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Angels And Venture Capitalists: Substitutes Or Complements?

Angels And Venture Capitalists: Substitutes Or Complements?

Thomas F. Hellmann

Saïd Business School, University of Oxford ; University of British Columbia (UBC) – Sauder School of Business; University of Oxford – Said Business School

Paul Schure

University of Victoria – Economics

Dan Vo

Sauder School of Business, University of British Columbia

February 23, 2015

Saïd Business School WP 2015-2


Angel funding is often viewed as a stepping stone towards obtaining venture capital. An alternative perspective is that angel investors and venture capitalists are distinct investor types that rarely mix with each other. Using a unique database from British Columbia, Canada, we provide evidence that angel and venture capital funding are dynamic substitutes, not complements. This finding applies across the performance range. Using an instrumental variable approach based on tax credits, we find evidence of both company-led selection and investor-led treatment effects. The substitutes pattern is more pronounced for casual angels and angel funds than for serial angels.

Angels And Venture Capitalists: Substitutes Or Complements? – Introduction

Equity financing of entrepreneurial start-ups has traditionally been equated with venture capital (VC henceforth), but the importance of angel investors is increasingly recognized. An OECD report from 2011 notes that “While VC tends to attract the bulk of the attention from policy makers, the primary source of external seed and early-stage equity financing in many countries is angel financing not VC” (OECD 2011, p.10). This same report estimates that the total angel market is approximately the same size as the VC market, an estimate in line with earlier studies (e.g. Mason and Harrison, 2002; Sohl, 2003).

How does angel financing interact with VC financing? Two opposing points of view seem to have emerged among practitioners. The first view sees angels and venture capitalists as synergistic members of a common financing ecosystem. They have different skills and networks, not to mention different levels of amounts to invest. Companies benefit from the combination of these attributes. Marc Andreessen, venture capitalist and founder of Netscape, for example notes that “[…] to get the best introductions to the A stage venture firms is to work through the seed investors […]” (Sanghvi, 2014). A common view is that angel financing is a“stepping stone” to obtaining venture capital. Benjamin and Margulis (2000) note:  “Angel investment runs the critical first leg of the relay race, passing the baton to VC only after a company has begun to find its stride.” The examples of Google and Facebook powerfully illustrate this stepping stone logic.

The second view sees angels and venture capitalists as alternative financing modes that do not mix well. They are competing approaches for financing companies, where companies that obtain funding from one type of investor are more likely to stick to that investor type. This could be because certain company attributes lend themselves to one type of financing, and/or because investors guide their companies towards staying within their investor type. Michael Arrington, founder of Tech Crunch, notes in a blog entitled “VCs and Super Angels: The War For The Entrepreneur”: “Pick the wrong investor and you’ve closed the door on others. You’ll never even know why it happened, but it will.” (Arrington, 2010)

In this paper we empirically examine the relationship between angel investors and venture capitalists (VCs). Our research question concerns the dynamic investment pattern of start-ups, and we ask whether companies that obtained angel financing are subsequently more or less likely to obtain VC funding, and vice versa. We specifically test the “complements hypothesis”, which suggests positive dynamic interactions between angel and VC financing, against the “substitutes hypothesis”, which suggests a negative dynamic relationship.

The biggest obstacle to researching angel investments has been access to credible and systematic data. We collect data related to a government program in British Columbia, Canada (BC), where tax credits are available not only to VC firms but also to angel investors (Government of British Columbia, 2014; Hellmann and Schure, 2010). The regulatory filings under BC’s Investment Capital Program offer a unique opportunity to obtain systematic and detailed data on both angel and VC investments. A useful feature of this dataset is the availability of documents that list all the companies’ shareholders over time, which allows us to construct detailed and comprehensive financing histories of start-ups. Our data includes 469 starts-up that were funded over the period 1995-2009.

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