Top ranked sell side investment analyst turned angel investor shares thoughts on startups and early stage investing.
Saturday, January 9, 2016
The Coming Angel Ice Age
The Coming Angel Ice Age
In a provocative post last fall, Caterina Fake called out the coming Age of the Cockroach. A period in which only the toughest, meanest unicorn startups would survive as funding oxygen at the highest high altitudes of start up land got more scarce.
Now, based on a my own experience and an admittedly unrepresentative survey of angel investors, I am increasingly worried about a coming Angel Ice Age: extending Caterina's thesis in terms of a pulling back beyond late stage Venture Capital tourists and others right to the entry level of the capital formation process. Namely angel investors. What makes me (and my sample group) think that?
1. Excess tech startup supply relative to investor bandwidth: The movement to the gig economy (and hence growth in entrepreneurship in many forms), the explosion of accelerators (both horizontal and vertical) and the fact that startups are so cool on campus (hence a massive expansion of entrepreneurship classes and no school feeling complete without its own incubator, accelerator etc) has generated an exploding tech startup volume but with, in my view, questionable quality. I am not alone as an early stage investor in finding it harder and harder to sift through so many opportunities. I, and I am finding many other angels investors, are simply over whelmed by deal volume and "velocity". (Personally one of my NY resolutions is to stop going to big accelerator program Demo Days. I increasingly find them to be way over rehearsed and a poor use of my time.)
2. More angels, but investment activity per capita seems lower: The expansion of long standing angel groups, the creation of a myriad of new angel groups (again horizontal and vertical), the success of new angel training programs and crucially the post financial crisis search for investment returns in an ultra low interest rate environment have served to pull many new angels into the startup funding market. Pretty good news for the broader economy and startup world, yes. One manifestation of the increased interest, even with hundreds and hundreds of seats, big accelerator demo days are crammed in deed over subscribed. But how many of these "new" individual angels are really active "writing checks"!? Feels to me like check volume/value per angel is on the decline. And as interest rates rise, which they have finally started to do, the marginal angel dollars might well revert to other asset classes. Asset reallocation remains to be seen. But perhaps the biggest issue is ...
3. More active investors are showing increasing symptoms of "angel exhaustion". From what I can see, many of the more active angels who got engaged in this exciting world in the 2010-12 timeframe have started to run out of "juice". The core problem: There just haven't been enough liquidity events to provide money for these investors to allow them to recycle dollars back into the current generation of startups. And their bank balances (and where relevant partners/spouses etc) are not endlessly supportive, neither is individual patience. The deferral of IPOs doesn't help and many angels are getting wise to, and wary, of the way their own economics get hurt by the terms enjoyed by later stage investors. Crucially, in my view, these more established but still recent angels are realizing quite how long angel investor holding periods are (i.e. much longer than they thought or hoped.) Also, as they grow weary of writing checks, a growing proportion of the dollars they do invest get committed to their current portfolio as successful investees come back for follow ons. (OMG - seems like every 12-18 months, because it typically is!). Hence even if they sustain their dollar pace, the capacity these angels have for first time commitments to the newest startups is increasingly constrained.
Sounds grim. But maybe it could be worse!? If angel funding gets tougher then a corollary will likely be a higher and more visible proportion of early stage company failures than in recent years. (Q. The primary reason for startup demise? A. Running out of money.) If that plays out too then those angels in exhaustion mode are going to become further disenchanted. As the saying goes, your lemons ripen before your oranges. As a result these angels could be even more put off new investments and focus even more on the winners they have in hand.
While all this might be too apocalyptic I am sure early stage tech companies that could have got angel funding "easily" in the past few years are going to be held to a considerably higher standard for funding in the next year and more.
So what is a founder to do? My two point advice from October on what to do "When The Tide Goes Out" still stands:
a) If you are raising money now do so as quickly as you can.Accept standard deal terms without a fight and definitely don't be greedy on valuation. Other than at the very early stage, consider pursuing a "priced round" (ie equity) as opposed to raising capital on a convertible note. Professional early stage investors really do not like notes (other than for a first small pre-seed round maybe) and typically only do them because they "have to". When they don't have to ... they won't. (In that context founders should think hard before using very investor unfriendly documents such as SAFEs.)
b) Hope is not a strategy. Have a Plan B for an immediate future where the external financing environment is irrelevant to your company because you can manage to a very long runway or, better, get to cash flow break even so your runway becomes infinite. I met a founder last year who had done exactly that. Shifted her business model somewhat to increase revenues near term and get to cash flow break even sooner than originally planned. Now the founder tells me people saying "you are running a lifestyle business". This because the company is no longer obsessively maximizing growth (and taking in capital repeatedly to achieve that). But the founder has taken back control of her future ... and is OK with that!