A common meme floating around right now is that there is an Angel investing bubble.
In the sense that an enormous amount of capital is being placed at risk, and its popping will have grave macro-economic consequences, No.
The total amount of additional capital flowing through the Silicon Valley early-stage ecosystem, thanks to Super-Angels and newly minted millionaires, is on the order of half-a-billion dollars or so. It’s no more than a middling-sized VC fund. Would the emergence of a new VC fund be considered a bubble? Would the collapse of one signal disaster?
Furthermore, most of this capital is replacing traditional Series A deals. As we say around here, “Seed is the New Series A.” The same companies that needed $3M to launch now need $30K-$300K to launch. So, it’s not surprising that there are many more of them.
Ok, but could that mean that the amount of capital for funding startups in the old environment is too much for the new environment? That the total supply of early-stage funding dollars should come down by a factor of ten rather than the number of companies being funded go up by a factor of ten?
This one is harder to ascertain, but my sense is that if there’s too much capital, it’s not an overwhelming overhang. Most of the small companies being funded will fail, but the ones that hit will generate fantastic returns. And because of their small size and operating costs, a greater percentage will be able to get “ramen profitable” than was traditionally possible. Of course, actual exits might still be rare. The volume of small M&A deals hasn’t scaled with the volume of Angel investments in small companies. I think we’re all going to have to become even more comfortable with failures, re-starts, and the kind of team re-combination that one sees from one Y Combinator Demo Day to the next.
One thing that has been happening is that Angel investment valuations have been climbing very quickly – un-sustainably so. Twenty companies in an Investors’ portfolio carried at a valuation of X might now suddenly be twenty small bubbles at a valuation of 2x. They may not be able to clear their valuation in a micro-acquisition, or lead to a down-round in a VC financing, or just give a sub-par return for what might otherwise have been a hit. Prices on the margin *have* been rising, and that will hurt returns.
Prices have been rising not because of a huge influx of money (no big, macro bubble), but because of a modest influx of price-insensitive money. Prices get set on the margin. On Wall Street, it doesn’t take an influx of $5 Trillion into the stock market to move the total market capitalization of all of the companies from $15 Trillion to $20 Trillion. (In fact, money never moves into the stock market – it moves *through* the stock market, but that’s another post). Rather, a small series of secondary transactions at the margin, done by price-insensitive buyers at high prices, can move the quotational value of each stock considerably higher. Similarly, a small number of high-profile Angel investments, moving small amounts of capital but at very high valuations, can make the entire market look overvalued.
So what’s driving the new, price-insensitive bidders? It’s three things:
1) VC Funds – Every VC that announces a $20M seed fund is basically a price-insensitive Super-Angel. They’re buying first looks and options to finance companies in the future, so they’re not particularly price sensitive. When you have $1B under management, $20M is pocket change.
2) Entrepreneurs Set Pricing – Leaderless “party” rounds often end up with the entrepreneurs setting the valuation. And clever entrepreneurs are getting the less price sensitive investors to sign off on the initial terms, and then taking those terms, social proof in hand, to Investors who would have been traditionally more price sensitive.
3) New Angels – People who have had modest exits and are now angels are just building their portfolios. They don’t have enough exits under their belts to understand that price does matter. Not as much as in other businesses, because a Power Law distribution here means that one winner can dominate your whole portfolio. But it still matters because a lower price allows you to pick more startups in the hope of finding that one winner. New angels often hear that “If it’s the right company, price is irrelevant.” That’s true, but that gives too much credence in your own ability to pick the right company. If you’re informed just enough to know how un-informed you are, then you doubt your ability to consistently pick winners, and a low price will give you more attempts to figure it out.
So does this always end in tears?
For VCs, they will look back at these seed funds and find that (a) their seed efforts didn’t have the best returns and that (b) they didn’t always get the first look options that they always wanted. But it will probably still pay off. Seed is the new Series A, and if you don’t do Seed, you’re basically retreating to later stage.
For Angels who are price-disciplined, things will be fine – we are undergoing an incredible renaissance in technology, with smart phones taking computing to local arenas and social networks taking it into the mainstream populace. There’s a lot of opportunity and great companies will be built. For un-discplined Angels, there will be pain (unless they find their one big winner early), but it’s part of the learning curve inherent in the business.
Entrepreneurs win big, all-around. There has been some concern that all of these small companies are going to get orphaned – who will fund them downstream? I don’t necessarily view this as a negative, though. Even failed, these entrepreneurs are going to be much more employable than those who never tried or had the opportunity, and given that the minimum efficient scale of businesses is getting smaller and smaller, more of them will succeed than in any previous generation.
Entrepreneurs sticking to the old model of hiring are getting hurt. The old model used to be that after a Series A, you could hire an engineer and give him 0.25% of the company. Good luck hiring a great engineer for that in Silicon Valley now, for a freshly-minted startup with a small seed round in your pocket. The opportunity cost for that engineer is now to go join a Seed Combinator or raise some Angel funding. So, we’re going to see the equity gap narrow between the founders of raw startups and early key team members. Only the best startups with high valuations and tremendous traction can recruit under the old formulas anymore.
People often mock Super-Angels as being impure because they invest other people’s money. We also often get asked “What are VCs and Seed Funds doing on AngelList?” (They’re clearly marked, by the way, and you can choose who your pitch is visible to.)
I will propose, however, that whose money you’re investing is less relevant than on what terms it comes on. Venture Hacks was created to educate entrepreneurs when the Angel market was much less robust. At the time, if you wanted anything more than $250K, you basically had to go to Venture Capital.
Venture Capital, at the time, was a bundle of three things – Advice, Control, and Money.
The money is obvious – you want money, you go get it. But in the case of VC, it came with control – because the amounts being disbursed were large enough, it made sense that they needed to be actively managed. And finally, because it was actively managed, you cared about how well it was managed, and thus the advice.
Now, thanks to increased dissemination of information on the web, Venture Hacks and many others (Series Seed, A VC, Feld Thoughts, The Funded, etc.) have helped entrepreneurs understand the control layer. Y Combinator and other seed incubators have essentially helped “union-ize” the startup workforce, and via reputation and standardized documents, reduce the control that VCs have over startups. Lower capital requirements have opened up the playing field of investors, and reduced the need or even the ability of early-stage investors to do active portfolio management.
So Angels are investors who leave out the control. They essentially bundle just Advice and Money.
The amount of money invested and whose money it is are factors that play into it, but most Super-Angels eschew control. Similarly, some seed funds (i.e., True Ventures), and some larger funds (i.e., Andreessen-Horowitz) make entrepreneur-friendliness a core part of their ethos, and as such often leave out classic control provisions (M&A vetos) or mechanisms (Board seats). Conversely, you’ll see some Super-Angels or even traditional angels asking for more control if they’re investing a significant portion of their investable capital.
We are also seeing the emergence of Seed Combinators and Pure Money plays. Y Combinator, TechStars, I/O Ventures, AngelPad, Founder Institute, etc., are basically giving advice – if you’re going there for the funding, then you’re not doing the math. DST and later stage funds are pure sources of money.
The net effect is that the Venture Capital is slowly being un-bundled, as mature industries often are.
One side effect of all of this is that reputation matters a lot less. It used to be that VC reputation was built on their ability to pick winners (this has signaling value to other investors and potential employees), the advice that they gave, and how friendly they were to the entrepreneurs, given that they essentially had Board control. Most of this doesn’t matter anymore – it’s only the signaling and advice that carries much value for savvy entrepreneurs, and even the advice part is gradually being augmented and possibly replaced.
There is one thing that the new unbundled model can’t replace – which is the subtle influence of incentives. You may be able to get advice from the best advisors, money from the cheapest source, and keep control for yourself, but the one thing that an experienced VC partner can *uniquely* provide you is someone who has a strong incentive (because they own a lot of your company), and a very different perspective and experience base. That’s the old-fashioned “Investor as a Partner” model. It will always survive, to some extent, but it’s not the model that any but the best firms practice.
I co-founded AngelList because I was tired of saying no to entrepreneurs. I wanted to say instead, “yes, we can help you get funded.”
So, it’s especially disappointing when we get promising startups pitching on AngelList from remote locations. Some we’ve managed to get funded – including ones in Canada and Europe. Others are harder – especially in Russia, Latin America, and Asia.
The problem, as I’ve come to realize, is that funding markets develop in reverse.
In any given geographic region, the first companies that get funded are the ones that least need funding. They have strong operating histories, auditable financials, predictable cash flows, etc.. Funding these companies is less risky, and so a secondary, and then a primary, market forms around them. Call these the public markets.
After the public markets come the mezzanine investors, investing just before a company goes public. And because the mezzanines now exist to pick up risk, late stage private investors start forming behind them. And so on and so forth until you end up with Seed incubators and Angel investors.
Essentially, the single biggest risk that you have as an investor is “downstream financing risk.” The risk that the company won’t be able to raise more money once it has spent all of your cash.
This explains the apparent paradox that in less mature innovation cities, you’ll have an easier time finding VCs who will invest $10M in a mature business, than Angels who’ll invest $100K in a raw startup.
It’s a measure of the incredible strength of the Silicon Valley ecosystem that Y Combinator has chosen it as its hometown. YC and its brethren can only exist because of the rich Angel ecosystem. Paul Graham was smart enough to realize that his graduates couldn’t function without a rich Angel ecosystem, and went to great pains (such as AngelConf) to foster it.
Similarly, the true evidence that the NY Angel market has finally blossomed is that TechStars and a number of other seed combinators are choosing to do business there.
As an entrepreneur choosing your base of operations, take a careful look around. If you don’t see many VCs, you’re not likely to find many Angels either. Even though the VCs invest more money, they actually take less risk.
Similarly, Angels should realize how this whole pyramid functions. Investing in companies that won’t have access to Venture is incredibly risky. Investing at Venture valuations in Angel-stage companies means that your portfolio will likely generate negative returns.
Finally, if you are one of these talented entrepreneurs in a “frontier” location where there aren’t enough angels around, you have two choices. You’re either going to have to bootstrap to the point that you can show real financial returns, which will attract local and foreign investors. Or, you should consider relocating your headquarters (although not necessarily the whole company) to a funding hub.
All sorts of businesses are being built by violating assumptions about the privacy of data.
Flickr violated the assumption that you wanted your photos private by default. Before Flickr came along, the default photo sharing model, espoused by Shutterfly, Snapfish etc., was that of private photo sharing.
LinkedIn violates the assumption that your resumé is private.
FourSquare violates the assumption that your location is private.
Twitter violates the assumption that some of your thoughts are private.
Instagr.am violates the assumption that your mobile photos are private.
Blippy is testing the assumption that some of your financial transactions are private.
All of these services take your original notion and need for privacy, and trade them off against your need for fame and recognition.
It’s a common complaint – venture investors are driven by what other investors think, and therefore lack imagination and spine.
There’s some truth to it – it is human nature, after all, to look for social proof and authority when making decisions. However, that’s not the whole story.
In public markets, Investors make their decisions to invest in parallel, and in theory, most of the relevant information about a company is publicly disclosed, by law. Businesses are also much more mature, and therefore easier to value. Finally, the market is very liquid and very deep, so there isn’t much uncertainty about the supply of money available and availability of money in the future.
In a public market, it’s unlikely that I have access to private data about a company’s prospects, and if I do, I buy or sell the stock and move the price. Your ability to act on my knowledge is zero – by the time you learn about it, it will already be built into the price.
By contrast, in private markets, there is a lot more non-public information scattered across many individuals, and they have the luxury of deciding in series. Businesses are brand new and immature, and very difficult to value. The market is shallow and illiquid, and a “Keynesian Beauty Contest” means that you want to finance a company now just because it is likely to be financed in the future.
Therefore, when you see other investors piling into a company, you can infer: – They probably know something about the company or the market that you don’t, given that a lot of the information (quality of founders, state of competition, true size of market, etc.) is private and scattered across many minds
- This company is more likely to get financed in the future, since it seems able to attract many, high quality investors (the aforementioned Keynesian Beauty Contest)
- And you *still have time to act at the same price* on this new information
That last fact more than any other causes Investors to move in herds.
It is rational for private investors to move in herds. They have the strong incentive – limited and diffuse knowledge. More importantly, they have the means – financings in which the price doesn’t change as the investors decide in series.
A lot of entrepreneurs assume that the initial way to engage with an investor is to *insist* on a meeting. It’s a relatively safe assumption that anyone on the buy side (an investor, an advertiser, an executive at a large company) receives far more requests for meetings than they can follow up on, and are constantly looking for excuses to say “no.”
Synchronous activities, such as phone calls, screencasts, videos, and webex conferences are almost as bad. If you’re trying to get the attention of an investor or exec at a major company, and don’t want to waste either your time or their time, pay very, very close attention to the cost of their time and you’ll fare better. In order of escalation, one should proceed as follows:
- Introduction – have your introducer send them an email *without putting you in the to or cc line.* That way, if the target does not wish to engage, you haven’t put them in the awkward position of having to supply an excuse or a turndown. The introducer protects their ability to be taken seriously this way.
- Once you have a response / interest, send something written for them to look over and offer a phone call, webex, or meeting as next steps. Written always beats a video or screencast, since most intelligent people can read a lot faster than they can listen. A webex demo is a crutch – if your product has to be explained, it probably isn’t ready for the average consumer. And if it’s in beta, you should at least know how to open up a password-protected demo version.
- If the target displays interest in learning more, then you can move to a call or in-person meeting.
People who insist on a webex demo or in-person meeting at the outset are forcing the target to make a high-cost decision, and are subtly signaling that they don’t value their own time, and certainly don’t value the targets’ time. They might think that they are demonstrating persistence, but one wants to see persistence in chasing the product, not in chasing dead-ends.
In short, your high-value targets don’t have time for meetings between un-screened parties, and since you’re busy building a company, you shouldn’t have time for them either.