Super Angels, Lean VCs, Proto-Incubators, whatever. Focus on social contract.

I swore to myself I was going to stay out of this super angel versus VC debate but I find I have this compelling urge that I need to satisfy.

First of all, let's move away from Roe vs. Wade style debating.  There is no super Angel class that somehow redefines what venture is about, and venture is not a species threatened by sudden shifts in temperature.  These incredibly convenient simplifications may help the debaters explain why their camp mates best, but they remain confusing and are not useful to those outside the industry.

Let's quickly rehash:

Capital efficiency has come of age.  The new orthodoxy rightly states that some businesses can build, launch, iterate on limited cash.  Those that have product greatness and are heavily networked into the right groups can achieve velocity faster than others.  The best bard if SG Blank and his awesome "4 Steps to the Epiphany". 

Networks thrive on networks: the notion that somehow the dominance of facebook, google et al means that the market has matured is misguided.  We live in the age of markets and platforms feed off platforms.  Zynga is the posterchild and a new eldorado for those seeking to derive economic rent from facebook.

Many VC's are lazy and hooked on fees. OK so whilst it's the laziest generalisation of all, it's true that many firms are run by fundraisers and not by outbound folks who actually care about entrepreneurs, and they get paid too much regardless of returns and hence have a self-destructive bias towards larger funds regardless of their own stage preference (read: early versus late).  I took the trouble of getting feedback from a ton of entrepreneurs on this, read the "Arrogant VC".  This create a great opportunity for newcomers.

You can see market evolution, and the market has responded in kind with the creation of new financing options for entrepreneurs.

Here is a taxonomy of what we see:

1. The Super Angel (Jeff Clavier) does his own deals, the ultimate lean angel, talks little about them, gets them sold, has a high batting average, probably shows up at your board.
2. The Accelerator (YCombinator) takes you at birth (as entrepreneur) and accelerates your development, hopefully making you in no time a full citizen of the entrepreneurship word able to deal with the pitfalls of growing a small business
3. The Incubator (Betaworks) leverages these trends through a mixture of internal development and external financing
4. The SuperNetworked Angel (Ron Conway) invests in everything that fits a theme provided there is some kind of "social proof", looks for some massive upside generators, plays the optionality game. 
5. The Small Possee Fund (FounderCollective) gets a group of networked folks together, raises a decent amount of money, does deals selectively, has some full-time partners, makes sure its positioning as first-round-only-we-dont-follow is clean and well understood.
6. The Lean VC who treats every seed like it matters (Mark Suster) does seed because it's what he does, does only a few deals, treat everyone of them like a "real" deal, plays his role as a lead

So McClure says "most VCs are dinosaurs";  I agree, but those that keep getting funded typically aren't. Kedrosky says super angels are probably too abundant and more likely to be short lived; the response from Dixon and Sacca is interesting: no because the good ones invest together and keep pricing in check.  Does that remind you of someone ?

What's my point: this "species" debate is not the right debate.  VC versus not VC, who really cares.   I know for a fact that David Skok at Matrix just spent a ton of his personal time helping an entrepreneur that is not even looking for money getting his go-to-market right, opening doors to analysts and customers.  He might be a VC but as an entrepreneur I would sure want that kind of commitment on my board !

What you do need to care about are is the SOCIAL CONTRACT:

• Do we have DNA match ?  Can I survive an eight hour car drive with this guy or girl ?
• Is this a partnership ? is there mutual respect, alignment, understanding ?  Do we agree on strategy (or how we discover it) ?
• Does this partner really get my market ?  Does he work and play with other people who get it ?
• If it matters to you (I think it always does), does this person deeply understand what we do ?
• Do I want and need a lead ?  Do I want social proof or a guy who is going to sit on my board and actually have some hours in the day to help me out ?
• Is this person accountable ?  Do they care if I go under ?  Who owns my demise ?  Who is willing to support me no matter what ?
• If I need them, are there reserves lined up to support me ?  How much ?  When does this financier want to exit and does this match my own expectation ?

Here are two questions I have not heard decent answers to:

• If you are a VC fund with 5 partners and you invest in 50 seed deals, who cares when one goes bust ?
• If you invest in 200 companies at seed level, what are you really contributing ?  How is that not a passive options portfolio ?

I don't have hard and fast rules, each investor needs to find out what works for him and be open about the social contract he builds with the entrepreneur. If you're an experienced entrepreneur and you want people to let you get on with it and get access to some good network, find investors that match. If you think you might need a ton of guidance, money, support, whatever it mat be, find investors that match.

I think the common trait amongst these various species we described above is low body fat.  Steve contributes a good expression likely to stick and I will leave him with the last word: the Lean VC.  Or did I meant the lean Angel ?  Damn, here we go again ... 

Comments

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[Raphael Briner]

I have 2 mentors. We go to restaurants, they play hard with me, they see my upcoming problems without looking at my forecasts (normal summer troubles) and they are not investors. They haven't any stocks. They are just analysing the social business market with me and maybe waiting the right time they will join my train. It's precious, I'm lucky. From the other side, I have a private investor, a meeting per year, only concerned on benefits.

Sometimes, I would like the 2 sides to merge, sometimes I think it's the best combo. Meanwhile I love when the 2 mentors exchange market vision (with me in cc !) and I hope to meet more angels addicted to techmeme. For the moment, it's really somethin' rare in Switzerland.

[Fred Destin]

@kirill touche :-) Working on it :-) VC's have one shortcoming, fiduciary duty to their fund and partners. they cannot act against the fund. an angel can decide to take a random writeoff or do something economically absurd.

[Sheynkman]

Best attempt to put a taxonomy on the VC noise of 2010. Excellent stuff. And, the "social advice" -- how rare is it to find a VC that has all of the mentioned "fits" Never happened in my career, but can always wish.

[Jeff]

Yo ;)

Yes I do show up at board meetings - the few I actually sit on, and some of the cos where I can actually add value. But the bulk of the activity is outside of the board room, and is based on very efficient interactions - emails, phone calls, even DMs - plus a series of planned or adhoc meetings. Every company is different: founder style, team needs, maturity, etc. So you have to adapt accordingly.

The thing most people forget when they look at our portfolios (85 deals closed/committed in 6 years for me) is that we put a lot of emphasis on the quality of the syndicate we put together, and try to bring in an "Ocean's 11" team to support our cos.

I am nervous about these syndicates where there is no clear lead or role/responsibilities being assigned. When the shit hits the fan, and it always does, you don't want to start discussing/pointing fingers as to whose role it was to step in and help.

Hope all is well!

[Dlifson]

Great post and comments here!

As one of Dave McClure's portfolio companies, I have to say Dave has been one of my most helpful investors. He's my go-to guy for intros to top investors, and the time he spent with us going over our user experience in detail was insightful. So he's definitely adding more value than just money :)

The angel fundraising experience that Paul Graham outlined in his last post is exactly what we've experienced. I wrote the term sheet (with help from my lawyer), set the valuation, and rounded up the investors. No one led the round or took a board seat because no one was willing to step up and put in more than $100k. (I think that's a sign of the new angel investment model more than any signal of weakness in our company.)

It may also be helpful to note that I turned down seed investments from VCs due to signaling concerns. In my mind, to avoid signaling, I'd have to create a syndicate of VCs, which I perceived to be too time-consuming with little upside over a syndicate of angels.

I think the way for VCs to win seed deals from angels is to leverage their larger fund sizes by investing at slightly higher valuations and splitting the deal with 1-2 other VCs. Not by a lot, but the difference between raising $750k on $2M pre- (27.3%) and $1.5M on $4M pre- (also 27.3%) is meaningful to the entrepreneur. It's a win-win for everyone: the entrepreneur gets twice as much money to prove out their business and each VC only risks $500-750k. If things go well, the VCs will be first in line to do a $3-5M Series A at a valuation of $8-12M pre-.

(I've had one VC tell me it can get a little awkward if there are > 2 VCs in a seed deal because all of them can't "share" the following round if it's desirable. I agree with Paul Graham that power is shifting to the entrepreneur, and VCs are just going to have to figure it out and adapt.)

[Eric]

Thank you for the post. Sometimes the obvious just needs to be put out there. The best part of the evolution of the VC/Angel market is that as an entrepreneur you have many more options to find the right match for your needs.

[Fred Destin]

hi dave thanks for dropping by. you hit on driving fund reserves to winners (something we do extremely proactively e.g have been looking for ways to drive $$$ into zoopla from early on and no let it go back to market unecessarily). i agree with you that your strategy is financially optimal and one i fantasize about. but i am not sure how to make it work (for us at AV) sustainbly.

the question goes back to chris dixon's signalling. if 25% of your companies look like early winners (easy), 25% losers (easy), but 50% in greyzone, what happens to these guys in the greyzone ? founder collective positioned itself as a no-follow fund, so they're not benefiting from dollar averaging as the companies get derisked but they simplify their positioning (we don't follow). if your are index seed (the strongest brand in europe) and investing in say 40 companies of which 10 are meant to graduate into full series A, it gets tougher.

I assume you can get away with it if you say "i will invest in 100, i have capacity to follow 15-20, the resk you guys can decide whether my seed investment was smart ?". If you're defining this as a new engagement model (500startups fund, small fund, i'll follow some, you follow the others), i can see that as being coherent. your seed companies will just need to build relationships with other investors early.

so far at atlas (we've always done seed but not all are communicated), we have still erred on the side of caution, keeping a relatively high batting average on follow-on's, in line with what mark suster and fred wilson were describing. By the same token we're chomping at the bit to spread our seed money wider, but we do not want to do this in a way that sucks for the entrepreneurs. It may simply be that our modus vivendi is not optimally geared to replicate what you're trying to do. Damn marsupials.

[Dave]

great piece Fred... even if u don't like my asteroids & dinaosaurs analogy ;)

re: your question:

>> If you invest in 200 companies at seed level, what are you really contributing ?  How is that not a passive options portfolio ?

it's not a passive options portfolio if you selectively follow-on invest in the winners.

ex: do 200 at seed, then top 20% = ~40 at series A, then perhaps 1/2 of those at Series B, resulting in a "dollar-averaged" portfolio that increases weighting as winners emerge.

hardly passive, and not at all traditional "dinosaur" model (which looks like 30 at Series A, 10-15 at Series B, hope for 1-3 big winners).

[John F Frankel]

Firstly, I totally agree with your analysis: Capex has become Opex and the costs of starting a (software/Internet) business are 1/10th what they were a decade ago. Likewise I see the emergence of Google, Facebook, Twitter et al as disruptors that create opportunity, and you statement that "Many VC's are lazy and hooked on fees" captures the spirit of what is going on with larger VC's but not why it has happened or why it will reverse over the last decade. For that you have to look at their sources of funds - they literally have been force fed money by institutions that wanted to cut large checks, but not be more than X% of the fund. That will reverse as institutions have less money to allocate to the space.

All the published research and what I have personally seen over the last decade indicates that the smaller the valuation you invest in the higher the potential returns. Many think the risk is higher in early stage investing, but I am not convinced - certainly not at a portfolio level. I am a believer that this is the only asset class that can return significant IRR's over the cycle. There will be periods to step back and others to press forward, but overall, and with some hard work, good returns can be had.

By hard work I meed effectuating the outcome by rolling up your sleeves and helping out - smaller startups means smaller teams and this means that the impact of an investor can be far higher and more needed than in the past. It also means that there might be better portfolio returns in taking a bar bell approach: not only focusing on your winners, but also on companies that are not perfroming - to see if you can avoid them becoming losers.

Finally, the spray and pray approach will only ever give you average returns, albeit in an asset class with above average returns. Being selective and nurturing 3-5 winners out of portfolio can lead to awesome returns. It jus takes time. To me investing in a company involves the idea that I will, perhaps, not get my money back for 6-8 years or more. That is fine if the company ends up being a strong growth company in the out years, but it is outside the patience of many.

[herve]

I seldom react to posts I read (more often). Now that I read Graham's essay, I am even less sure there is an issue even if there is a debate. In 1968 Intel's and in 1998 Google's A rounds were angel rounds. I am not sure who was in charge, the entrepreneurs or the investors. So yes, I need to go back to basics or maybe it's just that the future is in the past...

[Fred Destin]

Ah Herve thank you for this and a pleasure to find you here. We are really talking around and not about the issue of what good governance is for a startup (if an investor starts giving orders by virtue of his ownership, he's meddling with management) and what role the investor who becomes a board member should really play. Are we saying governance does not matter anymore in startups because their master is market data ? Is this a pre original sin idealised view of the entrepreneur and the process of company creation ? Funny how you need to get back to basics. Working on a little follow up post after reading Paul Graham's latest. Best / Fred

[herve]

While I agree with all what you write, I wonder about a little thing I have experienced myself: aren't we confusing investors with mentors? Entrepreneurs critically need both money and advice but it does not have to come from the same individual. A mentor can give great advice and no money and he may do it just because he loves the entrepreneur/idea/product and an investor may provide the resources without which you cannot do anything and still not provide the right advice. Sometimes, even worse, because they have provided the money, investors are convinced that the advice is right or all of a sudden an order. I have no solution or proposal for your concerns and I feel the same about this stupid "the VC model is broken" but there is no doubt for me that there is tension when you mix money and advice...

[Fred Destin]

Not you're right just a Mandlebrot. Meant to refer to what I consider strong path dependency of venture returns :-)

[VictusFate]

Excellent analysis Fred, appreciate your professional take on what matters most (social contract). Bonus points for a fractal avatar (Mandelbrot + something else in the background?)