I really enjoyed the Boston Angel Boot Camp on June 1. A shout out to Jon Pierce for a job well done.
Among the many great discussions, the most critical one in my mind centered on the impact that the source of money can have on an early, seed startup. The discussion covered two main sources of seed funding: Vc and true angel.
What’s different? Isn’t seed money just seed money?
Absolutely not. There are hugely different expectations around returns and time depending on the source.
- Return Expectations — VC Moonshots
- Vc’s have much bigger war chests than angels and are paid to deploy and return that warchest and more to their limited partners (investors to VC’s). They need to deploy large amounts of capital with strong returns in order to be a great performing fund. Typically they need to return 3x their fund size in order to give their investors and themselves a decent return (See Fred Wilson for a clear concise explanation of this). Therefore, they look for 10x returns of the capital they invest, understanding that few of their investments really hit that number. But they shoot for the moon knowing that one or two moon shots make their entire fund’s return. Those moonshots can cover a multitude of sideways performers.
- Ok you say. 10x is very cool. Yeah, but not to the VC or the LP’s of a VC. 10x on $ 1 million barely moves the needle on a $400 million fund that is supposed to return $1.2B. VC’s can’t afford the time to spend only $1 million for a 10x return. They can only handle so many companies (usually 7-10, max at a time). For a company to have an impact on their return report card to their LP’s they want/need a $4-10 million investment returning a $40-100 million return on exit or IPO in order to even begin to move their investment needle with their investors.
- Time expectations
- If the investment size isn’t enough of an impediment, the time horizon for most funds adds a second blow to the chest. Typically a VC looks at an investment within a 5 year window in order to return capital plus a return to their limited partners. If the portfolio company is not on the road to IPO or exit in 5 years, the investment falls into the “sideways” category. The situation can be fixed and result in success (as in Pandora) or end up in trouble and either a sale of assets or simply closing the doors.
- Most seed investments, however, are just that — seeds. Not sprouts or full grown plants, just seeds. Depending on the trajectory, the seed can grow quickly, but as we all saw and conjecture with CRV and Twitter, the first year or so of operations, I suspect, was relatively unconvincing and caused CRV to drop out of the subsequent funding process. While hindsight questions that decision, its more easily understood when time expectations of the VC are accounted for. My guess is that CRV did not see a trajectory that would get them to a strong exit in a 5 year window.
Where does that leave entrepreneurs looking for seed capital (< $1 million)?
- Look for seed money from angels.
Most seed investments are not best done by VC’s. Their timelines are too short and money requirements too large. Most seed companies have not proven anything yet. Certainly not anywhere near enough to show a trajectory to exit in 5 years consuming millions of $ in capital with great valuations along each stage. Think of a seed as sparks of a fire with a few kindling type pieces of wood — barely heating or lighting anything.
- Look for seed money from a few highly experienced angels in your sector
Money is not money in the angel world. Find angels who understand your business and/or demonstrated success operating, managing or investing in similarly inclined businesses. Whereas a VC can straddle many widely varying disciplines, angels have a hard time usually because their angel business is not a full-time job.
The impact, positive or negative, that an angel can have in the early stage of the company’s life is enormous. I liken it to the rocket ship analogy. On launch a change in 1 degree of the rocket’s trajectory can be the difference between landing on the moon or the ocean. A small change in trajectory has a huge impact the earlier the rocket’s launch trajectory. Same holds true for startups.
- VC’s are best in post-seed investments (Series A and beyond gigs) where the amount of invested capital is significant and the timeline to exit is predictably shorter. The product is built and customers like it and are paying real money for it. Dilution is usually more manageable, since the product is in the market and generating traction.Another apt analogy here is fuel and fire. A series A company looking for venture capital should be like the fire that has shown its promise, but needs more wood/fuel to expand its impact. The size of the fire and the amount of wood needs to be proportionate so that the fire does not get choked out with too much fuel or starved to death with too little.
So there is a difference in the kind of money you raise for your seed startup. Find angels who have experience in your business sector and make sure that they have the time to help you. Avoid “spray and pray” angels. They do not have the time to help. Talk to VC’s when you have viable product so that the negotiations and onward growth are more on your terms than theirs. VC’s add great value, but you must know when to apply them to your company’s growth trajectory.