Misstatements about early-stage investing have been proliferated for far too long. Unchecked, they take on a life of their own and create confusion that can hurt entrepreneurs and the startup economy. Here’s an example: a recent article by Forbes contributor Dileep Rao suggesting that Minnesota and other states dump angel tax credits essentially because they don’t have robust Venture Capital communities or billion-dollar entrepreneurs. While I think well-crafted angel tax credits are effective in increasing angel investment in good companies and there is data to back that up –my purpose here is to address myopic views about venture capital, angel investors, entrepreneurs and unicorns that are much bigger than the tax credit issue.
Rao’s three main points are: 1) States without much Venture Capital cannot support high growth businesses, 2) all investor focus should be on billion-dollar entrepreneurs and 3) my personal favorite (not) “Angel funding can actually hurt areas outside of Silicon Valley. Ventures with significant amounts of angel financing often follow a capital-dependent strategy rather than developing capital-smart entrepreneurs.”
Seriously? Let’s take a look at how the American angel community is actually working.
Angel investing is not concentrated in Silicon Valley – it is everywhere. American angels invested an estimated $24.1 billion last year in about 73,000 deals. Counter to Mr. Rao and other media reports, these investors and companies are in every state. Great angel deals happened in Silicon Valley, but also in companies based in Minnesota, Montana, and South Carolina. Exits too. The winners were the companies, their employees, investors and their state economies.
Not only is wealth everywhere, but interesting entrepreneurs are too. Importantly different areas have their own competitive advantages that spawn entrepreneurs, innovative ideas, and exit possibilities. For instance Minnesota is home to
Angel sophistication is growing throughout the country. For more than a decade angels have been developing and sharing firsthand experiences and best practices in financing startups – from evaluating companies to structuring deals to mentoring companies for growth and exits. Many angel investors are entrepreneurs with successful track records. Others are or were corporate leaders and business professionals. They have avenues for sharing ideas and learning from other good investors, including angel groups and platforms, statewide and national professional associations such as the Angel Capital Association, and many other excellent education programs.
Many angel-backed companies don’t need venture capital. Don’t get me wrong, angels love to see billion-dollar companies. But these unicorns are truly rare. Angel portfolios across the country have a balance of investments, with some that will need VC funding to expand and others that don’t require VC money and get acquired for smaller amounts of money, $20 to $100 million. These angel-backed companies are win-wins-wins. Angels, entrepreneurs and states realize great results with strong financial returns, jobs, and innovations that diversify and grow local economies.
Rick Vaughn, who leads the Mid-America Angels in Kansas City, reminded me of how this can work. Entrepreneur Toby Rush received angel backing for his first company, Rush Tracking and didn’t require VC funding. He (and his Kansas City area investors) had a small but successful exit. Things are different for Rush’s second company, EyeVerify, which has a combination of angel and VC support and is on a path (knock on wood!) for a significantly larger exit. This company has moved to larger quarters to house its expanding team of employees.
Sophisticated angels invest in capital efficient companies, especially outside of Silicon Valley. Angels are increasingly educated in both assessing capital efficiency in reviewing investment opportunities and mentoring entrepreneurs to use funds wisely and efficiently. It’s our own money after all. Vaughn says: “I believe nearly all smart angels and angel groups want their startups to be capital-smart, not capital-dependent. This means they should start small, stay lean and local, raise only the funding really needed, grow the business judiciously and then exit.”
Ironically, the pressure toward capital-dependency often starts in Silicon Valley. Stories of companies with high valuations and more money than they can spend come predominantly from the Bay Area. Sadly there is also a growing number of entrepreneurs in Middle America who have seen those Bay Area valuations in Internet databases and tried to get the same valuations in their hometowns, only to be turned down for funding because their price was too high.
John Huston, an Ohio-based angel, uses a process that demonstrates the combination of angel sophistication, focus on capital efficiency and the different paths startups can take: “We estimate at the outset whether a lucrative exit can occur without VC funding, or whether VCs are a necessity. If they are, that puts the company on a different pathway to show the growth and build a team that is VC-fundable.”
Angels syndicate deals and provide follow-on investment, sometimes filling a VC void. Angels have figured out how to syndicate investments effectively, particularly in regions that have few or no VCs. It is increasingly common for two to five angel groups, family offices and other investors to work together not only on an “angel round” but on several follow-on rounds. Necessity can be the mother of invention, and the angel market has worked out ways to pull together VC-like capital when VC firms are not around.
Rao seems to be saying that states shouldn’t have public policies that catalyze angel investing because most states don’t have VCs. Really? Isn’t the point to drive smart early-stage investing into deserving companies in these areas? If not for angels, who would fund startups outside of Silicon Valley, New York and Boston?
I’ve enjoyed several of Mr. Rao’s columns in Forbes and really appreciate experience and good advice to entrepreneurs. One area we likely agree on is that companies that can effectively grow through bootstrapping or bank loans should go those routes rather than equity from angels and/or VCs. Many really great billion-dollar companies never sought outside equity financing. I’m sure we agree on many other things as well. Sometimes we find, however, that the real story of angels and the startups they support is not fully understood and that is why this story must be told.
