Angel Dust is now Angel Seed

There are those who say that the Venture Capital model is broken. Perhaps even the industry itself feels that way. Because so many have explained how venture capital works – or doesn’t work – why it’s broken, and how it may be fixed, I’ll leave the more detailed thoughts to those in the know, including the prescient Fred Wilson, Brad Feld, and Chris Dixon (here and here); there’s a very good reason why these guys are on my read-often list.

It’s true that the VC community now needs to “find itself”. The traditional 1-4-5 model (one home run, 4 base hits, 5 strikeouts for each 10 portfolio companies) that fed the VC machine struggles to find its relevance with high-tech IPOs effectively being zero. The tail end of many pitches that I have heard over the last 5 or so years is “and Google will buy us”. Well, that’s just a tad presumptuous, no?

Maybe not so no.

Just as the world was dazzled by the Netscape IPO, it was again dazzled by Google’s acquisition of YouTube. Buying an intangible asset for a lot of money came into vogue. Large exits became the starry-eyed dream of many an entrepreneur, replacing IPO-mania. Think about it: an IPO gives the founders the added responsibility of running a company to the standards required of the SEC (or your local regulatory commission), while an acquisition exit is an EXIT – you get to leave at some point, often of your own choosing.

Acquisitions come in 3 flavours: offensive, defensive, and talent – although an acquisition can encompass more than one. If you’re curious about Google’s appetite for companies, just see here. While the billion dollar exit is the new black, most exits are much smaller, in the sub-million to $10MM range.

VC economics don’t favour these exits, sometimes the Series A legal fees alone are more than a startup needs to launch a product. The “lean startup” movement towards building fast, lightweight companies, is a seismic shift both in the software and venture capital industries. They are capital-efficient on the one hand, and fairly uni-dimensional on the other. Many of them are FNACs (“Feature, not a company”, and I can’t find the original source for the acronym, although I think it might be Mark Suster) a little light on the revenue side, whose only hope of returning investment is to be bought for more than was put in.

Cue the Angel investor. True to the moniker he sweeps down from heaven, full of faith and a fat checking account. Many are former entrepreneurs who dun good, and want to share the wealth. Without Andy Bechtolsheim would Google have been? While our backs have been turned, they’ve been busy getting organised. There are some pay-to-pitch angel groups (Run away! Run away!), and then there are the less notorious ones such as the “PayPal mafia” and the Founder Collective, offering not only cash, but their expertise and network, which I consider to be of at least of equal value to their monetary investment.

However, they are somewhat of an old-boys-and-girls network where being an insider is your best bet to get investment. So what’s a bright young – and not so young – lad got to do to get some insider credentials?

Cue the seed accelerator. While there are many, the better known amongst them are Y Combinator, TechStars, and Seedcamp. In a somewhat more democratic process, anyone can apply to be accepted to the programs which typically run for several months. Along the way the teams are mentored by industry insiders and potential investors.  (In a future posting I’ll take a closer look at seed accelerators.)

Cut back to the angel investors. This is a place where they can play nicely. Depending on their nest egg, and the angel’s appetite for more chicken, angel investments can be as little as $5000 and topping 100 times that amount. A typical angel round would be in the $25-250k range, with several participating angels. There may be a “lead angel” (would these then be “archangels”? But I digress…) and the rounds are surprisingly unstructured and rather open-ended – fundraising continues over a period of time until the company has raised the money it wanted. Angels will bring other angels who are making many small investments instead of a few large ones. Here the economics do play in their favour if they are investing in companies where growth of the asset is the main mover, and not control of the asset.*

Sniffing around the edges of a lot of these deals are “super-angels” (aka mini-VCs). While still being institutional investors, super-angels are unencumbered by the 1-4-5 mantra, don’t require board seats, might not even be taking management fees from the fund, make fast decisions, and can do small deals. Since managing portfolio companies is generally not an issue, they can have very large and diverse portfolios. Will the super-angels at once push your average angel out of the market and kill off venture capital as we know it?

Stay tuned for our next episode…

*If you don’t believe me you can always ask Y Combinator’s Paul Graham.


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