I was at the Capital Innovation event in Montreal yesterday where we heard from Jacques Bernier, head of Teralys Capital and his vision for a new risk capital sector in Canada as well as from Ian Sobieski, founder of Band of Angels, Silicon Valley’s oldest seed funding organization. It was interesting to hear Mr. Sobieski criticize the VC model to a room full of VCs and it got me thinking about the relationship between angels and VCs.
Sobieski talked about how when VCs come into angel deals the time to exit goes up and the probability of exit goes down. All things that kill returns for angels. His arguments echo and I believe in large part came from Basil Peters’ excellent book Early Exits.
Basil calls for a new model of angel investing and tech entrepreneurship arguing that “early” exits at $10M, $ 20M values are a good thing. The thinking being that this creates a virtuous circle of new angels and wealthier, proven entrepreneurs willing to bet bigger the next time around.
But here’s the rub: Band of Angels posts an impressive 53% annual rate of return (IRR). But, when you back out the nine IPOs in their portfolio their returns are negative 9%. What this tells me is that up till now, their success has been largely driven by VC-backed companies. You don’t get to NASDAQ-level run rates without serious capital that goes way beyond what even Band of Angels can provide.
Also, Band of Angels is quite transparent about their track record. For every 100 companies they have invested in, 27 have achieved an exit. This is no better than the overall VC assumption in terms of exit rate.
So, who’s right? Who’s more successful? Can angels live without VCs? Vice versa?
Angels have historically played a far bigger role than most people realize in funding startups. Sobieski shared some stats to back this up yesterday. With the VC industry contracting this trend will only continue. But, I think the relationship between angel and VC is a wary one and so as a startup you need to have a dual track growth plan.
Angels are wary of VCs. So, if you present a funding plan that takes multiple rounds of capital and is absolutely dependent upon VC follow on, you will have a tough time. So, you need to break your funding strategy into two stages:
Angel only: A capital efficient plan that can be angel / seed funded that gets you to break even or enough traction, momentum and proof to generate an early exit, cash flow sustainability or follow on funding.
Venture: A plan that you turn on only if you and your investors decide to “go for it”, double down and go for venture-scale returns.
Angels are absolutely essential to early stage funding. Build your fundraising and growth strategy around their needs. If you decide to expand your vision and capital requirements later that’s all good. But don’t depend on more capital from day one.
This approach is also better for the venture community. They will get companies that, while small, have more validation and proof points. Companies will have more chance of raising venture because of these proof points.