Sunday, May 23, 2010

Angel Funding Better than VCs?

The Kauffman Foundation’s Paul Kedrosky reviewed the Inc. 500, a list of the fastest growing companies. Over the last ten years, 800 hundred firms made that list. 645 firms were either bootstrapped or angel-backed. Only 155 firms took VC money. 81% of the fastest growing companies on the planet did not take VC money! 

I spoke with Jay Turo, the CEO of Growthink, a investment banking firm located in Southern California.  He shared the matrix below (again from the Kauffman Foundation) on the danger of taking Venture Capital. A big take away from this matrix: a firm achieves the highest financial return by NOT taking VC money.

The data was self-reported (this may bias the data, although I am not sure which direction). Also, this data set includes a lot of deals done in the 1998-2000 period which may influence the data also.

But what does this mean for the Space Entrepreneur? Let’s look at the Suborbital industry as an example. Most of these young suborbital companies are bootstrapped or Angel-funded. But over the coming years, the profile of the industry will rise through mission success, the potential for increased NASA-funded projects, and increased speed to market of derivative products/services. As industry awareness grows, VC interest in the industry will undoubtedly increase. But do these young space firms want money from venture capital sources? But if not from the VC's, then from where?  With young software/Internet firms: a few hundred $K, a good idea, and frugal management can get you to market. As a general rule, Space entrepreneurs will need more capital to bring a product to market. I envision scenarios where these companies demonstrate a significant milestone like a flight to XX altitude. To go higher and faster, they need more capital for additional equipment and personnel. Will Angel funding be large enough for the needs of these growing firms? If angel funding is insufficient to reach the next major company milestone, the siren call of VCs will be alluring. If VC funding can taint a company (for reasons I am not going to get into today), what can be done to insulated the New Space industry from that siren call of VC funding while still promoting Industry growth?

Here are some potential solutions:
  1. For a generic list of suggestions, see my overview post on the Seven Signs of a Growth Industry.  Read below for some specifics.
  2. Increase Angel Activity. Again, let me recommend Angelsoft and its tools both for deal analyzing and its Angel groups to consolidate and focus funding toward worthy entrepreneurs. Growing the power of Angels will allow them to participate in larger subsequent funding rounds.  Although Angelsoft is not exclusively focused on the space industry, there are Angel groups using Angelsoft that are space focused.
  3. Increase Mergers and Acquisitions. Between 2001 and April 2010, Google acquired 57 companies. These firms developed a technology that Google wanted and sold their company to the giant search engine. They started their companies with a sale in mind! They planned the liquidity event from the beginning. Aerospace firms built on winning Government contracts shy away from this model because their name recognition and Past Performance are key elements in them winning future business. But suborbital firms (and most of New Space in general) are a part of a new generation of aerospace startups leveraging more than Government research grants to close their business case. I do not hear Armadillo, Masten, or others positioning themselves for sale upon reaching 100KM. I would like to see more space firms abandon the assumption they are building a company that will last 100 years. Once you develop a successful product, sell the company or spin off the technology and then sell the spin-off company. The cash generated both bounds a firm’s need for outside capital (dampening the allure of VC-backed capital) and can serve as the seed funding for the entrepreneur’s next venture. And young space/defense companies ARE being acquired within the space industry. From 2001 through April 2010, General Dynamics acquired 31 firms, Northrop Grumman, 14 firms; Boeing, 13 firms; Raytheon, 13 firms. One of Northrop’s acquisitions was Scaled Composites.  Look for large aerospace firms to duplicate Northrop Grumman’s strategy over the coming years – buying the innovations of the young and risk tolerant.

Venture Capital is like fire, a very powerful tool allowing some firms to achieve the impossible and change the world. But it is fire...I just hate singed eyebrows.

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