My colleague and friend Jeb Spencer recently wrote a piece for Xconomy about angel investors looking for “Unicorns,” those rare early stage companies with valuations—justified or not—of $1 billion or more. He wondered if angels are flying too close to the sun by misunderstanding their chances of success and failing to do their homework on deals—and perhaps pumping up company valuations in future rounds.
He’s right in one respect. Many angel investors, especially “super angels” do indeed selectively shop for that home run deal, relying mostly on their intuition, judgment, and what they consider to be their deep knowledge of technology and understanding of people. This methodology contrasts sharply with the heavy lifting that angel groups like ours do, which involves thoroughly researching each startup and its team, technology, and market.
Many super angels believe they are smart enough to pick the winners. Many simply have more money than time, and they don’t want to bother digging into the dirty details of every deal.
Angel investing is an important part of the financing that serves startup companies. They help bridge the critical gap between the entrepreneurs’ savings (usually running out somewhere around $50,000 and $150,000) and the first venture capital round (usually above $2 million). Angels and angel networks are also an integral part of the local startup community, making investments and helping entrepreneurs.
Of course, many startup businesses fail. But this happens regardless of the source of capital. Many of the most successful growth companies were founded by entrepreneurs who had already been through at least one failed startup, learned their lessons, and tried again. In such cases, angel investors often provide the crucial support that institutional investors are unable or unwilling to make. We get entrepreneurs through the Valley of Death.
Yet it’s important to distinguish between super angels and angel networks. Most of the organized angel networks do a good bit of work to deeply understand the investments they are making, as well as the risks they take.
In San Diego, for example, our Tech Coast Angels group has a team of analysts overseen by a volunteer member, and they perform our due diligence. These are highly educated people, most with graduate degrees, who produce research that we consider to be critical in our decisions about who gets funded. I read one of these reports this morning that was 95 pages long, a fairly typical length for our group. If we fund a startup, we share our research with the founding entrepreneurs, and this is very valuable to them.
Angel investors, both individually and through networks, invest about the same amount in the startup ecosystem from year to year. Last year the total amounted to about $24 billion —and was roughly equal to the total invested by VCs in 2013. From this perspective alone, angels are a critical piece of the economic generator that is our capital system. And the importance of angels goes way beyond the money.
A recent study by the Keck Graduate Institute shows the impact the Southern California Tech Coast Angels have had on the regional economy. Their findings include:
—Southern California’s Tech Coast Angels have invested over $130 million in startups across a region that extends from San Diego to Santa Barbara.
—Of our portfolio companies that are still active, 85 percent remain in this region, creating an “anchor effect” for local economies.
—Those companies have a combined annual revenue of $990 million and employ over 4,500 people.
From the impact in this region, imagine the total impact that all individual and networked angel investors have nationwide.
Amid speculation about a “pending vaporization,” Spencer asks, “What will become of all these companies?”
My answer: The same thing that always happens in a down market. There will be a shakeout of winners and losers. The talented entrepreneurs among the losers will dust themselves off to make another go at it—sometimes with angel money—and some will become winners in the next cycle.
The “great winnowing” of startup businesses that Spencer describes is a fact of life for all entrepreneurs and investors. This is the way of business creation in our system. And it works.
All the investing entities in the U.S. startup ecosystem are there for a reason. We all have a part to play, and we all support this incredible engine of growth and opportunity. My advice to entrepreneurs is to take advantage of the available capital that makes the most sense for you at the time you need it. And my advice to investors is to do your homework.
