By Fortune Editors
May 16, 2011

“Venture capitalists” still exist, but it’s become a bit more complicated than it used to be.

By Manu Kumar, contributor

Reporters love the term “super angels.” They use it at almost every opportunity they get, and sometimes even when they don’t have the right opportunity for it. In my view, the terminology being used for early-stage investors is not as clear as it should be. I’ve talked about this on several conference panels, but figured it would make sense to do a post explaining my taxonomy of the early-stage investing world.

Friends and Family: Or sometimes referred to as the
3Fs
for Friends, Family and Fools. This is probably the very first group that an entrepreneur may approach for some funding. These are “investors” who are investing in you — not on the basis of your idea or the merits of your investment, but on the basis of a personal relationship. Sometimes this money comes with strings attached – strings in the form of expectations, which if not met can often hurt the relationship. The 3Fs invest their own hard-earned money, usually under $50K. They may or may not be accredited investors, and they don’t invest regularly or often.

Incubators and Accelerators: Incubators and accelerators have, to a large extent, replaced friends and family. The incubators and accelerators are investing $15-$50K in a large number of early stage teams (the current YC class has 60+ teams!). They provide additional value add in the form of coaching and mentorship, and most of all access to a network of other entrepreneurs and smart people — that to me is really the real value of being involved with an incubator. They also help get their teams get visibility amongst potential investors. The funding for the incubator may come from the principals running the incubator (as I believe is the case for AngelPad, i/o ventures etc.) or may come from VC firms (as is now the case with YC being funded by Sequoia).

The incubators invest usually for an equity stake and buy equity at an extremely low valuation (for example, 7% for $15,000, which implies a pre-money valuation of less than $200,000). The companies go through a 3 to 6 month long startup bootcamp and then typically try to raise angel/seed funding.

Angels: Angels are individual investors, who are investing their own capital and doing so on a part-time basis. Most angels will usually invest under $50K per investment. They are generally high-net-worth individuals who invest for a couple of reasons: Some do it because they genuinely love the startup space and this is their way of continuing to be involved in a startup, sometimes vicariously. Others do it because they are somewhat naïve about the returns from angel investing and think that this is a way to make a lot of money (in most cases the returns from angel investing will not be anything to write home about). Some do it for their own ego, to be able to say “I’m an investor in X, Y or Z” at cocktail parties.

There are too many angels and an even higher number of wannabe-angels. In fact, I would go as far as saying that there are too many unsophisticated angels. This is what has led to the current frothiness at the seed stage, because these angels pay up for access to deals. They know that they will only be able to get into the deal by accepting whatever terms are proposed to them — because the supply of money at the seed stage far exceeds the number of good quality companies at the seed stage. They also are insensitive to valuation because they’re investing a small amount of money and they’re hoping for a big hit — they’re buying expensive lottery tickets.

This in theory is very similar to the behavior of institutional investors, however, there is one big difference. Institutional investors make sizable investments in a company, so that when they do get a big hit they can make the whole fund. To me, the big hit approach doesn’t really work at the angel investing stage, given the small amount of capital being contributed by any individual angel (in short: less leverage).

Super Angels: I define a super angel as an individual investor, who is investing his or her own capital, but doing so on a full-time basis. They invest prolifically and also write slightly larger checks (~$100K) than the individual angels might and have a somewhat more sophisticated view of investing. They typically have a thesis that they’re trying to test and prove. More often than not, the “super angel” is a transient phase — a person who has decided to be a professional investor and is in the process of building his or her track record to be able to raise a fund.

Micro-VCs: This is the category that the press has really been calling super angels. However, in my view, the big difference here is that the micro-VCs are not investing just their own capital. They are still individual investors, they invest on a full-time basis as professionals, but they have funds with limited partners.

Some of the more well known micro VCs are Mike Maples at Floodgate, Aydin Senkut at Felicis Ventures, Jeff Clavier at SoftTech VC, Dave McClure at 500 Startups. [Note: Since K9, also has LPs — individuals and family offices — I would also classify as a micro VC.]

The fact that these micro-VCs have LPs is not to be understated, since it changes how they are investing. They now have a fiduciary responsibility to their LPs. This also changes the types of deal terms that they will undertake. As fiduciaries, the general partners of the have to begin to focus on the dreaded VC I-word: IRR. This now means that they will slowly start behaving less like angels, and more like institutional venture capital funds.

At first blush, micro VCs acting more like institutional venture capital funds may be considered a bad thing. However, there is a difference. The founders of these funds are entrepreneurs in their own right — either as people who have founded successful startups before, or as the founders of their own venture funds, which are also startups. In my view this means that these investors relate better to founders, creating for a more founder-friendly early stage investor.

Micro VCs acting more like the institutional funds can have positive effects as well. They will probably become more active in taking board seats, and take a more active role in helping the companies — the way the institutional funds used to do at the early stages about 10-20 years ago.

Institutionals Venture Funds: Your friendly neighborhood traditional VC fund. The institutional funds typically manage a relatively large pot of capital (~$300M or higher per fund, with multiple funds running). They have 4-10 partners who are investing on their behalf. They typical check size for the institutional venture funds has edged upwards to be $3M – $5M for an initial investment. Since the funds are managing a bigger pot of money, they need to be able to deploy $10-$20M per investment in order to the math to work out for them and consequently they look for much bigger $0.5B – $1B type of exits.

Here is a handy cheat sheet for investor nomenclature:

The angels of today, will become the super angels of tomorrow. The super angels of today will be the micro VCs of tomorrow, and the micro VCs of today, will become the early stage venture capitalists. The institutional venture funds will morph into what we used to call growth funds. The cycle will continue, as it inevitably does.In the venture industry, the only way for a venture fund to grow, is to move upstream and start managing a bigger pot of money. It is the natural evolution of the venture business and funds. This is what has happened with a lot of the institutional funds over the past decade. This gradual upstream movement in the venture industry, is what I refer to as
the Venture Spiral
.

The one change that seems here to stay is the initial financing of companies will come from the angels, super angels and micro VCs, who have become an intricate part of the venture capital eco-system.

Manu Kumar (@ManuKumar) is the founder of K9 Ventures, and previously was founder and CEO of SneakerLabs (acquired by E.piphany) and iMeet (acquired by Premiere Global Services).

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