I read an unusually interesting article by financial advisor and former venture capitalist, Andy Rachleff, regarding advice to would-be angel investors. The gist of the article was that few, if any angels make any money on their investments. I somewhat agree with Mr. Rachleff, but have a different view as to the future of this important financing resource. There is little doubt that the system is broken, especially when you consider the low returns tolerated by angels. In essence, angel investors take the same risks as venture capitalists. By virtue of their structure and organization, however, VCs enjoy far more protections, and subsequently make more money.
Regardless of Andy’s “skepticism,” I believe that angel investing plays a crucial role in allowing new companies to get off the ground. Many entrepreneurs don’t have friends and family with the substantial means it takes to help them get a company off the ground. Without angel investors, these would-be superstars have few options. And it’s highly unlikely that these entrepreneurs could simply just jump right into VC funding without some seed capital. There are emotional benefits to Angels as well; the term ‘Angel’ connotes romantic visions of mentorship and tenacity, driving an entrepreneurial chance of a lifetime.
Angles are critical in building value in more than one way. While VCs dictate larger exit valuation, angels provide companies with flexibility to ultimately choose VC funding or opt for organic growth once the initial model works. As Rachleff suggests, VCs may have reasons to go “double or nothing” or take meaningful commercial risks. After all, they are later stage investors and are protected by special liquidation terms and other such fail-safes. Angels generally do not have these protections, and therefore must take some unintended risks.
While angels may typically be the linchpin for the creation of a beautiful company, they are susceptible to “grinding” by more powerful investors and are often increasingly ignored as the company matures. Angels are an import ingredient to any start-up, but their vulnerability and how they are treated by later stage investors as a company grows shows that the model is broken. This demonstrates that in many cases, angel investing is a romantic hobby, not a profession. Changing this formula might very well improve more investment outcomes.