Even Rich People Have Trouble Breaking Into the Startup World
WHY YOU SHOULD CARE
Because you’ve gotta know who’s pulling the levers of power with purpose, and who’s just playing with them.
It wasn’t your average pitch meeting. Mark Hamilton, a 33-year old consultant, sat hunched over his computer in a thatched hut, trying desperately to hear his buddy Grant Hughes over the buzz of the fan.
Hamilton, a former political appointee with the Department of Defense, was holed up with nine others in a compound, providing consulting services for an African prime minister regarding his re-election campaign. Through the radio, Hughes was pitching him on his new software platform, FocusMotions. Hamilton, far from your typical startup fiend, had verbally committed $25,000 to his friend.
The investing world calls people like Hamilton angel investors. Technically, “angels” are wealthy individuals who invest less than $1 million in seed stage companies. Angels are often involved in the tech industry and therefore, plugged into existing networks of startups. But plenty of angels — like Hamilton — come down from on high to fund startup founders with no connection to the tech world. Why do they throw thousands or millions at an industry they don’t know much about? Because if you’ve got spare money and a friend with an idea, amateur angel investing might just be your very expensive hobby.
I don’t know very many angels that have ever made money.
In the case of Focus Solutions, almost every dollar of the initial $280,000 round of funding came from Hughes’ friends and family. “For a first time investor like myself, it comes down to trust,” Hamilton says, “I would not have invested if I didn’t know Grant.”
In 2013, active angel investors collectively invested $25 billion in about 70,000 companies across the United States. Most of those startups are expected to fail. That’s all part of the model. Angel investing isn’t like its cousin, venture capital, which seeks returns in the form of home runs via acquisitions or public offerings. Rather, angel investing is about putting your fingers in a lot of honey pots – it’s much more about a batting average. Which means you need some diversity among the honey. But it’s a risky game to play.
“I don’t know very many angels that have ever made money,” says Brian Cohen, the Chairman of New York Angels, a consortium of more than 100 individual accredited angel investors, “But it’s exciting and shiny and these people have expendable income.”
Not the most intuitive way to spend your hard-earned money, is it? But these people are part of a larger trend of individuals hoping to diversify their portfolios — by investing in small, early-stage companies. In fact, the Center for Venture Research sees double-digit growth in the number of these investors in the past year.
But not all angels are created equally, at least if you ask Cohen. Especially not the amateurs.
“Your average angel doesn’t know how to do due diligence. Not doing due diligence is like [having] unprotected sex. You don’t know what you’re getting; there is only the excitement.” So naturally, “60 percent of angels regret their decision within six months.”
That regret is more than buyers’ remorse. Professional angels have ways of dealing with it; groups like New York Angels help pool capital for “professional” angels, such as Cohen, to have better access to deals. Web platforms like Angel List and Gust have also become a popular way for would-be “Hollywood” angels — or amateurs — to sift through potential investments. However, nothing exists to do the due diligence that would allow your average rich person to partake in a form of passive angel investing.
Your average angel doesn’t know how to do due diligence. Not doing due diligence is like [having] unprotected sex.
That, says Tuff Yen, long-term venture angel investor with 13 successful capital exits, is a demand problem — on the angels’ side — that the market is not currently solving. He is trying to change that. “Today if you are a client at Goldman or Morgan Stanley or any of the financial firms that manage your wealth and you ask them, ‘Hey I want to do angel investing, can you bring me startups and qualify them for me?’ the answer is no,” he says.
Yen’s firm, Seraph Group, is offering what it claims is the first-ever structured angel fund (SAF). SAF works like an exchange-traded fund in that it holds a basket of startups that investors buy into. Like an incubator for investors, its 205 angels, which run the gambit from doctors to lawyers to the former CIO of AT&T, each put forth at least $100,000 plus a $5,000 flat investment fee.
…Average people invest, while professional wealth managers do all the hard work behind the scenes.
These successful — and wealthy — corporate executives may be great at their jobs, but that doesn’t exactly translate to choosing great companies to invest in. While big companies have an established business model, customer base and value proposition, startups are still trying to figure it all out. Not to mention, they have no idea how to look at a term sheet.
Hamilton agrees, “It’s true. I am a rookie at this, mainly because I don’t have the time. I also just don’t have the access and don’t know what I’m looking for in the due diligence.”
Yen says the future of angel investing lies in this type of product which lets average people invest, while professional wealth managers do all the hard work behind the scenes. (Tuff believes that won’t be a problem with his product. He has designed the system to allow investors to actively support entrepreneurs when and if they want to.) He sees it revolutionizing the angel world, much like Charles Schwab did with the brokerage industry when it offered the average, middle-class American the ability to buy stock from home, without an intermediary.
Cohen is not so sure. “It’s a little weird to me. Everything an angel does is about enhancing an entrepreneur’s ability to succeed. The wealth manager is in the business of deploying money and getting money back as a commission in return. I don’t see how it is clearly helpful to the entrepreneur.”
Hamilton, for his part, believes he’s contributing a lot as an angel investor — from professional contacts to mutual mentorship. “It’s really fun to do. I’m learning from Grant and he’s learning from me.”