Where have all the angels gone? That is the question a growing number of ambitious but cash-strapped small firms are asking as they struggle to find investors.

Already hit by a slump in bank lending, they are now suffering as angel investors thin out, forcing them to delay expansion. The absence of angels is being made worse by the retreat of venture capitalists, creating a widening funding gap for firms.

Angel groups, which usually invest about £1 billion in British businesses each year, are expected to invest a third less this year, said Jenny Tooth of the British Business Angels Association, which is trying to recruit new investors.

“There has been a general knee-jerk reaction since the last quarter of 2008, when angels started concentrating on their existing portfolios,” she said. “They are now a lot more risk-averse and less willing and able to make investments.”

The demand for funding from small and medium-sized enterprises (SMEs) has soared at the same time. “We have seen a 40% to 50% increase from SMEs knocking on the door,” said Tooth.

SMEs seeking large deals face particular problems. In the final quarter of 2008, venture capitalists invested in 50% fewer deals than the same period the year before, according to the British Venture Capital Association.

“With syndication it’s possible for angels to do deals up to £2m but beyond that it’s difficult to find money. Venture capitalists these days are not looking at deals much below £10m,” said Tooth.

Noel Guilford, chairman of the Forum of Private Business and owner of Guilford Consulting, a corporate finance adviser, said: “There’s no doubt angel investing in SMEs is falling. Angels like to see their investment being geared up and they can’t get the same returns without bank debt.”

Those investors that are still looking are getting pickier and hunting for better deals, he said. “They are more risk-averse. Small firms’ working capital requirements increase as they come out of recession and those who understand that dynamic realise that investing is far more risky.”

SME owners are risking more of their personal wealth, said Guilford. “For the first time in quite a few years mature businesses have seen their bank facilities withdrawn or reduced. We are seeing people borrowing personally to prop up their own businesses.”

The investment drought is forcing those looking for funds to be creative. Simon Campbell, founder of ViaPost, which uses the internet to print and deliver commercial post locally, used his own business network and those of fellow directors to find investors.

The start-up business raised £500,000 from about a dozen individuals in the final quarter of 2008, said Campbell. “We had to go out and look for them but I’m fortunate this is not my first business and I’m a member of the Supper Club and other entrepreneur networks, which made a difference.”

Private individuals who do not see themselves as angel investors have become a recent and often untapped source of finance. “There are a lot of people with money in the bank who are annoyed it’s earning them so little and who look at an Enterprise Investment Scheme-registered business and don’t seeing throwing £50,000 at it as a big risk,” said Campbell.

He has since gone to high net worth individuals to borrow money after being rejected by Royal Bank of Scotland for a loan through the government-backed Enterprise Finance Guarantee scheme. “After putting a lot of information into their black box, the computer said ‘No’. They offered £100,000 under a different facility, which had to be backed by a load of guarantees.”

He is now borrowing £200,000 via firstfunding.org, which match-es businesses with investors. It will enable him to avoid giving away more equity. “The last thing you want to be doing when you’re approaching breakeven is to take on more equity when the banks should be there to support you.”

Will King plans to secure £5m to fund the growth of his shaving products firm, King of Shaves, by offering £1,000 bonds to up to 5,000 retail investors, who will receive 6% interest a year (plus free shaving products).

Chris Gull of Hudson & Bridges, a concierge company in Brighton, is also having to be creative after failing to secure bank lending for a £500,000 bar, café and performance venue in the city. “I used to own a dental practice so I’ve been part of the Brighton & Hove business community for a while and I’m using that network,” said Gull.

He has so far raised £20,000 of seed funding from local investors to secure the lease and pay for the planning process. He is considering funding the next stage by inviting small investors to put in £5,000 or less. “It would be like the way small films are often funded. It would give people a chance to invest money in a local venue at a level they understand is a punt.”

Raising money in this way has advantages, said Campbell. “It’s cheaper and it means you have a group of successful people with a small stake in the business. They are shouting about it to their networks and getting us referrals and new business.”