Irony of What’s Suitable for an Angel: Early vs Late Stage Investing

Irony of What’s Suitable for an Angel: Early vs Late Stage Investing

It’s been over 20 years that I have been talking to angel investors in the Valley and around the world about their individual investment preferences when it comes to direct individual investments and wanted to share some of the results of these conversations.

The way the real world works is that until recently most VCs do not invest in pre-seed or seed stage startups. Especially as most Sand Hill Road funds increased in fund size from $50m and $250m to $700m and $1.2bn per fund as a result of 2001 and 2008 downturns. These super-sized VCs need to write bigger checks and invest in later stage financing rounds than they did in the 80’s, 90’s and early 2000’s.

So angel investors filled this need for early stage seed investing. Then we saw the birth of micro-VCs like Ron Conway’s SV Angel raising institutional funds and investing at the angel / seed stage like a machine out of their funds with fulltime investment professionals focused on angel investing. We now seem to have an accelerator for every type of startup and the best ones have their own funds and invest seed capital in an institutional manner and nearly all of these financings with the micro-VCs and accelerator funds also include angel investors. This is where we expect to see the angels active.

The result of all of this is that angel investors today and in recent years do have access and are welcome to invest in seed stage financings for tech startups in the Valley and around the world. However, once these startups make more progress and progress to a Series A financing where the average financing size in the Valley is currently trending around $10m in the size of the round, the angels are pushed out unless they happen to be existing incumbent investors with pro-rata rights from previous seed rounds. Often we even see the existing angels “thrown under the bus” by the new greedy VCs investing out of super-sized funds and young CEOs often don’t fight hard enough to defend the angels that initially backed them to allow them to invest in the later rounds.

As these startups progress through $5m to $10m Series A, $15m to $35m sized Series B and C financings and so on, the angel investors are not welcomed to participate. No one wants the CEO of a tech startup meeting an angel investor at a Starbucks on a Tuesday morning about making a $10k or even $250k investment into a Series B or later financing round when the size of the round is north of $15m. Everyone wants that CEO to focus her time taking in big $5m or at least $2.5m sized checks to fill in that round and get back to building the business. Depending on the capital requirements of the startup it might even make sense to only accept new investors that have deep pockets and can continue to fund the company with even bigger checks as the startups reach more milestones and grow in value.

Now here is what I find ironic. The angel is typically investing off of her personal balance sheet, meaning out of her personal savings. For most individual angel investors they may not be able to carve out enough time to get into a meaningful number of deals to create the diversification that will adjust the actual risk of the early stage investments they are making to the level of SV Angel or other micro VCs with full time teams.

More importantly if we were to ignore the Series A crunch and assume that these seed stage investments these angels make do extremely well, they can expect most of them to take a few years or at least one or two years to get to a Series A. There is usually no liquidity there and so the angel is likely to see their money tied up for a few additional years. So the irony here is that the angel probably is in need of a higher degree of liquidity than the VC funds on Sand Hill Road and yet the VCs invest in later stage deals or at least the bulk of their fund dollars into later stage, so that they are often years closer to an exit than the angel. Also by the time the VCs invest, much of the technology, product, team, customer and execution risk has been mitigated. Angels usually invest when the risk it at its highest and many of these startup companies are still very binary with real risk of total failure.

I often hear angels say things like, “I like to only invest in deals with single digit pre-money valuations. Once I see a startup with a valuation north of $10m or god-forbid $100m I don’t like to invest as my check will just get washed out and have no meaning.” What does that same angel think is happening when they invested that same sized check years earlier and actually got diluted by these later financings? That’s what getting washed out actually is.

I think the view most “sophisticated” angels have here is not logical and they are investing in the opposite profile of deals compared to what is actually suitable to them as individuals, but I understand why this is. The real world has simply conditioned them that this is where they are welcome to invest and pushes them out of the deals that are most suitable for them. Over time from this conditioning I hear the angels actually ask for it!

In my view this is what angels are doing. They invest in tech startup deals that:

  • Are very far away from an exit and can expect to not see cash flowing back from exits for many years as these startups are just seedlings
  • Risk of losing all or a big chunk of their cash investment is still very high
  • Fail to remotely get the amount of diversification that micro-VCs or late stage VCs get in a 2 to 3 year period / vintage. The portfolio of most angels is too small to adjust the risk or
  • They may not get any privileges of “major investors” such as full liquidation prefs, structured deals, pro-ratas and other meaningful terms VCs get that do translate to higher returns
  • Fail to generate a dynamic of investing more capital into the winners of a portfolio benefiting from advantages of investing in the private market where trading on inside information is legal and expected

They should be keen to invest in deals that:

  • Are closer to an exit so they can get cash back in time to impact life according to their family time lines of kids growing up, retirement, re-invest into new deals, etc.
  • Already have proven unique technology, product market fit, strong revenue growth and fully populated management teams
  • Put the angel at the top of the waterfall liquidation stack where not getting at least 1x back is very low risk
  • Into a portfolio with meaningful diversification to adjust the risk of each individual investment. Ability to push more money into the winners.

In sum, angels are doing the opposite of what they should be doing or what is most suitable to their individual investment profiles.

We had all of this in mind when we designed the Rubicon Venture Capital strategy and how we can take a limited number of accredited angels into our fund. As LPs they gain access to our sidecar special purpose vehicles (SPVs) to co-invest with the fund on the deals they like ranging from early stage to very late stage pre-IPO. We do this in a way that makes the other VCs and CEOs happy to welcome angels into the deal as value added investors via one shareholder (Rubicon’s Fund + SPV). This is a win-win-win for startups, VCs and, of course, the angel investors.

One last point – I would hate to see angel investors stop backing seed stage deals, but as this is mainly their only point of access I don’t worry that their appetite for seed investing will dry up.


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