November 22, 2012 4:09 PM

This is a guest post by Ryan Caldbeck at VB, CEO of CircleUp, the largest equity-based crowdfunding platform in the US.

Six months ago I called the Director of Business Development for a well-respected angel group in California and told him about my company, CircleUp, an equity-based crowdfunding platform that would allow his angels to invest into private companies.  He had no interest in talking, saying “our angels wouldn’t be interested in something like this.”

30 days later, several of “his” angels invested through our platform (they had heard of CircleUp through word of mouth). As it turned out, his angels loved us because we gave them access to quality dealflow they would not have otherwise seen.

Crowdfunding has the potential to dramatically increase the ~$23B Angel investment market in the US and the ~$25-50B informal investing market (basically friends and family). It will lower the cost, in time and minimum investment size, to make early-stage investments, and thus expand participation in early-stage investing.  Heads of angel groups, many of whom are responsible for providing the group’s “proprietary” dealflow, and so-called “Super-Angels” will likely need to adjust their model with the coming disruption.

Some in the media have questioned whether that disruption will be good for investors and companies.  It will be.  More information and more choice will benefit smart investors and make fundraising more efficient for entrepreneurs.  Others have hypothesized whether this disruption will also extend to venture capital firms as well.

Over the past decade there has been a dramatic shift in the early stage funding landscape.  VC funds have raised larger and larger funds.  According to Tom Grossi of CNNMoney, a significant trend over the past decade has seen limited partners (LPs) to the VC industry concentrate “ever more capital among fewer firms with larger funds.”  As fund sizes increase, investors face two challenges. The first is a challenge of expected investor returns: Typically larger fund sizes come hand-in-hand with larger equity checks and later-stage investments, when businesses are less likely to provide out-of-this-world returns. The second challenge of fund size growth is that minimum LP commitment to the fund increases in tandem. Individual LPs who historically would have been able to participate in a small early-stage focused VC are now excluded because they can’t meet minimum thresholds of participation.

Largely in response to these trends, angel investing has grown significantly. But a market where only angels swoop in to provide necessary seed and early-stage capital is problematic.

The angel market is much less efficient than established venture capital. According to the Angel Capital Association, most angel investments happen locally – sometimes because of a desire to be close to the entrepreneur, but often because the deal was sourced through word-of-mouth, or even to support their local community. Sourcing is very difficult, in part because of the historical ban on general solicitation (lifted by the JOBS Act but not yet effective).  Angel investments have historically been conducted through personal networks (something that will shift with the JOBS Act’s lift on the ban on general solicitation). The typical Angel process includes lots of meetings and introductions – without a central location for buyers and sellers to come together.  AngelList is making a big push to bring the stealthy world of seed investing out into the public. We applaud them for this. But proprietary deal flow is still a hallmark of the industry, and leaves newer funders with less established track records in a weak position.

To summarize, angel investing is inefficient and rewards established players.

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