by Randell Young, General Partner, Venture-Net Partners
Know that one about the guy looking on the kitchen floor for the contact lens he lost in the dining room because the light is better in the kitchen?
A lot of entrepreneurs are intimidated by VCs and think they are going to have an easier time pitching their deal to so-called angels. So rather than focus on the 540 or so funds that control about 96 percent of all the dollars that will actually be invested in startups in a given year, they waste months, sometimes even years, dancing around with risk-averse time-wasters, also known as angels.
Angels are playing with scarred money. Their number one worry is that they are going to lose their money. Their due diligence process can literally take forever. For every one of these guys who actually brings himself to pull the trigger on a deal, there are at least 20 who are never going to write a check – but love being fawned over while they play the role of big-shot-mentor-investor. We call these guys “guru-wannabes”.
Even if you are dealing with a real angel, one that actually does have dollars he or she is willing to put at risk, the odds are overwhelming that they don’t have the resources to play Venture Roulette like a real VC.
A VC fund manager knows he or she only has to hit on one-out-of-ten deals to keep their total portfolio’s internal rate of return north of 30 percent – and, hence, keep them in the Venture Roulette game – playing with limited partners’ money. VCs are more worried about missing out on the homerun than they are about losing any one bet. That doesn’t mean they are going to get sloppy on their due diligence. It just means that the purpose of their process is to actually get to the point of placing a bet – not prolonging the dance indefinitely for the sake of reaping an ego-driven, non-financial payout.
Angels want to risk as little money as possible and still get a major portion, if not the lion’s share, of your upside. VCs want clarity. They want the deal to succeed (or fail) as soon as possible. They are ready to throw down whatever it takes to give you and them a fair chance to cash in on the opportunity you have convinced them is worth pursuing.
Further, VCs figure an 80-percent internal rate of return on a $12 million deal beats a 90-percent internal rate of return on a $1 million deal and they factor in that it takes as much time and aggravation to babysit a $12 million deal as a $1 million deal. It’s a completely different mindset.
The chances of getting sued by a disgruntled angel are very high, probably at least 30 percent if not higher. The likelihood of an arrogant VC fund manager admitting that he or she was snookered by an up-and-coming entrepreneur is pretty close to zero. Even taking the ego piece out of it, as far as the limited partners are concerned, a bad bet is just a bad bet… and all VCs are going to have a lot of losers. But a breakdown in the due diligence process indicates a lack of competence and that is something limited partners are not going to tolerate… and that loss of confidence in their limited partner pool is exactly what a fund manager has to risk in order to sue you… not likely.
These are all important distinctions – and they all break in favor of the VC over the angel – but they all pale in significance to the number one difference: The 1,300 or so key decision-makers that call the shots at the 540 or so U.S.-based VC funds active in early-stage investing control more than 96 percent of all the dollars that will actually be invested in startups.
In 2014, U.S.-based VC funds invested a total of $48.3 billion in start-ups. According to the 2014 Halo Report issued by Angel Resource Institute, Silicon Valley Bank and CB Insights, US angel investments totaled $1.65 billion while Crowdnetic reports a total of $218 million in equity crowdfunding in 2014. Thus, US-based venture capital funds contributed over 96 percent with angels (3.29 percent) and crowdfunding (0.43 percent) combined less than four percent of all dollars invested in start-ups in 2014.
Remember the answer Willie Sutton, the notorious bank robber, gave as to why he continued to hold up banks even after getting caught so many times?
“Because that’s where the money is.”
US-based venture capital funds, truly the mother lode of start-up capital, are where the money is.
Then, there is the visibility issue. The 540 or so real funds active in this space all have websites which offer a high degree of transparency with respect to their partners, resources, portfolios and exits. You can check out their managing general partners and know they are for real right from Jump Street. That one or two or maybe even five percent of the remaining dollars available for startups is literally scattered out amongst hundreds of thousands (if not millions) of small time, risk averse players interspersed with millions (if not tens of millions) of posers. It’s like looking for a needle in a hay field.
Angels are neither easier to deal with nor easier to close a deal with than VC fund managers. They are risk averse. They are afraid of losing their investment. They usually have a lot less money to invest than they represent. They are difficult to separate out from all the brokers, service-providers, guru-wannabes and other time-wasters posing as serious investors. They are very quick to make accusations and/or sue if everything doesn’t turn out perfectly… or, in many cases, even if it does.
And, best case scenario: they bring only a fraction of the dollars controlled by VCs.
If you are trying to launch a startup, you should make as much progress as you can with your own money and that of so-called friends, fools and family. But as soon as you can put your ideas into a coherent professional format, you should go straight after the mother lode of startup funding: VC funds.