Angels Vs Venture Capitalists

There Is A Difference

I co-founded one of the busiest angel groups in the United States. I also had a partner in a microVC. I have interfaced with plenty of larger venture capitalists.

I think I understand the flow in the venture capital industry.

Understanding the flow doesn’t make you a perfect investor. In startups, if you hit 3 out of 10 you go to the Hall of Fame. It’s sort of like baseball.

There are lanes in venture capital. VCs often specialize. They will specialize by discipline or by round. As the round sizes of venture have changed over time, fund sizes and fund discipline have changed.

One reason that my partner and I decided not to raise another fund was we saw round sizes and initial valuations get silly. They were undisciplined and because both of us had a very keen sense of risk/reward, it made no sense to put money to work when the probability of a good return was not as high.

Angels are different. They can be undisciplined and do what they want. It’s their money. However, there have been plenty of actual studies done on angel behavior so there are best practices.

Doing a lot of upfront due diligence helps tremendously when you are an angel. You can’t take forever to perform this task, but having a rigorous approach that is the same deal by deal helps you analyze quickly.

When I co-founded HPA, the idea was a “fast no” and a “slow yes”. No entrepreneur deserves to die out on the vine while they wait for a decision. Being transparent about your process also helps them. When I was at HPA, we were never secretive, and when we ran our VC we were never secretive. We were clear about what we were thinking and where we were in the process.

Angels are built to take a lot of early risk in deals. They ought to be the first check. They ought to be out sniffing the field for up-and-coming deals. Angels do super well when they invest money in that very first round of capital. Risk is highest, but so is reward and if they invest as a wolfpack they can keep their pro-rata and continue to invest in succeeding rounds, maximizing return.

Earlier I said investing is like baseball but the process of investing is like poker. You ante to see the first cards. If they are decent, you continue to put money in the pot until all the cards are turned over.

There is a point as a seed investor where it’s not appropriate to put money into a deal even if it’s good. For example, assume you invested in the seed round, the next round, and the next round. Maybe as a wolfpack of angels, you have a stake of 5%. Now the company is raising a $50MM-$75MM round at a valuation of $250MM-$500MM. You are better off not investing and finding a seed deal to put the money to work in.

Why?

Because of risk/reward and opportunity costs. As a small investor, putting money in large deals is like peeing in the ocean. It makes no difference, and you don’t get enough in return. Meanwhile, even as deals move along the venture financing stack from Seed to Series E, there is still risk. Plenty of late-stage companies fail.

I am not investing anymore but I watch the market. I saw a blurb about how the angel organization we co-founded participated in a Series A. It was a large round, since Series A deals are significantly larger than they used to be 10-20 years ago. I was pretty disappointed because when we started the thing, the idea was to be the first check into a deal to support entrepreneurs and build an ecosystem. An initial team and an idea that has just been launched that shows a little promise.

If you are an angel group and you want to build an ecosystem, along with getting outsize returns on capital invested, you have to go very early in the cycle. That is unless you are a gorilla-sized angel who can put millions of dollars to work.

Series A entrepreneurs have plenty of support. They don’t need angels and unless that angel was hyper strategic if I was the entrepreneur, I might turn it down.