Have angel investors become the new venture capitalists? Earlier this month, my colleague Wade Roush reported on a presentation by James Geshwiler of the Boston-area group CommonAngels about the changing nature of angel investing. Between Geshwiler’s comments and what I’ve been hearing around Seattle, it seems like the dynamic between angels and VCs has shifted in the tech community.
To get the local angel perspective, I had a chat with Geoff Entress, one of the most prolific early-stage investors in the Northwest. Entress, a former venture partner with Seattle-based Madrona Venture Group, works closely with several regional investor networks, including the Alliance of Angels, Keiretsu Forum, Zino Society, and Founder’s Co-op. “Things have changed radically in the angel community the last few months,” Entress says.
The reasons for this include the economic downturn and lower startup costs. Particularly on the Web 2.0 or social networking side, Entress says, startup companies can now realistically turn to angels, who are usually a network of individuals who have run companies themselves and are able to put in a few hundred thousand dollars in seed capital. “It costs a lot less to start a business these days,” he says. “Companies may raise low millions and that’s all the money they’ll ever need, and they’ll get to cash-flow positive. A lot of companies I’m in, that’s what’s happened with them.”
Whereas venture capital firms typically look for much bigger deals. If you’re a fund with a billion dollars in assets under management and you’re talking to a startup that may ultimately be worth $50 million, Entress says, the potential returns aren’t big enough for the investor. “You’ve got to do better than that. You’ve got to get bigger amounts of money in and get the same multiple to really move the needle for a huge fund. We were seeing all this before the economy turned bad,” he adds. “Optimally, what a venture firm needs is to get the first couple million in, but then the idea is they’re going to put more money in—tens of millions of dollars in order to be a meaningful deal for them.”
Entress then summarized what he sees as the top three trends in angel investing in the current climate:
—Valuations of companies are substantially down. “You’re seeing huge decreases, 80, 90 percent in some cases, and about 50 percent on average,” he says. That must be factored into any investing strategy.
—Angels are getting a chance to invest in deals that used to go to venture capitalists. “VCs have been focusing on triage,” Entress says. “Everyone’s worried about financing risk going forward. If you’re worried nobody’s going to fund a company down the road, you’re going to hold back.”
—Angels can acquire existing companies and websites at the right price. “There are opportunities for interesting strategic combinations,” Entress says. As recent examples, he points to his acquisition of Seattle startup Judy’s Book last year, as well as Pet Holdings’ pickup of Fail Blog.
So, are angels the new VCs? Entress won’t go that far. “Angels have become an alternative to VC, particularly for Web 2.0 deals,” he says. It is true, he adds, that angels have stepped in to fill some of the early-stage funding gap. But it sounds like although they may compete for more deals now, angels and VCs still have very different strategies and outlooks—and it will be interesting to watch how each continues to adapt to the climate.
