Yesterday, I received an interview request for an Inc. Magazine article concerning angel investing. The article is being driven by a recent survey by George Washington University that found 58% of venture capitalist respondents said that angel involvement “sometimes” or “mostly” makes a company unattractive. The main reasons given were that angels tended to give start-ups overly high valuation, made negotiations unnecessarily complex, or were unsophisticated and uninformed about the requirements of venture financing. Occasionally my interview requests are via email (preferred) so in this case I wrote up my thoughts. I have no idea what will end up in the article so I figured I’d post the thoughts here for anyone interested in my point of view on the angel / VC dynamic.
While 58% is a nice number, I think that an aggregate statistic isn’t that useful. I’ve had a large number of experiences with angel investors – both as an angel and a VC. I’ve found – not surprisingly – that there is a wide range of quality and experience among angel investors – if they are experienced and high quality, they are good; if not, they are have no impact or are not good.
When I actually read the study (after the interview, of course), the lead result was that 94% of VC respondents answered “Yes” to the question “Do VCs consider angels beneficial to the venture industry?” In fact, only 6% of VCs responded that angel involvement “mostly” makes a company unattractive (52% said sometimes – which is where the 58% mostly/sometimes stat came from.) So – as with many articles – the data is being munged in a way to tell a more provocative story. Only 5% of VCs said that angels “never” make a company unattractive – if you take off the tails of the normal curve (“mostly” and “never”), you end up with 89% of VCs saying angels “sometimes” and “seldom” make a company unattractive to VC investment – a total non-story as far as I’m concerned (at least around this measure.)
During the interview, I was asked three specific questions. The questions and my answers follow:
1. What, in your experience, are the most important problems?
- Unsophisticated angels / entrepreneurs who structure the angel investment poorly.
- Angels who are “too active” – they think they are running the company instead of letting the entrepreneur run the company.
- Entrepreneurs who give up too much of the company too early to angels that “are going to help” (but end up only being money) and – as a result – the VCs are faced with founders that don’t own enough of the company.
- Unrealistic valuation expectations.
- Chronically bad advice (e.g. “I don’t know technology, but here is what you, oh Mr. Technology CEO, should do.”)
- Ego ahead of value (e.g. the angel investor is more interested in being able to say “I’m an angel investor in company X” than having company X be successful.)
- Toxic view of VCs (or angels.) I’ve met many angel investors who think VCs are bad. I’ve met many VCs that think angels are bad. This is just dumb. Individual people are either good or bad – evaluate them on their own merits.
- And the biggest –> bad partners. Whether it’s an angel or a VC, the investor becomes the entrepreneur’s partner. The entrepreneur needs to make sure he wants the partner. If there’s a mismatch here, it’s often fatal (or at least very painful.)
2. Could you provide any examples where the angel investor and the venture capitalist clashed and the start-up was held back as a result?
- Case 1 (where I was the angel investor): I was an angel investor and chairman of a company. We were a young (20 person) startup that was raising its first VC round (we’d raised about $1.5m of angel and strategic investor money.) The CEO was young (early 20′s) and I was in my late 20′s. The CEO was doing a terrific job, we had a hot young company, and had four different VC firms put term sheets down to lead the deal. One of the VCs did a great sales job on the CEO and the partner said something to the effect of “I’ll work with you and mentor you.” We chose that firm to lead the investment. Two weeks after the investment closed, the same partner took me out to breakfast “to get to know me better” and within 15 minutes said “I’d like to bring in an experienced CEO to run the company.” As you could imagine, this bait-and-switch didn’t go over very well with me or the CEO. However, after a week or two of struggling with it, we decided to help the VC bring in a “professional CEO” to run the company. We helped recruit the new CEO (took about 3 months) and then the CEO transitioned the business (took about two weeks) and there was nothing for the founder / CEO to do (since the old CEO / founder was – well – the old CEO and the other exec positions were filled.) So – he resigned (as did I as chairman – I didn’t want to be on the board at that point.) There was more tension (not drama in this case – but tension) then necessary (I’d like to think that in this case we went quietly.) The new CEO failed and was fired within a year, but the following CEO that was hired did a great job, the company was ultimately successful, had a very strong IPO, and my angel investment ended up being worth 50x. The dynamic between the angels and the VCs originally cost the company some time and potential market leadership, although the story ultimately had a very happy ending.
- Case 2 (where I was the VC investor): I was leading a financing of an angel backed company. The largest angel investor didn’t like the valuation. The founders had been working for 9 months to try to raise money and were literally being held up by this angel. He was angry, hostile to the founders, generally unpleasant to deal with, and very irrational. We patiently worked through the issues (I really liked the founders.) At the 11th hour, the angel started insisting on new terms for himself (just him – not the other angels.) The company was out of money and had no options. I walked from the deal. The founders ended up giving the angel some of their equity to get him to support the deal (totally inappropriate behavior on his part.) We did the investments. Six months later the company was acquired – we made 3.5x our investment and the angel made over 5x his investment. Again, a successful outcome, but the entrepreneurs ended up with less then they should have gotten (and a lot of unnecessary stress.)
3. Is there anything a business owner can or should do to resolve the differences that may exist between his early stage angel investors and his later-stage venture investors?
- Pick your angel (and your VC) carefully.
- Do your homework / due diligence – make sure you know who / what your angels (and VC) are.
- Hire a real lawyer and do a real seed / Series A financing. Treat the angel investment professionally – just like you would an early stage VC investment.