266 ENTREPRENEURSHIP
to $500,000, with an average investment of about $50,000.
14
This may be enough in
the early development stages, but additional money will be needed later if the firm is
successful. These additional sums may be out of reach for the angel or the angel may not
want to put too much money in a single business.
A third problem concerns the relationship between the angel and the top manage-
ment team. Private investors tend to be overprotective of their investment. They often
call the entrepreneurs or complain when things are not going well. If the business is ac-
cessible and local, they may even visit in person, creating headaches for the entrepre-
neur.^15
Small business investment companies (SBICs)are privately owned and managed
investment companies that combine private equity capital with debt borrowed or guar-
anteed by the government at favorable rates. They typically will lend the entrepreneurs
twice as much as the amount of equity invested. SBICs are regulated by the govern-
ment. In 2007 there were 385 active licensed SBICs and there is a National Association
of Small Business Investment Companies based in Washington, D.C. SBICs cater to
businesses with less than $6 million in after-tax earnings and net worths of less than
$18 million. Their investments are typically $2-3 million per company and it is diffi-
cult to get SBIC financing. “Typically, of all the companies that come to us, we might
fund one in 100,” says George Kenney, founder of Shepherd Ventures LP, a San Diego
SBIC.^16
Venture capital is outside equity that comes from professionally managed pools of
investor money. Instead of wealthy individuals making investments one at a time and on
their own, they pool their funds along with those institutional investors and hire profes-
sionals to make the investment and related decisions.
The venture capital industry has long been associated with new venture creation and
has its own entrepreneurial history.^17 As in any industry the factors that affect profitabil-
ity are the power of the buyers (investors), the power of the suppliers (entrepreneurs
who supply the deals), the threat of substitutes, the height of entry barriers, and rivalry
between venture capital firms. Also, macroenvironmental factors create both constraints
and opportunities for these firms, just as they do for new ventures. These macro factors
depend on the type of industry the venture capitalists specialize in. Because industry-spe-
cific knowledge is required for evaluating new venture financing proposals, venture cap-
italists tend to specialize in certain industries. For example, there are high-tech venture
capitalists who look for cutting-edge technological investments, distribution-type ven-
ture capitalists who invest in ventures that provide logistical benefits, and restaurant spe-
cialists who look to invest in the next Domino’s or McDonald’s restaurant chain.
Venture capital is risk capital: The investors are aware of the high risk that they will
receive little or no return on their investment. To compensate for this risk, venture cap-
ital looks for deals that can return at least 35 to 50 percent compounded over the life of
the investment (typically a five-year planning horizon). To achieve such lofty return, the
business opportunity must be extremely attractive with a potential for very strong
growth, and the venture capitalist must be able to own a substantial portion of the firm.
However, venture capitalists can often bring additional money to the table when need-
ed, and provide advice based on experience and on important industry contacts.
One new venture capital firm has very specific advice and contacts. It is In-Q-Tel,