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Angels vs Venture Capitalists: Substitutes or Complements

Venture south fallback
VentureSouth Team
Last updated: June 11, 2024
Open book

How do angel investors overlap, collaborate with, compete with, benefit from, or get punished by venture capitalists? There is a lot of opinion and research about this topic – here about pay to plays and VC behavior, for example. Today’s paper, Angels and Venture Capitalists: Substitutes or Complements? from Thomas Hellmann, Paul Schure, and Dan H. Vo provides an interesting review of how angels and VCs overlap. The article is available here on SSRN.

The authors look at how much, and how, angels and VCs work together on investments, or invest separately. Are “angels and VCs synergistic members of a tightly knit ecosystem,” with angels supporting companies first and then sending them over to VCs to scale (p.3), or are they “separate financing paths that rarely cross each other,” as angels back different types of companies or try to avoid their portfolio companies working with VCs (p.4)?

Using data on tax credits related to the British Columbia Investment Capital Program, so not the usual Crunchbase or Pitchbook sets, covering 469 companies (mostly technology-based) from 1995-2009 (a total of 18,925 investments by 9,424 unique investors across 2,184 financing rounds in 469 companies), the authors find a few interesting results:

  1. “Dynamic persistence” within investor types - i.e. a company that raised capital from one type of investor is likely to raise more from the same type (p.24).
  2. “Negative dynamic effect” between angel and VC financing – i.e. companies that obtained more angel financing in the past are less likely to subsequently obtain VC funding; and vice versa  (p.24).
  3. These choices are “company-led” (i.e. driven by the company characteristics), not “investor-led” (section 5).
  4. There is no “quality contingent complements” – meaning that VCs were not just backing the “better companies” from the angels’ portfolio, though there is evidence that VCs had better results (section 6).
  5. Overall the second description above, of separate financing paths, is much more the norm than the tightly knit ecosystem.

These results are summarized on pages 4-5 and derived in detail, with supporting statistics that for brevity we’ll skip here, in the rest of the article. 

This is pretty fascinating stuff. If you read the Silicon Valley-dominated tech press or consume angel content, I’m sure you would selected the “ecosystem” and “quality contingent” hypotheses. The overwhelming public opinion is (i) angels fund early to set up a company for VC money and (ii) angels fund weaker companies that often fail to “graduate” to VCs. Turns out, these ideas might not be correct.

Does this translate to the VentureSouth experience? 

Speaking personally and from anecdata, I (Paul) would agree with the article and side against the agreed wisdom, but I think it has changed over time and still varies by geography. Ten years ago, VentureSouth members absolutely prioritized businesses capable of achieving an “early exit” without necessarily seeking large amounts of venture capital funding, because that was simply not available in the southeast. This is consistent with the conclusion and data timeframe of the study.

But as more VCs have entered the SE market, and perhaps our members’ appetites have evolved to prefer slightly-later-stage, larger rounds, and more VC-coinvesting, this has changed a bit over time. We still prioritize time to exit, and hold rounds that intentionally bridge to large raises to stricter scrutiny. But we have coinvested with many smaller southeastern venture capital funds (and the boundary between “angel” and “micro VC” always gets more blurred), and appreciate the positive momentum from seeing a later-stage VC round well capitalize the company and increase our book value. Perhaps the dynamics change as ecosystems “mature” or get more VC capital locally or more interest from tech-hub VCs?

As we have noted in prior papers, getting good data is hard. This paper struggles, like all do, with quantifying exits. For example, resorting here in some instances to rating an acquisition successful “if there is some kind of press release with substantial and positive praise of the acquired company” (p.16) – which is a leap of faith! It also has to fill in a bunch of gaps (e.g. investors don’t necessarily claim or take their tax credits).

The jury remains out on whether recent trends will lead to better returns or not. In the paper, the VC investors had more frequent positive exits than the angel investors (with VC-only companies having a 27% higher probability of exit and 18% lower probability of failure). But this is not necessarily saying the VCs had higher returns – outcome depends on the entry valuation, ownership and dilution, challenges along the way, and much more. Either way, angel investing and VC investing is hard.

Our experience aside, the paper is a valuable reminder that good angel deals do not necessarily involve venture capitalists, and that positive exits can be achieved, and potentially more quickly and, though not covered in the paper, potentially with greater founder liquidity, without VCs. There are substitutes and complements to the “right way” to fund early stage companies! Overall, the literature remains inconclusive about the relationship between angel and venture capital funding (p.11).

As always, we like to pick out a couple of interesting nuggets of data or ideas. Here we learned:

  • In this dataset, VCs invested only slightly later than angels (p.18 and Panel A) – at 2.3 years for angels and 2.7 for VCs. The received wisdom is VCs invest much later than angels; even in early/non-SV markets like British Columbia 1995-2009, this was not true. (This supports the main “substitute” hypothesis, but even by itself is an interesting stat.) 
  • 24 companies IPO had an IPO – 5%, more than I would have guessed. More angel-only deals (6) IPOd than VC-only deals (5) – the opposite of what you guessed?

Of the 7215 angels in the study, 6801 are casual angels – meaning they only invested in one company in the dataset. (214 were serial angels and 200 angel funds.) Yikes. Please be diversified!