Venture capital firms are making investments earlier in the life cycle of target companies, overlapping with angel investors as they fund more startups with smaller checks.
Smaller investments by venture capital funds—sometimes a half-million dollars or less—have become increasingly pronounced in Orange County, home to industry clusters in technology, medical devices, and other sectors stocked with a vibrant base of entrepreneurs.
The venture capitalists’ shift to smaller investments and growing sense of collaboration with angel investors are helping downsize risk and increase potential gains upon portfolio companies’ exits.
The shift downward is being driven by a substantial drop in startup costs over the past several years.
“Especially in companies that are software-driven, including digital media and mobile, the cost to launch the company and really get it to a point where you can see whether there’s going to be traction has come way down,” said Bruce Hallett, a managing director and cofounder of Corona del Mar-based Miramar Venture Partners, which focuses on technology-based companies
Stuart Frost would know.
Frost, a serial entrepreneur, said his 2003 data storage application startup, Datallegro Inc., required his team to “invest heavily” in hardware. It therefore needed more money from investors to make the venture happen.
“We raised $60 million in VC money to do that,” Frost said.
Microsoft Corp. bought the Aliso Viejo-based company in 2008 for $275 million.
Cirro
Frost’s more recent startup, Cirro, which provides platforms for big-data analytics and cloud-based storage, has raised just $2.5 million since launching in 2010, getting the money from both angels and venture capitalists.
“If Cirro had been started at the same time [as Datallegro in 2003], it would have needed a similar outlay of capital,” Frost said. “These days, we can just rent the same capabilities from Amazon.”
“It’s just different times,” he said. “You can do things [online]. … You can actually find a decent amount of progress with a few hundred thousand dollars.”
San Juan Capistrano-based Cirro’s backers include “numerous angel investors,” plus Miramar, Mark IV Capital Inc. in Newport Beach, and Frost Venture Partners, an incubator and “fund aggregator” Frost created to start and nurture companies from within.
Frost Venture has seven companies in its portfolio and has raised about $25 million in angel funding, Frost said, adding that it plans to raise another $40 million or so.
Some angels welcome collaboration despite the inherent competition VCs represent as they move into smaller investments.
The expansion of “VC funds into what one might call traditional ‘angel territory’ is … a nice addition to the investment ecosystem,” said Don Kasle, chairman of Irvine-based angel-investor group Tech Coast Angels. “I see that as a supporting opportunity for the entrepreneurs and for us. There’s only so many deals that we can fund and do due diligence on. In reality, if VCs are coming into the angel market to begin funding, there’s probably an awful lot of room for both.”
Tech Coast Angels has worked with venture capital funds on both new and follow-on deals. The organization put $8 million in new deals with a number of companies that raised a total of about $18 million last year.
“So that $10 [million] came from other angel groups or VCs,” Kasle said.
The gap was bigger for follow-on investing: Tech Coast Angels provided $1.4 million out of a total of $21 million.
An average new investment by Tech Coast Angels has been about $400,000 for the past couple of years, according to Kasle.
“What traditionally has been a dark hole and is now becoming brighter is the investment opportunity between half a million dollars and $2 million,” Kasle said. “That’s where we’re seeing some more VC activity.”
Investment banker and startup adviser Tarang Shah called that new midlevel space “super-angel territory.”
“It’s not really angel, and it’s not really institutional VC,” said Shah, who currently serves as a managing partner at Bois Capital LLC investment bank in Newport Beach.
He spent several years at the OC office of Newton, Mass.-based Softbank Capital, where he focused on West Coast investments. Shah also is the author of “Venture Capitalists at Work.”
“I think there’s a great opportunity between small seed rounds and series-A rounds,” Shah said. “VC firms are very comfortable moving into that range. Before, it was sort of hands off. Angels would [invest first and then] hand it over to series-A investors. But now they are working in the same deals.”
Investor collaboration and earlier moves are also seen as ways to dampen risk for the parties involved.
“They’re changing their risk-reward profile,” said Dean Stoecker, referring to venture capitalists.
Alteryx
Stoecker is founding partner and chief executive of Alteryx Inc., a data analytics company based in Irvine. “The investor wants to be the early worm to get a foothold but wants to put in as little as needed to see if the seed actually sprouts. Then the farming can begin with bigger checks.”
Stoecker has seen 16-year-old Alteryx through three separate funding rounds since its start. It got $1.8 million in seed money from Thomson-Reuters Corp. and additional funding from Palo Alto-based SAP Ventures, a “traditional” venture capital firm, according to Stoecker.
Alteryx recently got funding from Irvine-based Toba Capital, a venture capital firm started by Vinny Smith after the $2.4 billion sale of his company, Quest Software Inc., to Dell Inc. last year.
The changing investment landscape, while it “certainly allows entrepreneurs to get companies up and running without as much risk as they used to,” has Frost concerned about gaps left by the move of VCs into the lower end of the investment spectrum. A bigger VC presence in the smaller investment range might sap available capital in the later funding rounds, he said.
“The danger is when there’s not much series-A funding for these companies,” Frost said. “Seed funding is easier to find, but they can’t raise the next round. A lot of these companies will be disappointed [when they see] the funding isn’t there.”
