This document discusses the changing relationship between venture capital and angel investors in funding startups. It notes that due to economic downturns, venture capital investment has declined while angel investment has increased. Certain industries like life sciences and software continue to attract significant VC funding, while sectors like telecom see less investment. The roles of angels and VCs are overlapping more, with angels now funding some later stage deals. Terms of funding may be more restrictive in poor economic conditions. Outsourcing is becoming an important strategy for startups to attract venture funding.

1. Changing Relationship Between
Venture Capital And Angels
Impact On Funding Of Startups
Prepared by
Charles V. Fishel
Hoffman Row Group
for
IP Society
February 4, 2004

2. Venture Capital
Trends

3. Venture Capital Historical Trend Data
(National)
2002-3
2001-2
2000-1
1998-4
1997-3
1996-2
1995-1
$0 $5,000,000, $10,000,000 $15,000,000 $20,000,000 $25,000,000 $30,000,000 $35,000,000
000 ,000 ,000 ,000 ,000 ,000 ,000
Investment Amount # of Deals
Price Waterhouse Money Tree at http://www.pwcmoneytree.com/moneytree/nav.jsp?page=historical on 040202

4. 19
95
$10,000,000,000
$12,000,000,000
$2,000,000,000
$4,000,000,000
$6,000,000,000
$8,000,000,000
$0
19 - 1
95
1 9 -2
95
19 - 3
95
19 - 4
96
1 9 -1
96
19 - 2
96
19 - 3
96
1 9 -4
97
19 - 1
97
1 9 -2
97
19 - 3
97
19 - 4
98
1 9 -1
98
19 - 2
98
19 - 3
98
1 9 -4
99
19 - 1
99
19 - 2
99
Investment Amount
1 9 -3
99
20 - 4
00
20 - 1
00
# of Deals
2 0 -2
00
20 - 3
00
20 -4
01
2 0 -1
01
Venture Capital Trend Data Silicon Valley
20 - 2
01
2 0 -3
01
20 - 4
02
20 - 1
02
Price Waterhouse Money Tree at http://www.pwcmoneytree.com/moneytree/nav.jsp?page=historical on 040202
2 0 -2
02
20 - 3
02
20 -4
03
2 0 -1
03
20 - 2
03
-3

5. Se
l f-
fu
C r n di
ed ng
it
Ca
rd
s
Fa
m
il y
Fr
ie
nd
Co Su s
m pp
m lie
As er rs
se c ia
t -b l
as B an
ed ks
Le
In nd
su I n ers
ra st
nc i tu
e tio
Ve C om ns
nt pa
ur n
e
Levels of Funding - Firm Maturity
Ca ies
p
Pr ital
iva ist
te s
P u E qu
bl i ty
ic
Eq
ui
C o P ub ty
m lic
m De
er
Bygrave, Portable MBA in Entrepreneurship (Wiley, 2d) p. 1
cia bt
lP
ap
er

6. Se
l f-
fu
C r n di
ed ng
it
Ca
rd
s
Fa
m
il y
FFF
Fr
ie
nd
Co Su s
m pp
m lie
As er rs
se c ia
t -b l
as B an
ed ks
Le
ANGELS
In nd
su I n ers
ra st
nc i tu
Pre-Bust
e tio
Ve C om ns
nt pa
ur n
e
Levels of Funding - Firm Maturity
Ca ies
p
Pr ital
iva ist
te s
VENTURE CAPITAL
P u E qu
bl i ty
ic
Eq
ui
C o P ub ty
m lic
m De
er bt
cia
IPO
lP
ap
er

7. Se
l f-
fu
C r n di
ed ng
it
Ca
rd
s
Fa
m
il y
FFF
Fr
ie
nd
Co Su s
m pp
m lie
As er rs
se c ia
t -b l
as B an
ed ks
Le
In nd
Now
su I n ers
ra st
nc i tu
e tio
ANGELS
Ve C om ns
nt pa
ur n
e
Levels of Funding - Firm Maturity
Ca ies
p
Pr ital
iva ist
te s
P u E qu
bl i ty
ic
CAPITAL
VENTURE
Eq
ui
C o P ub ty
m lic
m De
er bt
cia
IPO
lP
ap
er

8. VC Investments by Stage
(2003Q3)
60
50
40
30
20
10
0
Startup/Seed Early Stage Later Stage Expansion
Price Waterhouse Money Tree at http://www.pwcmoneytree.com/moneytree/nav.jsp?page=historical on 040202

9. “Pre-Bust”
(1998)
l Entrepreneurself-funds through
concept/patent application
l VCs step in to fund to IPO/acquisition
l Average Deal Size: $4 – 6 Million

10. “Internet Boom”
(1999-2000)
l Entrepreneur gets an idea!
l VCs step in to fund to IPO/acquisition
l Average Deal Size: $10 Million
(+++)

11. “Post Bust”
(2003)
l Entrepreneur gets an idea
l Self-funds through revenue
generation
l VCs step in to fund to IPO/acquisition
l Average Deal Size: $2 – 4 million
l Fewer deals done.

12. Valuation Changes
1999:
l Sequoia Capital paid $5 million for
8% of eToys.
2003:
l VCs agree to valuation of $4 million
and invest $4 million
l50%
SJ Mercury News, 5/18/2003, p.F1

13. l Venture market may be close to end of
"post bubble" adjustment:
l healthier technology stock market,
l higher percentage of "new" Series A
deals, and
l lower number of restructuring
transactions.
The Buzz of the Week, PE and VC Issues and Commentary, December 16th, 2003

14. l Nationwide, venture capital
investments rose 6 percent to $4.49
billion from $4.24 billion in the third
quarter, the highest level in a year
l Silicon Valley now provides more
than 37 percent share of the nation's
total venture capital -- up from the 34
percent average seen over the past
six years.
Posted on Mon, Jan. 26, 2004 , Venture funding soars by 22% By Matt Marshall, Mercury News

15. l Nationally, only 19% all the venture
capital handed out in 2003 went to
first-time fundings .
A Tough Chase for Venture Capital By Ellen McCarthy, Washington Post Staff Writer, Monday, February 2, 2004; Page
E01

16. l USventure capital investments
jumped 15 percent in late 2003
l Risk-averse investors mostly
shunned young startup companies,
pushing late stage financing to a 20-
year high.
http://www.msnbc.msn.com/id/4077505/ as of 040202

17. Changing Relationship Between
Venture Capital And Angels

18. Shift Away from VC Funding
100%
80%
60%
Non VC-backed IPO
VC-Backed IPO
40%
20%
0%
1998 1999 2000 2001 2002 2003 ytd
S.J. Mercury News, 5/18/2003, p. 1F

19. Shift Away from VC Funding
VC-backed Non-VC-
IPO backed IPO
1998 62 305
1999 231 278
2000 218 166
2001 18 86
2002 26 81
2003 ytd 1 5
S.J. Mercury News, 5/18/2003, p. 1F

20. Angels vs. VCs
l Considerable overlap and interplay among
l angel investors,
l private equity, and
l venture capital.
The Private-Capital Survival Guide. From: Inc. Magazine, March 2003 | By: Harris Collingwood

21. Angels vs. VCs
l Boundaries between angel investors and
venture-capital investors are particularly
fluid,
l having mainly to do with degree of
organization and size of their
investments.
The Private-Capital Survival Guide. From: Inc. Magazine, March 2003 | By: Harris Collingwood

22. Funding “Sweet Spots”

23. AMOUNTS RAISED BY SECTOR
(National - 2003Q3)
Industry Sector Amount Deals
Life Sciences / Biotechnology $929m 90
Software $856m 165
Telecommunications $492m 73
Medical Devices and Equipment $324m 55
Networking and Equipment $324m 48
Business Products and Services $209m 28
IT Services $173m 37
Semiconductors $168m 24
Computers and Peripherals $167m 31
Media and Entertainment $164m 30
Industrial/Energy $146m 32
Consumer Products and Services $120m 16
Electronics/Instrumentation $99m 12
Healthcare Services $51m 16
Retailing/Distribution $22m 16
Financial Services $15m 12
Price Waterhouse Money Tree at http://www.pwcmoneytree.com/moneytree/nav.jsp?page=historical on 040202

24. Amounts Raised by Sector
(National - 2003Q3)
Ot her
R et ail ing / D ist rib ut io n
El ect ro nics/ Inst r ument at io n
Ind ust ri al / Ener g y
C o mp ut ers and Peri p herals
IT Services
N et wo r ki ng and Eq ui p ment
T eleco mmunicat io ns
Software
B i o t echno lo g y
$0 $100 $200 $300 $400 $500 $600 $700 $800 $900 $1,000
Price Waterhouse Money Tree at http://www.pwcmoneytree.com/moneytree/nav.jsp?page=historical on 040202

25. Favored Sectors
l Lifesciences dominated investments
for second consecutive quarter,
l displacing software as top sector
l Lagging far behind:
l telecommunications and
l network sectors.
http://www.msnbc.msn.com/id/4077505/ as of 040202

26. Less-Favored Sectors
l Computer and communications
sectors continue to fight for funding
following massive over-investments
during dotcom boom years
l Telecommunications, which suffers
from lingering overcapacity, had
hardest time raising new money.
http://www.msnbc.msn.com/id/4077505/ as of 040202

27. Software
l Most viable new software companies
will be those that sell software as a
service.
“VCs make Silicon Valley predictions” Robert Mullins http://www.bizjournals.com/sanjose/stories/2004/01/12/daily50.html?f=et79
Silicon Valley /San Jose Business Journal, January 16, 2004

28. Nanotechnology
l May be “next wave”.

29. [Offshore] Outsourcing
l Venture capital firms are encouraging
outsourcing
l One major American venture capital
firm, for example, is understood to insist,
as a condition of investment, that “any
company it invests in outsource its
computer programming tasks to the
greatest extent possible.”
VCs Turn Their Gaze Offshore, Gabor Garai is a partner in the Boston office Epstein Becker & Green,
`http://www.businessweek.com/smallbiz/content/feb2004/sb2004022_8952_sb020.htm at 040202

30. Outsourcing
l Outsourcing will increasingly be viewed by
venture capitalists
l not just a way to save money,
l but to make money
l Outsourcing is a way for small companies to
speed development and focus on their core
competencies by leveraging cash.
VCs Turn Their Gaze Offshore, Gabor Garai is a partner in the Boston office Epstein Becker & Green,
`http://www.businessweek.com/smallbiz/content/feb2004/sb2004022_8952_sb020.htm at 040202

31. Outsourcing
l Company's ability to attract venture capital
won't be limited to its location, but
increasingly to its ability to make the best
use of its assets –
l both physical and intellectual
l Thus, outsourcing may help smaller
companies attract venture capital.
VCs Turn Their Gaze Offshore, Gabor Garai is a partner in the Boston office Epstein Becker & Green,
`http://www.businessweek.com/smallbiz/content/feb2004/sb2004022_8952_sb020.htm at 040202

32. Strategic Alliances
l Easier funding
l Particularly working with investment
bankers and consultants.

33. Desperation = Tough Terms
l The more urgent an entrepreneur's need
for money,
l the more onerous are the terms
l Desperate companies may sell equity to
someone and promise that investor will
never be diluted
l Severe terms can stop company's growth
cold."
The Private-Capital Survival Guide. From: Inc. Magazine, March 2003 | By: Harris Collingwood

34. Restrictive Terms
l During downturn, many venture capitalists,
secured their investments with so-called
``liquidation preferences''
l Clauses guaranteed that, if start-up was
sold,
l VCs would get their money first –
lbefore other executives or
employees.
Posted on Thu, Nov. 06, 2003, VCs hope higher spending will boost start-up sales
By Matt Marshall, Mercury News

35. Restrictive Terms
l This sets management and employees at
odds with their VCs
l May be counter-productive
l Start-up's employees won't profit, and will
resist merger / acquisition
l Many deals fall apart on their own
complexity.
Posted on Thu, Nov. 06, 2003, VCs hope higher spending will boost start-up sales
By Matt Marshall, Mercury News

36. Tough Terms
l Down rounds continue to dominate (79%)
l However, use of some tougher terms such as
l multiple liquidation preference,
l ratchet anti-dilution and
l pay-to-play are trending toward more
customary levels
l Suggesting increased VC optimism.
The Buzz of the Week, PE and VC Issues and Commentary, December 16th, 2003

37. Angels

38. Traditional Angels
l In the past, most angels flew solo,
l meeting with prospective entrepreneurs
individually,
l doing their own due diligence, and
l investing at their own pace.
A Chorus of Angels. Inc. Magazine, January 2004 | Page 38 By: Suzanne McGee Illustrations by: Christopher Neal

39. Major Hassle for Entrepreneurs
l Cash-strapped business owners were
forced to haul dog-and-pony shows from
one angel to next,
l making the same pitch over and over.
A Chorus of Angels. Inc. Magazine, January 2004 | Page 38 By: Suzanne McGee Illustrations by: Christopher Neal

40. Good News?
l New wave of angel groups is changing
l Angel groups, generally composed of 50 to
60 wealthy individuals focus on reducing
risk and increasing odds of finding a top-
quality deal
l They are far more likely to spot a flawed
business plan.
A Chorus of Angels. Inc. Magazine, January 2004 | Page 38 By: Suzanne McGee Illustrations by: Christopher Neal

41. Good News?
l Angels and seed funds that once
provided needed capital for first two
years of growth have adopted same
criteria as traditional venture funds,
l leaving entrepreneurs to fend for
themselves until they can
demonstrate traction.
Three Trends in Startup Financing 03.04.2003 - By Robert Dellenbach http://www.avce.com/main.php?load=displayMatch&newsid=128 on 040131

42. Active Investors
l 200,000 individuals
l Typical startup
l 5 – 6 angels.
Center for Venture Research at University of New Hampshire, Press Release 6/11/03

43. Sector Analysis
l 40% - Software
l 14% - Life Sciences
l (other than biotech)
l 5% each for other sectors.
Center for Venture Research at University of New Hampshire, Press Release 6/11/03

44. Stage
l 2002:
l Angels typically fund seed/start-up
stage
l47% of angel investments in
seed/start-up ventures
l 33% of investments were early stage.
Center for Venture Research at University of New Hampshire, Press Release 6/11/03

45. “In the Zone”
l If you are raising an angel round from
individual investors and you can get
away with selling 10-15% of your
company
l If you are raising a Series A round from
professional institutional VC investors
and you can get away with selling 20-
40% of your company.
12 Secrets of Negotiating the Best Valuation for Your Company
By Jeff Parness

46. Regional
Angel
Groups

47. Silicon Valley Band of Angels
l Founded in 1995. Invests across all high-technology
categories. Majority of investments have been made in the
seed or early round (Series A or B): $82.6 million into more
than 132 startups
l Sweet Spot: Silicon Valley-based high-tech start-ups.
l Average investment: $1 million
l Number of angels/investors in the network: 150
l Contact:
Band of Angels
3130 Alpine Rd.
Suite 200-7003
Portola Valley, CA 94028
415-441-2887
info@bandangels.com

48. CVBI Angel Investor Network
(Central Valley Business Incubator)
l Accepts applications only from businesses
in California's Central Valley region.
l Average investment range:
$10,000 to $500,000
l Contact:
CVBI Angel Investor Network
2555 Clovis Ave.
Clovis, CA 93612
559-292-9033
kfurtado@csufresno.edu

49. Sierra Angels
l Preference businesses located in Nevada, California, or
other nearby locations ---companies with unique products /
proprietary technology.
l Sweet Spot: Northern Sierra-based companies.
l Average investment range: $500,000 to $2,000,000
l Contact:
l Sierra Angels
PO Box 3215
Incline Village, NV 89450-3215
775-831-7804
Send E-mail to the most appropriate address:
l Software@sierraangels.com
Computing_Communications@sierraangels.com
HealthSciences@sierraangels.com
Internet@sierraangels.com
OtherTech@sierraangels.com

50. The Angels' Forum
l Invests in companies based in Silicon Valley / SF Bay Area.
l Portfolio companies include consumer products, enterprise
software, industrial products, Internet and E-commerce,
medical devices and services, networking technologies,
pharmaceutical, semiconductors, telecommunications, and
wireless. Most start-up companies come to group
prescreened through professional contacts in the banking,
investment, and legal fields.
l Sweet Spot: Companies specializing in disruptive
technologies.
l Average investment range: $100,000 to $750,000
l Number of angels/investors in the network: 25
l Contact:
The Angels' Forum
PO Box 1605
Los Altos, CA 94023-1605
650-857-0700
inquiries@AngelsForum.com

51. Fast Angels
l Invests primarily in companies in Silicon Valley. Seeks out
technology entrepreneurs focused on helping business "act
faster, act smarter."
l Sweet Spot: Seed-round financing in companies with less
than a $2.5-million valuation. Average investment range:
$50,000 to $1 million
l Number of angels/investors in the network: 12
l Contact: Web site only
l Submit business ideas via the Web site.

52. Monterey Investor Roundtable
l affiliated with Gathering of Angels
l Monthly presentations have included
environmental, biotech, biomedical, eCommerce,
nanotechnology, explosive detection, software,
hardware, semiconductors
l Investments are made by individual members
(Roundtable does not seek to invest as a group)
l Contact:
l cfishel@hoffmanrowgroup.com

53. Golden Capital Network
l Conferences where entrepreneurs
can present to VCs and Angels.

54. International Angels Organization
l Led by Hal Nissley

55. Non-Disclosure Agreements

56. Use of NDAs
l Most U.S. venture capital and investment
banking firms will not execute NDAs because
they:
l see many different projects and
l do not wish to inadvertently be perceived to be
in violation of NDA
l May want to steal your idea…
l Instead, entrepreneurs must rely upon firm’s
integrity as a firm and its close working
relationship with the client to achieve successful
outcomes.

57. NDAs - an Investment Banker’s Perspective
l “Possibly we could get NDA's from people we talk
to but then how could they help us without
discussing what we have with others. Usually these
types of agreements are not signed with
investment banking firms because of the very
nature of the work we are dealing with.
l We have already spent substantial time defining
who would be the critical partner in this matter, but
it would be hard to deal with anyone without telling
them what we are doing.
l It undercuts everything we will be talking about
when we meet.”
Robert Spira, Chapman Spira and Carson

58. Secrecy Backfired
l Entrepreneur
refused to provide
investment banker
with information for
due diligence
l By default, another
firm “won” funding
of $5.5 million.

59. l Only do
business with
someone you
can trust
l It’s
safer than an
NDA
l NDAs are nearly
worthless…

60. Hoffman Row Group, Inc.
98 Del Monte Ave., Suite 205
Monterey, CA 93940
Tel: 831-224-8800 • Fax: 831-401-2340
cfishel@hoffmanrowgroup.com
www.hoffmanrowgroup.com