VCs Look Poised to Gain Share in Early Stage Deals

Listen to Goodwin Procter Partner Jonathan Axelrad tell it and it is easy to draw the conclusion that venture capitalists will regain early stage ground from angel investors.

Axelrad, a 20-year vet of working in the venture capital industry, says traditional VCs appear to be scrambling harder now for early and seed stage deals than 18 to 24 months ago.

More have set up fund subsidiaries for early stage investing and formalized relationships with third parties for new sources of early stage deals, says the attorney, referring to his client base.

Axelrad declined to discuss specific steps his clients have taken or to identify the third parties that have been striking deal flow relationships. But what he most likely refers to are angels, incubators, entrepreneurs and universities. And most probably, the kind of fund subsidiaries he has in mind are akin to what Greylock Partners set up for Reid Hoffman when it gave him control of a $20 million seed and early stage slice of the firm’s $575 million 13th fund.

“I see venture firms with hundreds of millions of dollars under management who are happily making investments in the sub-million-dollar range,” Axelrad says. And the number is increasing.

VCs have certainly not ignored early stage. Even during the downturn, the percent of investments dollars they turned toward early and seed stage deals increased – to 35% in 2009 from 25% a year earlier. So far this year, the level is largely unchanged. Thirty-three percent of invested dollars are funding seed and early stage startups through the third quarter. As today’s MoneyTree Report states, a third of U.S.-based VC investments are going to first-time deals, which are typically early stage startups.

But some signs suggest angels hold an upper hand. A study this week by the law firm Dorsey & Whitney found that 59% of early stage entrepreneurs who raised money took it from angels. Nineteen percent raised it from VCs.

Yet there are signs these active angels could be over extending themselves. Research from the University of New Hampshire found more angels in the position of needing to reserve cash for follow on rounds. The share of their deals with early stage companies fell to 35% last year from 50% over the previous five years.

This may leave room for VCs to muscle in. “My experience is that venture firms are substantially more energized about doing early stage deals than five years ago,” Axelrad says.