I invariably started down this startup-investing path a few years ago. I had helped folks out before, but it was more Kickstarter than investor. I started looking at startups more and more as a serious investment. I foolishly made my first investment without even a rudimentary understanding of the mechanics, but I quickly filled in the gaps by talking to other investors, reading blogs, and joining angel groups. Now equipped with both knowledge and experience, I can unequivocally state that I know not that much more now from when I started.
Investing in startups is inherently frustrating. The volatility, the lack of clear direction, and the human factors all contribute to make this the most confounding of investment vehicles. There are also the competing and diametrically opposed motives when it comes to angel investing where money, notoriety, altruism, relationships, and community all battle against each other. You could be strictly clinical about investments and focus on the business, ruthlessly seeking alpha. For most angel investors though, the motives are of a more selfless nature driven by a desire to pay-it-forward.
My ultimate desire is to help novice entrepreneurs to build successful and sustainable technology businesses. I also want to see NYC develop into a global center for innovation and technology. This is why I spend as much time as I do with entrepreneurs providing advice and guidance despite the challenges of balancing my time between business and family. That being said, I still want the investments I make to matter to the entrepreneurs and to pay off down the road.
From what I have observed, there are four results in the course of investing that most frustrate angel investors:
- Blocked out from a desired deal – Happens quite often on hot deals where the entrepreneurs have the leverage to pick and choose investors.
- Invited into deal but cannot accept terms – Usually occurs when the terms of the lead investor are untenable or the valuation makes the investment not worthwhile.
- Crushed down in subsequent funding rounds – Going beyond normal dilution, this can occur when the next round of investors get greedy, the founders want to push out the old investors, or there is a down round.
- Investment ends up being a total wash – Unfortunately this is the overwhelming majority of investments, which return significantly less than the capital invested or nothing at all.
I have been fortunate not to get crushed down or blocked from a deal. One investment that could have resulted in nothing was salvaged, but still resulted in a loss, so I have been fortunate there are well. But the one area that keeps causing me frustration is deal terms and valuation. While I stated last week that endless rounds of deal negotiations were counterproductive, I still firmly believe that the deal has to be fair for both investors and entrepreneurs. One-sided deals simply cause problems and aggravation down the road.
I am genuinely pleased when an entrepreneur can secure a windfall in funding. I believe that it is in the best interests of entrepreneurs to raise the most capital as possible at a reasonable price. The worst situation you can find yourself in is being in perpetual fund raising mode because you did not raise enough in the first place. There are too many variables involved to not give yourself as big of a cash cushion as possible.
For many angel investors though, big seed rounds are problematic. Putting in less than $100K in a $500K raise at a $2M pre still gives the investor a meaningful stake. When it is a $1M+ raise at a $5M+ pre-money valuation, that stake becomes much less meaningful. Furthermore, larger seed rounds are generally led by institutional leads that have little motivation to protect the interests of other investors. This can lead to bifurcated terms that serve to punish investors that put in small amounts of capital.
Your best investors early on are not necessarily the ones with the deepest pockets, but those that can help. I saw the following quote from Vinod Khosla the other day:
The key role of early investors is not funding, but personal attention and guidance. But generating buzz too early can inflate a startup’s market cap and make them a less lucrative investment of time and money for the top-tier advisors they need.
Finding quality investors that are the right fit is not an easy task. If you have someone that is willing to invest, can provide material help and is passionate about you and your idea, it behooves you to figure out a way to bring that investor on board. Those are the people most willing to lend a hand and give you support. When no one else has the time, they make the time to help you out. Ultimately, those are the types of investors you really need in the early days, the folks that will be your heroes when trouble comes and you hit that rough patch. It is those frustrated investors that are your real angels.
This article was originally published on Strong Opinions, a blog by Birch Ventures for the NYC tech startup community.
Image credit: CC by Alex
