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Angels … then death? Amid boom in angel investing, the next funding round becomes new Valley of Death for startups

It’s not a bad time to be a D.C. tech founder in search of seed funding.

New angel investors and seed-stage venture capitalists aren’t shy about signing scores of checks. Barely a day goes by when rumor of another startup pulling in $50,000 or $100,000 doesn’t enter circulation.

Entrepreneurs have far more seed funding options today than they did just a few years ago, including angel networks, venture-backed accelerator programs and wealthy individuals who — after sitting on the sidelines through one or two recessions — are betting cash on risky early-stage deals.

But after the angel round, what’s next?

The region’s glut of new first-in funders hasn’t been accompanied by an equal number of institutional investors ready to take the handoff from the seed guys. That can mean greater pressure to become self-sustaining faster without any more outside capital.

Though, for some companies — like consumer app developers — that’s not necessarily a problem, said Simon Rakoff, a general partner with District-based Fortify Ventures LLP who recently launched the Standup Capital angel group.

“If you take your typical mobile app company, with $100,000 or even less, you can build and launch a working fully functional app that people will download and pay for,” Rakoff said. “Most of the companies that we’re seeing now are really able to capitalize on the reduced cost of entry. You don’t need $10 million or $20 million anymore.”

But that’s not the case for all tech-sector inhabitants, especially enterprise startups that face a much slower sales cycle — and a much steeper climb to land even the first customer. And few companies, whether they are trying to tap consumer or corporate markets, can rapidly scale up without external capital.

The advice from investors and entrepreneurs seems to return to one major theme: Don’t expect more investor money to be waiting for you; get profitable, and fast.

“If I were an angel investor, if I were advising companies out there, I would say don’t build your business plan on the assumption that you will raise institutional capital in the next couple of years,” said John Backus, managing partner of Reston-based early-stage venture fund New Atlantic Ventures. ”Build your business plan so that you can get to profitability on your angel round.”

The last quarter saw a rash of “growth” rounds for established companies that wanted expansion capital. “Want,” not need, is the operative word. It’s a long road from an angel-backed startup that needs investor cash to a credible business that can take funding on its own terms.

It’s the middle of the barbell, however, that remains unwieldy. The Washington area is home to traditional venture funds, like New Atlantic Ventures and Vienna-based Grotech Ventures, which typically provide funding between the extremes of seed and massive growth. But broadly speaking, that segment of the investment world isn’t getting the surge of momentum and enthusiasm the angel market is seeing.

In the first nine months of 2012, U.S. venture firms raised $16.2 billion, a 31 percent increase from the same period last year but well short of just four years ago. In 2008, VC firms raised $25 billion, according to the National Venture Capital Association.

By contrast, in D.C. alone, three new angel groups have stood up in recent months: NextGen Angels, led by Dan Mindus of the Virginia Center for Innovative Technology’s GAP Funds; Rakoff’s Standup Capital; and K Street Capital, led by Startup D.C. Chairman Evan Burfield. All are filling what was more or less a vacuum in past years.

According to the University of New Hampshire’s Center for Venture Research, 27,280 startups raised $9.2 billion in the first two quarters of 2012, up 3.7 percent and 3.1 percent, respectively, from the same periods last year. Less than 3 percent of them will be able to raise institutional VC, Backus estimated.

“That doesn’t mean that 97 percent of them are going to die on the vine,” he said. “A lot of them are going to be talent acquisitions, a lot of them are going to become lifestyle businesses. Then 70 or 80 percent of them are going to crash and burn.”

So how do you avoid the crashing-and-burning stretch in the long trek through the post-angel Valley of Death?

Perhaps take some advice from Reggie Aggarwal, who guided his McLean-based software company Cvent Inc. through a more than decade-long funding drought before raising a resounding $136 million last year.

“A lot of times you raise your angel round, then you raise your [Series] A, then you get your B. And you’ve never really disciplined yourself, because you have money coming in, and it doesn’t really force you to consider how to build a company that’s actually a profitable company,” he said. “Too many startups all focus on market share, and they don’t focus on profitability, because everyone is telling them ‘growth, growth, growth.’”

Backus had a similar take-away: “It’s a matter of getting the business to a scale and getting it profitable, or near profitable. If you’ve got a business that’s profitable, and scaling nicely, you can wait it out.”

But on the other hand, he warned, “if you’ve got a business that’s losing money, time is your enemy, not your friend.”

Washington Business Journal
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