being initially developed, and all the way through the point until the company actually can generate enough sales to cover its expenses.
The primary sources to fund a new business are:
- Bootstrap/Self-funded through founders
- Friends & Family
- Outside Capital
Each business has different capital needs, which widely varies by industry, but also by a particular business model & strategy. Utilizing the founder’s capital through bootstrapping would be most desirable given its cost of capital, but many entrepreneurs’ capital needs go beyond either their capability or willingness to fund by themselves. Other People’s Money (“OPM”) is a source for business growth, and the types of such money available to a company will differ based on the potential size of the business opportunity, the stage of the company, and the capital intensity of the business. At the same time, OPM has a cost attached to it, as it should, and this manifests itself in a number of ways, with varying degrees of magnitude: (1) giving up equity in company; (2) losing control of business; (3) requirement to report to, or advise “outsiders” of activities. Given the “costs” of taking money, some may ask why take the money.
The chapters to follow in this Intro to Angel and Venture Capital Investing series will explore the choices that company owners have in funding their business, the decision-making process of capital sources, the value that early stage funding sources provide, structuring issues, and case examples of early stage private equity funded companies.
Next installment: Exploration of Bootstrapping/Self-funding options.