Friday Dec 28, 2012 by Owen Johnson - Co-Founder & Managing Partner, Betaspring
In a previous post, I discussed the importance of angel investors for the entrepreneurial ecosystem. Startups need angels. But do they need angel groups?
As it turns out, formal angel groups aren’t a good fit for many early-stage companies and in recent history have played a diminished role in the startup scene. So much so, that angel groups are not even on the radar for many younger founders. Unless your company has strong intellectual property, significantly developed market proof, or a team with obvious pedigree, angel groups are not a great source of funding--and often a waste of time--for fast-moving founders.
The irony is that if your startup has cleared these hurdles, you probably don’t need angel groups anymore - you will likely finish up your round with investment from individual angels or VCs. For groups, this dynamic has created a deal-flow death spiral, where angel groups that once saw the best deals are seeing fewer and fewer.
What Happened and Can Angel Groups Get Back in the Game?
Over the last 10 years, three major changes have occurred:
1. Information about investing and raising investment has become more accessible than ever before. As an example, Brad Feld’s term sheet series has contributed significantly to reducing information asymmetry between entrepreneurs and investors.
2. Investors are now easier to reach than at any time in the history of entrepreneurship, and great companies can make themselves known more easily. Just consider the emergence of AngelList as a marketplace for connecting investors and founders. Don’t take my word for it, see what people are saying about AngelList on Quora.
3. Geography of investment, while still relevant, is less important to many investors, which widens the net for startups raising capital. One of our alums, Manpacks is a great example of a company that raised a round from investors in Boston, Providence, Canada, France and Silicon Valley.
These phenomena have created a rapidly accelerating paradigm shift in deal-flow where many A-grade deals never make it to angel groups, and when they do, it’s only for practice. If I were a member of an angel group, I’d be pissed. As an angel, I want to invest in A-grade deals, so if they aren’t showing up to the party, why would I?
With all these external forces working against angel groups, how do they stop this negative spiral of getting to see mostly B-grade deals? Here are some suggestions:
Timing is Everything
Three to six months for an evaluation is simply a deal killer for most top notch startups. Startups are evolving too quickly and angel groups need to change their process to speed up decision making.
Have a Core Group of Truly Active Angels
Not all individuals that are members of angel groups are truly active angels, so many groups aren’t the dense network of angels they used to be. Although it’s fine to have a diffuse group of potential investors, groups should consider identifying members who want to do a significant number of deals and make them their selection committee. If the selection committee doesn’t invest, then the deal doesn’t get presented to the group.
It’s Easy to Turn 3 Yes’s into 30 No’s
It’s easy to poke holes in an early stage startup and nothing turns “yes’s” into “no’s” more quickly than groupthink. Unless a startup is championed by a well-respected member, attempting to convince 30+ people to invest in a startup is nearly impossible. But well-respected champions who have already invested can break through the logjam of groupthink (see core group/selection committee suggestion above) and drive a deal over the line.
Adopt Open-Source Deal Docs
There are a number of quality, open-source, early-stage deal docs for preferred stock or convertible debt. Get your group on board with a few of these deal docs so if a startup comes to your group, you are ready to move, which is essential to getting in on A-grade deals. TechStars open-sourced model seed stage financing documents (http://techstars.com/docs/) and Series Seed (http://www.seriesseed.com/) are two examples of these types of open documents.
Moving Up Market Without Adjusting Price Expectations
Groups are looking for deals with much less risk than the angel groups of yore, but they haven’t adjusted their pricing expectations. With less risk comes higher price. I’ve been sparring with angel George McQuilken on this topic. The good news is that it appears this trend is correcting itself. Long live the free market!
Angel groups were once a viable source of seed funding for early stage companies. But over time, groups have earned a reputation for being slow, indecisive and hard to convert. I’ve seen the shift firsthand with Betaspring companies, who are, by-and-large, bypassing groups for individual angels. As insights into the shortcomings of the current dynamic become more and more apparent, leaders in the investment community should champion new processes that better align with and reflect today’s startup ecosystem. It’s this kind of transformation that will enable angel groups to reemerge an integral and effective source of startup funding.
Owen Johnson is a co-founder and managing partner of Betaspring. You can find this post, as well as other content on the Betaspring blog located here. You can also follow Allan on Twitter (@owenjohnson) by clicking here.