Angel Group Relevance

This is no substitute for a proper post on the benefits of angel groups, but until I get around to that, I need to address a debate currently ongoing. Owen Johnson of Rhode Island-based incubator, Betaspring, recently wrote a post on the BetaSpring blog in which he outlined why he felt angel groups were losing relevance with his incubator’s participants. The post was picked up in a couple other outlets, and generated a fair amount of controversy, with quite a few angels weighing in. Some of the most thoughtful responses occurred in a thread in the Angel Capital Association’s LinkedIn group. Since that is a closed group, I thought it would be helpful to republish those comments here in an open forum so others can reply and respond.

For the record, my own two cents on the matter is that Owen’s piece is lacking in facts on which to base his broad generalizations (I see the opposite of what he claims in many cases), but in addition to that, he fails to recognize or acknowledge that he is simply a acting as a partisan identifying with one side of a two-sided debate that has existed since the dawn of organized angel investing. The key tension is the balance of power between investors and entrepreneurs. The two sides have radically different perspectives. Entrepreneurs naturally think their companies are great and they want to convert people into investors. When it comes to convincing someone, picking off individuals is always easier than convincing an entire group of people at once. So of course you would always rather pick off individuals where you can if all you are thinking about is short term money in the door. Especially if you don’t have your story completely nailed – far easier to talk it through with someone than it is to present it to a group.

But the reality is that angels are not approaching this with the sentimental goal of funding an entrepreneur’s dreams, they are approaching it with a goal of making a return. And the reality is that from a returns perspective, they do better when they work together to spot issues with plans and to help fix them. And, although sometimes they can be slower than they should, as a general matter, their shared-process approach is more efficient for everyone when they can pool diligence, termsheet negotiation and deal documentation. So as with so many things, what is good for one side is bad for the other. But the advantages of working in groups are tremendous for angels, the benefits for entrepreneurs of working with groups (in terms of forming large amounts of capital, finding expertise and gaining assistance) are significant, and capital is always in short supply, so I don’t think angel groups are going anywhere any time soon.

With that said, here is the collection of comments posted on the Angel Capital Association LinkedIn group (with permission from the authors):

[Comment Repost] Jean Peters • I do not know Mr. Johnson, but let me try to understand his thesis. He suggests that angel groups are not relevant to the startup economy, largely because angel groups actually take time to do due diligence – a process which may average 6-12 weeks – before a network of angels will agree to provide upwards of $700K in funding (HALO Report 2012). So let me try to dissect Betaspring’s approach: It solicits applications from dozens of startups, each of which must undergo a competitive process (read: screening). From this 3-month phase, Betaspring selects some 20 teams and subjects them to 12 additional weeks of onsite diligence: the entrepreneurs’ entire teams are required to relocate and immerse with Betaspring — meeting with advisors in person at least three times per week — as it analyzes, pokes, prods, suggests, critiques and thoroughly reviews the capabilities of both the management team and its ability to execute on an idea. With this “incubatadiligence,” Betasprings invests $12,000 to a max off $20,000 – (of money that substantially comes from an angel group!), and takes 6-10% ownership in the company. At the gitgo. (It clearly limits the degree of “proof of concept” these startups can have if valuations are only in the neighborhood of ~$200K).

Per its website, Betaspring expects a third of its portfolio to achieve high growth appropriate to a risky, illiquid investment; another third to become essentially “zombies,” (those that that don’t fail, but also don’t rapidly grow (and, by corollary, exit)); and a third to fail. With these expected outcomes, it is not a wonder that angel groups haven’t swarmed in to vacuum up the cap tables of graduating progeny. (Oddly, Betaspring is substantially funded by leading angel group, Cherrystone Angel Group.)

This is in no way meant to disparage or cast aspersion on any of the myriad entrepreneurs who have gone through Betaspring. Nor is this intended to denigrate the important work that incubators do in general and their value to the startup economy. But, with a 12-24 week process that eats up 10% of an entrepreneur’s equity with no guarantee of any follow-on funding sufficient to ensure viability, incubators are no instant solution for cash-starved start-ups.

I would suggest that angel groups are among the most robust, vibrant and active sources of equity capital for high-growth startups. We do thorough due diligence, yes, because we are driven to achieve returns along with supporting entrepreneurship. But, we do it in a timely manner with disciplined processes that rely on a substantial network of expertise, thought leadership and advisory support among group members and across the amazing angel networks that today are laced together in a deep latticework of capital formation and syndication on both the financial and mentorship fronts.

Angel groups in fact are gaining relevance by the hour and minute, and may well become the most important pillar, as the “adult supervision” in the crowdfunding bullring unfolding before us.

We don’t take 3 months to screen candidates, then 4 more to conduct incubatadiligence and take 10% of the entrepreneur’s company from her for the favor. We take the time to make credible, return-oriented investment decisions and then provide significant outlays of our own money to support that thesis.

There is a reason that angel group Golden Seeds has grown from 3 members in 2005 to 160 in 2010 to 270 today, making our network of investors in high-growth, women-led companies the fourth largest in the country. We are relevant; we invest; and we support our companies explicitly, from screening through investment, follow-on funding and exit. We are active in advisory, mentoring and governance capacities with our portfolio companies.

And, yes, I would put my money on the success of angel groups over incubators, 8 years down the road. Any day.

[Comment Repost] Catherine Mott • interesting, I thing that blanket statements that are opinion based don’t deserve any merit. The ecosystem for entrepreneurial funding is vast and loaded with real data – one only needs to do so some good old fashioned research to keep from being misinformed.

The truth is there are multiple sources of funding for entrepreneurs and one only needs to look at cap table to see how all those sources integrate to fund the success of a venture. The life cycle of company is funded by personal credit cards, friends and family, crowd-funders, angels, incubators, accelerators, family offices, venture capital, etc. They all have their place in the ecosystem. And depending upon the industry, some will be more prevalent than others.
I don’t know the author of this opinionated, lack of data, blog, but to not recognize that all sources of capital is naive. I would encourage him to do his homework and be supportive of all the sources of capital for the benefit of his entrepreneurial audience. The entrepreneurs deserve to be properly informed.

[Comment Repost] David Beatty • Whats most fascinating to me is the 2 companies Owen highlights on his bio….neither gave the investors or the entrepreneurs an ROI. Could it be that his (and many others) criteria for success is getting funding, rather than a focus on ROI, with this perspective, his post makes perfect sense. I assess there will always be this type of hype and there will always be dumb money feeding it.

I often quote Basil Peters from his 2012 ACA keynote in this argument. He says an investor is about 3 times more likely to Exit when investing through a group that as an individual.

[Comment Repost] Basil Peters • Christopher – thanks for letting me know about this interesting thread.

This is a link to the PowerPoint from my talk at the ACA 2012 Summit that David is referring to: (slide 5).

I want to be careful about what we can conclude from these two data points. The title of this slide says it all – we don’t have enough data. These two percentages are all the large scale exit rate data I can find. These two points do not cover the same timeframe, so they are not strictly comparable. My personal observation is that angel investors in groups are much more successful than individual investors. Based on what I see, 3x seems about right, so I agree with David’s point.

To understand why I believe that, this talk from the 2010 ACA Summit contains quite a bit of information to support how beneficial angel groups are to the entrepreneurial ecosystem and why angels have more success in groups:

[Comment Repost] Jim Connor • The comments seem to reflect what happens when an incubator such as Betaspring experiences a lack of uptake among Angel Group investors, for the obvious reason: There are too many incubators/accelerators putting too many companies through an Entrepreneurs “finishing school” and graduating them to a DEMO day or Portfolio Showcase without sufficient innovation, market definition or defendable advantages in the product set. The result is a lack of interest and action among the investors, i.e. the angel groups and seed fund VC’s.

What’s an incubator to do when they have decreasing results from the Demo Day; the seed stage/angel investor has learned how to deal with that initial infatuation you feel after an impressive presentation, full of promises but asking for a high valuation and money for risky innovation, development, recruitment and execution? Write a blog and try to cajole, implore and imply that the Angel investor groups are not quite up to speed on the changing times, providing the self serving conclusion that the investor class should change ( lower ) their criteria and thresholds for making an investment.

The real question is: How long will it take for the everyday “two guys and a dog” incubator/accelerator to realize that they are not delivering sufficient value to the upstream investors with their offerings.

Maybe we are seeing the first evolutionary step in this process, the next hot blog could be “Confessions of an Incubator” as well as a book and movie titled “Washout” about the incubator meltdown of 2013/2014, time to start documenting the inflection points. I have an idea about a new reality show, about life in the incubator, when bright, idealistic Ivy League graduates all drank the kool-aid that their “me-too” idea could actually get funding and hooked up with an incubator who promised them mentorship and funding but abandoned them when they could not lure investors to buy into the polished but unsubstantiated pitch. Think of it as Survivor meets Shark Tank!

[Comment Repost] Brian Cohen • It really pisses me off when I see blogs like this that misinform the entrepreneur community and make vast generalizations about the seed stage investment environment.

If anything the Angel Group environment is growing, getting smarter and much more in-tune with the needs of the startup community – particularly in New York City, where the growing network of angel groups (new one recently called 37 Angels – for women angels), super angels, micro-VCs look for every opportunity to collaborate and learn from each other to be smarter investors and most importantly advise young entrepreneurs flooding in to the City from all parts of the globe.

The story about long processes is an old one. From my conversations with with many active angel investors they wish they had taken more time to ask more questions to make smarter bets. As a friend of mine once said, “not doing proper “do” diligence is like “unprotected sex”. A too quick draw investment without proper review is senseless. That’s what binary angel investors do. Either it wins or losses. That’s not professional-level angel investing! In fact, most of the entrepreneurs I know really appreciate the kind of insight a quality “do” diligence process provides.

Regarding the idea of “a group” being old and not a worthwhile entity for startups to approach – That’s ridiculous. Why wouldn’t a smart entrepreneur want to make a presentation to 100 smart angels instead of a longer on-on-one process? What am I missing here? In fact, In New York City we’re working on building a New York Angel “network” of angel groups that can share investment opportunities faster for the benefit of the entrepreneur.

The issue about term sheets is still a work in process for startups and entrepreneurs that is becoming more balanced and easier to manage.

The New York Angels has recently closed what we call an “Entrepreneur Catalyst Fund” among it’s members. This is an early seed fund that expects to make investment decisions in as quickly as an hour in those cases that fit it’s investment model.

Regarding AngelList, I’d like to see his stats about their success. Yes, they certainly have added a virtual approach to angel investing that has drawn a certain set of investors, but I do not think they have much impact on our deal flow of startups – which continues to increase dramatically.

Our membership at the New York Angels continues to grow (world-wide members) as angels realize that a group of experienced angel investors (most of whom were entrepreneurs) in a diverse number of vertical’s helps everyone make smarter investment decisions. It works for the entrepreneur as well because of the group smarts that can be provided to young entrepreneurs.

I could not be more proud of the hard work the New York Angels has provided to the New York City Startup Community. You’re right, Angels have changed, they’ve become more relevant than ever!

[Comment Repost] Christopher Mirabile • I called Owen to express my disappointment with the approach he took in this piece. I explained to him that groups are very different from region to region, city to city and even within the ecosystem of one city; that his generalizations didn’t apply to every group; and that for the good groups, the article was predictably a bit of a slap in the face.

He was apologetic and said he didn’t mean for it to be a criticism – he was just trying to stir up controversy and debate. He acknowledged that he may have over-done it a bit and tarred many people and groups unfairly with an overly-broad brush. We talked a bit about the journalistic differences between saying “you suck” vs “you have competition” – one is a little more constructive than the other.

Given how many angels from groups have volunteered their time at his incubator and provide much needed funding for his graduating companies, I cannot imagine how this blunder was good for business, but perhaps his branding is to associate with the entrepreneur and foster an “us against them” attitude amongst entrepreneurs. Certainly not how I would go about it, but it’s a free country so I guess he can say whatever he wants.

[Comment Repost] Ben Littauer • As a member of three Boston angel groups, and an individual investor as well, I think that Owen’s posting is a rather inflammatory way of highlighting some real issues with angel groups. That said, the Boston angel community is far more active and vibrant now than it was five years ago when I first joined in the fun.

We have funded a record number of deals here in the Boston Area. Most of these did not come through an incubator program. My own impression of the incubators is that to an unfortunately large extent the advantage they bestow on the new venture is PR: these companies are dressed up to present well regardless of the core value in them. That’s not to say that many of these companies are not great, just that their greatness is not typically much enhanced by the incubator experience. But boy are their pitches slick!

Occasionally a mentor will really help a venture tune up its business, rather than its business plan, and this is a huge value. Of course it also occurs outside the “paid incubator” environment: look at Mass Challenge and MIT Venture Mentors for formal examples, and at a number of high-value mentors who contribute their time within those contexts or on their own.

I do agree with Owen that sometimes our diligence process can be inappropriately heavy, we can suffer from “bad apple syndrome”, and we sometimes have non-competitive valuations. There are some deals I like that aren’t “group friendly”; so be it. But there is no evidence in my portfolio to indicate that the groups are mistaken in being careful about their deals or their valuations.

We will have to wait and see whether we’re in an “incubator bubble”, or whether the groups are stodgy old fogies who are missing the boat.

Comments, questions or reactions to this post? Leave a note below and I will respond to your questions.

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