Angels Keep Our Economic Future Alive

This following column was provided by Mark Davis. Mark is the author of Get Venture, a column designed to help entrepreneurs raise venture capital. He currently works at DFJ Gotham Ventures, a leading early-stage IT venture capital fund based in NYC.

The idea that angel investing typically declines in a recession is not new. The logic behind this is pretty basic – when the market crashes angels feel less wealthy and generally deploy less capital as a result.

When the market tanked last fall – the concern about the angel market (very reasonably) was one of the first to be raised by our industry pundits. For about ten weeks – this was the de facto conversation at venture events. The sky was falling and angel investing was expected to follow suit. Here’s what is interesting.

The New Hampshire Center for Venture Research recently reported that number of angel deals done in 2008 was down 2.9% in 2008.

To make sense of this number, we need to look at the run-rate of angel investments as that’s what is indicative about 2009. To this point, the run-rate for angel investments coming out of 2008 is probably a good bit lower than 3% down from 2007 given that the ‘wealth effect’ felt by investors was probably most prevalent in the last quarter of the year. To make a simplified adjustment, if you assume the entire decline in investing occurred in the fourth quarter, the implied run-rate would be 88% of the number of investments in 2007. In other words, the number of deals done by angel could be down by as much as 12%.

Looking at the big picture: The economy is in the midst of the worst financial crisis since the Great Depression, unemployment is sky rocketing, governments are pouring trillions of dollars into stimulus packages and angel investing is only down about 10%. That’s it? What happened to the belief that market for seed stage capital was going to completely dry up, leaving a wasteland of pre-revenue entrepreneurs to re-define the meaning of bootstrapping? It didn’t appear to happen – thank the big man.

The story, however, isn’t entirely rosy unfortunately. The pundits and the venture socialites were not wrong – the amount of angel capital deployed did declined by about 25%, meaning that entrepreneurs raised significantly smaller angel rounds.

If I had to choose, however, between fewer entrepreneurs getting fully funded or a lot of entrepreneurs raising less, I would vote for the latter. While fewer capitalized entrepreneurs nearly ensures that there will be fewer great new companies emerging, less capital per startup does not. While it will be more difficult for entrepreneurs to succeed with less capital, the best founders seem to have a knack for stretching a dollar as far as it needs to go. Furthermore in some instances under-capitalizing a startup can increase its chances, as limited resources can force entrepreneurs to operate more efficiently and position them to be more responsive to changes in their markets.

Startups are the fresh blood in our economic system. From a macro-perspective new companies drive growth, create jobs and increase the overall standard of living. They are always the team to be rooting for. As a result, the fact that angels are helping to keep the pipeline of new companies full is important news – news that beats expectations.