It is well known that angel financing is an important source of financing for private firms in the United States. However, beyond the fact that the annual amount of angel financing is much larger than that of venture capital financing, and that angels tend to be individuals who invest much smaller amounts than venture capitalists in individual firms, little is known about the important economic differences between venture capital and angel financing.
One of the objectives of this paper is to bridge this gap in the literature by developing a theoretical analysis of the different roles played by venture capitalists and angels in funding private firms, and to develop an understanding of the situations under which firms make use of each type of financing.
The second objective of this paper is to develop an analysis of the dynamic features of financing contracts in the private equity market. The empirical evidence (as well as descriptions of individual cases) indicates that typically, firms undertake several rounds of private equity financing. Sometimes these different rounds of financing to a firm may come from the same source: for example, the same venture capital firm may provide multiple rounds of financing to a firm. In other situations, these different rounds of private equity financing may come from different sources: thus, a firm maybe initially angel financed, and may later switch to venture capital financing; alternatively, a venture capitalist may provide funding initially, but may choose to sell his equity stake and leave the firm.
The above situations lead us to ask several questions: First, are there any important differences between venture capital and angel financing contracts? Second, what motivates firms to switch from one form of private equity financing to another? Third, if firms make use of multiple rounds of financing from the same source, are there (and should there be) any systematic differences in the contracts between the entrepreneur and financier from one round to another (i.e., how do venture capital and angel financing contracts evolve over time?). We develop answers to many of these questions here.
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Venture Capitalists versus Angels: The Dynamics of Private Firm Financing Contracts
