I was contacted a few days ago by an intermediary representing a start-up entertainment company with an interesting business plan. He was in search of prospective investors and was hoping I could provide him with some leads. I informed him, as I have others, that in my experience a very early stage company such as the one he was representing typically raises capital from "family and friends." Then, once it has reached a certain level of critical mass, say $3 - $5 million in sales, it will be in a better position to pursue “institutional” venture capital to help fund the next stage of development. Angel investors can be an alternative or adjunct to family and friends for such early stage deals. However, the search for angels should be a local one as these investors typically look to invest in nearby companies as it offers them an opportunity to monitor their investments first hand.

The point is that venture capital firms have been able to raise very large sums of money the last few years as a result of the increasing popularity of alternative investment vehicles among institutional investors. However, with so much capital to deploy, most venture funds do not invest in, or even review, start-up situations. They feel they just can’t put enough capital to work in such small deals to make them worthwhile investments. Sure there are exceptions to all rules, but by and large this is a fact of life and the sooner embryonic companies and their intermediaries understand this fact the faster they will be able to focus on raising funds from the types of investors who actually afford them a chance to succeed in those fund raising efforts.

While this is the current state of the venture world, it seems to me to be a little short sighted on the part of venture capitalists. I believe today’s typical large venture fund would be smart to set up a separate fund internally, capitalized with a small percent of the firm’s overall capital, with the mandate to invest in early stage companies. After all, it is these type of investments, more so than the current wave of deals involving “financial engineering” of mature companies, that offer the chance for meteoric growth and mega returns. At least in my opinion.

R.A. Dorfman
April 20, 2006