May 3 2013
by Todd Hixon

It’s Easier To Start A Venture Than Finish It

This post first appeared at

We’ve seen a boom in U.S. angel funding of new ventures in recent years. A study performed by the University of New Hampshire Center for Venture Research (more) estimates that angels funded 66,000 companies with $22 billion (an average of  $330k per company) in 2011. That’s up from 38,000 angel investments 10 years ago.

What is happening? Here is my view:

The cost to start a company has declined dramatically. A smart phone app can be built for a few hundred thousand dollars. One of our companies built version 1.0 of a robust cloud-based shared workspace system for about $1 million.

The cost to operate has likewise declined. A couple of our companies service about a million users with operating expense of about $20,000 per month, using Amazon EC2 or similar cloud infrastructure.

It’s cheaper and easier to acquire an initial user base. The major app stores (Apple, Google, Amazon) make it simple and inexpensive to publish applications. There is a cornucopia of social marketing tools. Sophisticated search helps users find products that offer special value. And social networking companies are inherently viral: customers become salespeople.

Knowledge diffusion has accelerated. Boot camp programs like TechStars help entrepreneurs learn how to use these tools and techniques. Entrepreneur clusters like Cambridge Innovation Center (link) help entrepreneurs teach and motivate each other.

And [big “and”], there are some great, well known success stories. Instagram spent less than $7m before it was sold to Facebook for a cool [revised] $700 million. And it is truly a phenomenon with users. Zynga, Rovi (Angry Birds), 4Square, and GroupOn are other examples of companies that began with small investments and  exploded to stardom.

Considering lower barriers to starting businesses and high potential rewards, one can see why entrepreneurs and angels have jumped in. Plus, there is inherent appeal to the idea of “reinventing venture capital” and leap-frogging the old guard.

But [big “but”], once a business has a start, it’s often hard to take the next steps. Few businesses get as much growth as they need from viral marketing, especially growth among customers who will pay. Proactively acquiring customers in volume is still expensive: when a business needs to roll out its revenue strategy and drive growth, it needs to spend money on marketing and sales, so it needs to raise money. GroupOn raised over $1 billion from venture investors and spent most of it on growth: via organic customer acquisition or acquisitions.


Thirty angel fundings for each initial VC funding


And, while angel funded start-ups are numerous, initial venture fundings are comparatively scarce: in 2011 1,800 companies raised $8 billion in initial venture capital financings, an average of $4.4 million per company*. Venture capital funds typically invest after angels, when a business is more proven and needs bigger dollars to build out its product and scale its operations. Statistically, only about 3% of angel-launched companies will raise venture capital. So the angel boom is definitely a boon for venture capital funds which are seeing a large flow of prototype-stage investment opportunities.

Many angel-funded companies will not try to raise venture capital. Some will fail, some will become “lifestyle” businesses (providing a living for a few people, growing slowly), and some will be acquired. However, finding a buyer is difficult for companies without scaled-up revenue. Acquirers dislike buying losses, and there is a virtual herd of companies at this stage looking for exits. Hence, corporate development teams are busy, decisions are slow, and prices are often disappointing.

Venture is a cyclical business. A boom is usually followed by some type of correction. Some angels have apparently done very well (track records are seldom analyzed, but an angel I know well has an amazing record). But current market conditions argue for a high degree of caution. Building a company is a long race that’s hard to finish.

*Source: NVCA 2012 Yearbook.

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