I am in the middle of raising funding for my business right now and the one eternal question that many entrepreneurs struggle with is do I go for angel funding or go for VCs?
For many that is easy. If you don’t really have revenue and are in prototype phase without customers you are really in the seed/angel stage. If you have customers and some revenue/traffic track record you could go for venture funding.
But alot of that is changing.
I was motivated to write this post in response to a TechCrunch post “Where have all the bold VCs gone?” that took an excerpt from Paul Graham’s post “Why aren’t there any more Googles?” who astutely observes:
I used to think of VCs as piratical: bold but unscrupulous. On closer acquaintance they turn out to be more like bureaucrats. They’re more upstanding than I used to think (the good ones, at least), but less bold. Maybe the VC industry has changed. Maybe they used to be bolder. But I suspect it’s the startup world that has changed, not them. The low cost of starting a startup means the average good bet is a riskier one, but most existing VC firms still operate as if they were investing in hardware startups in 1985.
They’re terrified of really novel ideas, unless the founders are good enough salesmen to compensate.
And yet it’s the bold ideas that generate the biggest returns. Any really good new idea will seem bad to most people; otherwise someone would already be doing it. And yet most VCs are driven by consensus, not just within their firms, but within the VC community. The biggest factor determining how a VC will feel about your startup is how other VCs feel about it. I doubt they realize it, but this algorithm guarantees they’ll miss all the very best ideas. The more people who have to like a new idea, the more outliers you lose.
TechCrunch points out that most web startups don’t need $2 million, but rather $300-500K. The reason most VC’s don’t do those smaller amounts is not risk but rather resources. Many entrepreneurs don’t understand the VC fund model so I will give you the quick and dirty explanation:
- VC’s that have a fund of let’s say $100 million have only a certain amount of partners and associates that can sit on boards and actively participate in guiding the companies to their next round or their exit.
- The lower equity position for a higher investment round stays within a risk-return ratio they have established at their respective firm.
- Despite many VC’s saying they invest in risky ventures, they are still investing other people’s (their limited partners) money and have to produce a return or they are dead in the water to raise money for a future fund.
So with all of these innovative companies that only need $300-500 to really get traction and become an excellent acquisition target, where have all the good angels gone?
Back during the Internet boom (oh, those were the days) everybody and their brother with a little bit of liquid assets where investing in web companies thinking they would have the next Yahoo or Amazon. As we know, that didn’t pan out to be the case and many people went to more solid things like real estate and bond markets. We all are seeing the bottom falling out of the heated real estate market so there should be people out there ready to dip their toe into the Internet pool again.
So again I ask, where have all the good angels gone?
Sure, there are angel groups and investment groups that pool investments from rich doctors or real estate developers but their risk level is not what it should be in order to take advantage of this new market landscape.
I have a two part solution.
Part 1: A separate seed fund within a larger VC fund.
- This would be a fund of $2-5 million that would have higher risk-return and separate books for those LP’s looking for diversification in their portfolios. You could get a few associates and one partner to manage this and the fund would have a ready portfolio of companies ready for their next stage of funding with better terms.
Part 2: Angel groups need to partner with venture funds
One of the greatest challenges to an entrepreneur raising angel funding is they know that the money is enough for a while to reach certain milestones but they know they will have to almost immediately start working to raise the next round. If angel groups are partnered with VC firms the angel groups will be more apt to find these diamonds in the rough to get them ready for VC rounds with an agreement to not get badly diluted. For the entrepreneurs they will see an easier path to future rounds of funding without having to spend so much time fund raising and can focus on running their business and delivering their product.
So I put this out there to the audience, where have all the good angels gone? Do you have any examples of this working in the marketplace that we should know of? Please comment and share your opinions.