First round – Angels vs VCs

Interesting blog by Ben Horowitz on when to take angel money and when to take VC alongside a bit of the history of venture capital. Ben’s firm, Andreessen Horowitz, is a fund that invests small amounts in lots of deals so it is no great surprise that he concludes that this is probably the ideal operating model.

Ben argues that most early venture deals were for hardware businesses selling into complex supply chains, and sophisticated and expensive requirements for people, land and manufacturing equipment.

This meant that the best investors would have some well defined attributes:

  • “Access to large amounts of money to fund the many complex activities
  • Access to very senior executives such as an experienced head of manufacturing
  • Access to early adopter customers
  • Intense, hands-on expert help from the very beginning of the company to avoid serious mistakes”

Venture firms that met those requirements tended to organise themselves in similar, economically rational, ways (and not one mention of maximising the management fee per partner):

  • “Raise a large amount of capital from institutional investors
  • Assemble a set of experienced partners who can provide hands-on expertise in building the product and then the company
  • Evaluate each deal very carefully with extensive due diligence and broad partner consensus
  • Employ strong governance to protect the large amount of capital deployed in each deal. This includes requisite board seats and complex deal terms including the ability to control subsequent financings
  • Manage own resources effectively by calculating the amount of capital/number of partners/maximum number of board seats per partner to derive the minimum amount of capital that must be invested in each deal”

Ben argues that this way of working is totally incompatible with the requirements of modern organisations that are far less reliant on capital at an early capital. (And here he may be right about certain types of web companies but the same rules still apply to hardware businesses). Organisations like the ones he describes above harm early stage businesses as:

As a result, for a modern startup, funding the initial product can be incompatible with the traditional venture capital model in the following ways:

  • “Lengthy diligence process. Venture capitalists take too long to decide whether or not they want to invest because they are set up to take large risks and have complex processes to evaluate those risks.
  • Too much capital. Venture capitalists need to put too much capital to work – often a VC will want to invest a minimum of $3M. If you only need 4 people to build the product and get it into market, this likely won’t make sense for your business.
  • Board seat. Venture capitalists often require a board seat and, for that matter, a board of directors be formed. If 100% of the company is building the product and the team knows how to do that, then a board of directors may be overkill. In addition, it may be too early to decide who you want to be on the board.”

Not surprisingly, Ben’s fund changes all those rules as it invests early, at a low level and doesn’t take board seats. Whether this approach is one that will show better ROI than current venture models is as yet unproven. His advice for deciding whether to accept VC money into an angel round is spot on though:

Don’t take VC money in an angel round unless the VC can…

  • “Be comfortable investing a small amount of money, e.g. $50,000.
  • Be able to make an investment decision quickly, e.g. in one or two meetings
  • Be able to invest without taking a board seat
  • Not require control of subsequent funding rounds
  • Not impose complex terms
  • If the VC wants to be in the angel round, but refuses to behave like an angel, then entrepreneur beware. Having a VC who behaves like a VC in the angel round can jeopardize subsequent financings.”

The last point is particularly important. An early investing VC that loses interest in the deal can be particularly damaging to the chances of a start up’s fund raising activity. As angels are getting more sophisticated, they may be reluctant to share the round in any case.
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