Who Receives Capital and Why Does It Matter?

Two recent papers shed light on the distribution and benefits of entrepreneurial capital. A CB Insights' report on the "human capital" of venture-backed Internet companies finds that vast majority of company founders are white. They also tend to be between 35 and 44 years old, male and have MBAs. The second report provides evidence that getting angel capital boosts a company's odds of survival, securing additional funding and faster growth. These benefits derive not only from the injection of capital, but also from the sustained guidance and supervision provided by angel groups. If both are correct, they suggest that founders outside of the typical profile might be underserved in access to capital and to mentoring and connections.

When venture capitalists are asked the most important factor in choosing a company for a deal, they often say that the founder or team weighs heaviest in their decisions. CB Insights drills down into this human element by providing data on the founders of Internet companies that received venture capital in the first half of 2010. The study includes data on race, age and experience, the number of founders per company, gender and the educational background/pedigree of the founders. It also provides specific data on deals in California, Massachusetts and New York.

Within the 165 deals tracked in the study, 87 percent of early stage, venture-backed Internet startup founders were white, with 83 percent of entire founding teams being all white. Only 77 percent of the general U.S. population is white. Asian founders represented 12 percent of founders, while making up 4 percent of the U.S. population. The percentage of Asian founders was larger in California, and their companies tended to receive larger investments. Black founders accounted for only 1 percent of company founders, while Native Americans and "other" represented less than one percent.

The founders in the study were overwhelmingly male. Across the country, 92 percent of founders were male and 86 percent of teams were all male. Massachusetts had the highest percentage of female founders with 27 percent. All-male and all-female teams received similar levels of funding, but mixed teams received substantially more.

Almost half of the founding teams had average ages between 35 and 44. Teams in the 26-34 age range, however, tended to receive more capital. Massachusetts favored somewhat older teams, New York favored younger teams, and California teams fell in the middle. Nationally, 51 percent of founders hold a Master's or PhD, but two-thirds of all teams had at least one person with an advanced degree. In New York, founders with only an undergraduate degree actually tended to raise more capital. Cornell, Stanford and Harvard produced the most founders with undergraduate degrees. Harvard, Stanford and MIT's graduate programs generated the most founders with advanced degrees. About 37 percent of companies had one founder, 40 percent had two, 19 percent had three, and 4 percent had four partners.

While providing an interesting snapshot of the founders who received funding in the first half of 2010, there are limits on the conclusions that can be drawn from the CB Insights report. It focuses exclusively on venture-backed Internet companies, and, since it is the first in a series of reports, no trend data is yet available. Also, without data on who is seeking for venture funding, the report does not reveal much about the preferences of venture firms. It is clear, however, that the population of venture-backed founders included in the study does not reflect the diversity of the U.S. population.

Read Venture Capital Human Capital Report Jan - June 2010 at: http://www.cbinsights.com/blog/venture-capital/venture-capital-human-capital-report-gender-and-education.

If venture capital is being doled out inequitably, it could have harmful consequences for entrepreneurs who do not fit the standard profile. William R. Kerr, Josh Lerner and Antoinette Schoar's The Consequences of Entrepreneurial Finance: A Regression Discontinuity Analysis examines the impact angel investment can have on a startup's long-term prospects. The results show that angel capital positively affects a company's odds of survival over time and their growth as measured by web traffic. These benefits are linked not only to the injection of early capital, but also to the full bundle of inputs that angel groups offer, including mentoring, oversight and connections.

Using the datasets from prominent angel groups Tech Coast Angels and CommonAngels, the authors reviewed the financing and performance of more than 4,500 ventures that had sought angel capital between 2001 and 2006. The data includes the number of angel groups, outside of Tech Coast Angels and CommonAngels, that had indicated an interest in investing in each company.

From this data, the authors find that there are critical mass thresholds in group interest that are predictive of a startup's chance of receiving angel funding. For example, 64 percent of all firms pitched to Tech Coast Angels received no interest from angel groups; 90 percent received interest from less than nine groups. These firms were very unlikely to receive angel investments. Among firms with interest from more than 35 groups, 40.9 percent receive funding. While it is unsurprising that firms with greater interest were more likely to receive funding, the authors were able to pinpoint the level of interest at which a firm is much more likely to secure a deal. Within the sample of Tech Coast Angel data, interest seems to reach critical mass when a firm has caught the interest of at least 20 angel groups. Firms that exceed that amount of interest are much more likely to receive angel capital.

Angel interest is important because the study found no other factor that was as significant in a company's long-tern odds of success. Among the firms that pitched to the two angel groups, firms that had interest from more than 20 groups were more likely to be funded, to still be in existence and to have more web traffic. No other variables beside interest and funding (including industry, team size, the quality of the idea, initial marketing and product development, or revenue generation) were significant in long-term success.

Firms that received angel investment were 27 percent more likely to survive for at least four years. Funded ventures also had a 39 percent higher average improvement in web rank over unfunded firms. Angel investment also increases the likelihood of subsequent venture investment by 44 percent, however, further investigation revealed that angel funding per se was not central in follow-on financing. The authors suggest that the "soft" benefits angels provide, in the form of connections and mentoring, might outweigh the contribution of angel dollars.

Read at The Consequences of Entrepreneurial Finance: A Regression Discontinuity Analysis: http://hbswk.hbs.edu/item/6347.html.