Editor’s note: This report is the latest in a series from WRALTechWire about the “State of Venture Capital,” with an emphasis on what’s happening across North Carolina.

RESEARCH TRIANGLE PARK, N.C. - Startups may find venture capital dollars scarce in North Carolina and the Southeast, but angel investors are rising to bridge the gap.

The southeast is emerging as one of the country’s strongest regions for angel investment, claiming 10.3 percent of angel group deals done in the third quarter of 2013. That tally comes from the Halo Report, a quarterly angel investment report from the Angel Resource Institute, Silicon Valley Bank and CB Insights. California claimed 20 percent of third quarter angel deals followed by the Great Lakes region at 14.0 percent and New England at 12.2 percent.

The Southeast ranked even higher in the prior year Southeast claiming 17.2 percent of angel deals In the third quarter of 2012, second only to California’s 19.4 percent. In dollar terms, the Southeast represented 11.1 percent of angel dollars invested in the third quarter of 2013 trailing New England 25.3 percent and California at 19.0 percent.

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The rise of angel investment contrasts North Carolina’s fall in venture capital deals and dollars in 2013. While North Carolina has historically ranked among the top 10 states for venture capital, the state fell to No. 13 last year, according to CB Insights’ 2013 Venture Capital Financing and Exit Report. North Carolina was surpassed by fellow southeastern states Georgia and Florida.

But startups in North Carolina, and the Triangle in particular, do have new sources for early stage funding. Bull City Venture Partners, NC IDEA and Accelerate Health Ventures all raised money in 2013, noted Andy Schwab, president of First Flight Venture Center, a Research Triangle Park incubator.

“The really positive news for the area, it’s not necessarily true for North Carolina but it’s true for the Triangle, there’s a new pot of money to invest in that hasn’t been here for awhile,” said Schwab, who is himself a veteran entrepreneur and angel investor.

Venture capital challenges

Meanwhile, venture capital opportunities remain a challenge for startups. The number of venture funds is down; the funds that remain have larger sums of money that is targeted for investment in later stage deals. Schwab said.

The most recent data bears that out.

The VentureSource report from Dow Jones counted 52 funds that raised $4.5 billion in the fourth quarter, a 9 percent increase in the dollars raised but a 24 percent decline in the number of funds compared to the prior quarter. The median venture fund size last year was $125 million. In 2013, 3,480 deals were completed, raising $33 billion, according to VentureSource. That represents a 5 percent decrease in deals and a 1 percent increase in dollars.

Jason Caplain, general partner at Bull City Venture Partners in Durham said that he is seeing more angels writing checks for technology investments.

The Piedmont Angel Network, Triangle Angel Partners, RTP Capital, Wilmington Investor Network and Inception Micro Angel Fund are all hunting for new deals. Angels are a good option for some companies to find their initial funding, but not all.

“It often takes a lot more capital to aggressively scale,” Caplain said. “That’s where the bigger VC funds are needed.”

Stronger North Carolina dealflow, particularly in the fourth quarter, was driven in part by the expiration of the state’s angel investment tax credit. Some of those deals would have happened anyway but in some cases investors wanted to take advantage of the tax credit before it expired at the end of 2013, Schwab said.

The Wilmington region raised nearly $20 million from angels in 2013, said Jim Roberts, director of the Center for Innovation and Entrepreneurship at the University of North Carolina, Wilmington. Roberts believes the tax credit’s expiration will lead to a decline in angel investing in the state. Risk tolerance, he said, is the most important factor. While high net worth individuals dislike the risk of angel investing the tax credit rewarded those willing to take it, he said. And those investors could attract other investors.

Schwab would like to see North Carolina restore the tax credit. But he also doesn’t think it will will bring North Carolina angel investment to a halt.

“For really good deals, they’re still going to flow,” he said. “Deals on the fence aren’t going to get funded.”

But the rise of the angel investors does not fill the investment gap completely. Series A has historically been funded by venture capital firms, though some have pulled back from investing in this earlier stage. Angels are firmly investing at the seed stage and increasingly angel groups are coordinating with the Angel Capital Association and syndicating by region to make investments, Schwab said.

Some of those angel investments are going to series A rounds or at least an advanced seed stage. This kind of investing activity didn’t exist 15 years ago, Schwab said.

‘Good ideas always find money’

Angels are favoring investments in Internet startups, followed by software. That is similar to the investment trends of venture capital firms as outlined in the PricewaterhouseCoopers/National Venture Capital Association MoneyTree Report, which is based on data from Thomson Reuters. Software attracted $2.2 billion in venture capital investment in 2013, more than any other sector. The MoneyTree Report shows that software investments are at their highest levels since 2000.

Internet investments represented 36.0 percent of angel deals in the third quarter, followed by software at 22.4 percent, according to the Halo Report. Internet and software were the two top sectors for angel investment in the year ago period, as well.

Internet, software and mobile technologies are attracting investment because costs for developing technologies in those sectors have never been lower, Schwab said. Startups in hardware, medical devices or anything that faces a long regulatory path face higher costs and present higher investment risk. As a science-based incubator, First Flight sees a lot of these companies. Schwab said that they’re finding dollars by seeking Small Business Innovation Research grants, grants or loans from the North Carolina Biotechnology Center, or other programs. Startups tap multiple sources to fund their technology until it reaches a milestone where angels or venture capitalists might be able to consider an investment.

Caplain acknowledged the lack of capital from sources based in North Carolina. But he encourages entrepreneurs looking for venture capital to build relationships with out-of-state funds. He notes that venture firms such as Freestyle Capital, Andreessen Horowitz, Core Capital and Flybridge Capital will be visiting the Triangle over next month, speaking at Duke Ventures’ Venture Workshop and Bull City Venture Partners Entrepreneurs Series next month.

“You may have to persevere longer, you may have to go out of state,” Schwab said. “But good ideas always find money.”