A Few Thoughts on Incubation and Angel Investing

There has recently been a bunch of chatter about the role of angel investors, Y Combinator and its ilk, and the motivations of those running large pools of venture capital.  All I can do is speak from personal experience and observation, but it seems to me that folks are trying to make sweeping generalizations about classes of investors when so much of the early-stage investment business is both context and case-specific.

Y Combinator

Y Combinator is amazing. What else can you say? Paul Graham is, well, I don't know what to say about him except that he is something akin to a prophet in my book. The manner in which he has built Y Combinator is not simply a model of how to incubate great ideas, but how to build great teams, mentor young people, and probably to raise creative, intellectually curious children with critical thought. I don't have Paul's technology brain or cumulative experiences, so would not be confident in running such a platform on my own. What might turn out to be commercially viable? Who knows. I need a little more information to go on than Paul and his colleagues when making an investment decision. I kind of feel about Y Combinator the way I felt about Fred and Brad investing in de.licio.us. They saw the value. I had no clue. They were right. I don't invest in things like de.licio.us. I lack the prism through which to see the value people like Fred, Brad and Paul see in stuff like this. Can Brad Feld and TechStars do this? Maybe so. But, in general, I don't think mere mortals can successfully run platforms like these. I sure as hell know I can't.

Angels

Angel investors are all over the map. One-time angels investing in a friend or a family member's business. Angels who are part of investment groups. Angels who used to be entrepreneurs and are now helping seed new entrepreneurs. Angels who made a bunch of money in one line of business and like investing in early-stage deals and working with young companies. It is very hard to characterize "angels" with a single, catch-all phrase. Their resources differ. Their experiences differ. Their risk tolerances differ. And their staying power differs. One trend I've noticed since becoming an angel investor is that those with relevant business experience and contacts are increasingly sought-after, and that many entrepreneurs are starting to distinguish among different types of angel investors. Since so many VC funds are so large and are either unwilling or unable to make <$1 million investments, entrepreneurs are turning to angels whom they perceive to have many of the benefits of a VC (domain knowledge, contacts, advice, money) without the related brain damage. Therefore "professional" angel capital is playing an increasingly important role in the early-stage capital formation process, and has truly become a distinct asset class between the small-time angel investors and the venture capitalists. This is where I currently fit within the early-stage investment ecosystem.

Venture Capitalists

Venture capitalists, like angel investors, are not a single nameless, faceless mass. Each firm has its distinct set of competencies and areas of interest and expertise. But even more important are the specific partners within each firm. Some partners rock. Others suck. I'd be willing to bet that a small number of individuals - not firms - are responsible for the lion's share of VC home runs over the past 30 years, meaning that it is the partner more than the firm itself that can pick winners and losers and help take those with potential to the top. This makes it extremely important for the entrepreneur to pick wisely - partners, that is - and to find the best match for the long-run. A firm is a brand. Brands have value. But getting the right partner certainly outweighs brand value for early-stage companies, since you want to be around for the later-stage when the value of the brand can really help you. And if you can get both together, fantastic.

Still in Business

Finally, while economic troubles may staunch the flow of angel dollars from the marginal angel investor, the professional angels of which I speak will still be around for funding good, commercially viable ideas. And since most professional angels aren't looking to the IPO market for exists any time soon, they are less sensitive to the dependency on the exit as opposed to building long-term value that will be monetized at the appropriate time. And this is of huge benefit to the entrepreneur, who is seeking that value-added, stable capital that professional angels can provide. All is not lost in early-stage land. There are still a wide range of attractive sources from which to raise funds, depending on your stage, business model and type of investor you are seeking.

Comments

[David S Rose]

As usual, you're right on target: four for four :-). Paul and yCombinator are really impressive, and it takes a very, very special mindset and energy to do that. We're starting a tiny, junior variation of that in our little startup world on 23rd Street, but I don't foresee ever 'growing up' to be Paul.

On the other hand, the rapid growth of angel investing has been one of the most fascinating 'institutional' changes in the market (unlike Paul, who is essentially sui generis). With over 420 angel groups, consisting of 6000+ angel investors current using the Angelsoft platform, we're seeing 'smart' angels being sought after as much, if not more, than early stage VCs. But the result is that getting a Scott Kurnit, or Esther Dyson to invest in your deal is at LEAST as hard as getting a VC!

Finally, I tend to agree that the recessionary trends are likely not to cause a significant breakdown in the early stage angel market. The pace of innovation does not slacken during a downturn, and since no is relying on mythical IPOs any more for take outs, angel deals that are rationally priced will continue to get funded.

[Ken Kamada]

I absolutely agree with you that the success of early stage businesses are context and case-specific. But, I think Wall Street and institutions have created many sub-par entrepreneurs. Most startups are so focused on the exit because institutions have been slinging dough to the next Youtube or Myspace. Every pro-forma I've vetted in the last 12 months revolve around ad-revenue or a 12 month acquisition target date. Rarely do you find the old school owner operators these days. Kudos to Y Combinator for bringing the focus back to building great businesses.