Threat to VC Is from Regular Angels, Not Super Angels, CEO Survey Says

[Corrected, see below] “Mounting tensions” would be the journalistic cliche to describe recent relations between traditional Silicon Valley venture capital firms and the growing class of “super angel” investors—groups like Ron Conway’s SV Angel, Mike Maple’s Floodgate Fund, Dave McClure’s 500 Startups, Aydin Senkut’s Felicis Ventures, and Jeff Clavier’s SoftTech VC.

The relationship between these super angels and VCs matters a lot, because it could have an impact on investment for the next generation of small, Internet-based ventures. Thanks to innovations like cloud computing, many of these Internet companies don’t really need the multi-million-dollar rounds traditionally dispensed by venture firms. So, when the super angels aren’t sniping at each other about how to work with entrepreneurs (witness the blizzard of leaked e-mails prompted by TechCrunch’s “AngelGate” kerfuffle), the VCs are circling warily and arguing that big venture firms make better business partners than super angels, thanks to their larger networks and operational experience.

But if traditional venture firms are concerned about losing out on deals, they may have the wrong targets in their sights, judging from survey data released today. Software, Internet, and mobile entrepreneurs raising their first or second round of funding are much more likely to turn to individual angel investors than to either super angels, traditional VC firms, or early-stage VC funds, according to a survey conducted by attorneys in the Palo Alto office of Dorsey & Whitney, which works with numerous venture firms.

The 363 startup founders who responded to the survey said they were mainly looking for investors who will offer attractive deal terms and valuations, who can move quickly on deals, and who won’t push startups to take more money than they need. On all three counts, angels happen to have the perceived advantage. But the entrepreneurs indicated that they cared more about getting deals done than about whether there are big names on the other side of the table. Which means traditional venture firms who don’t want to be locked out of today’s smaller companies probably shouldn’t waste time worrying about super angels (who are arguably evolving into mini-VCs in any case).

Dorsey CEO Funding Chart“The survey results say that that debate is beside the point,” says Matt Bartus, a partner in Dorsey & Whitney’s corporate group and a co-author of the survey report. “Entrepreneurs are looking for investors to fill their funding needs along with the relevant expertise, and they are pretty much indifferent as to which entity that comes from.”

Bartus conducted the survey with Ted Hollifield, another partner in Dorsey & Whitney’s Palo Alto office. Participants for the online survey (full report here) were recruited through the firm’s internal contact list as well as via blurbs in TechCrunch, Venture Beat, and StartUp Digest. The CEOs who responded were mainly from consumer Internet startups (34 percent), cloud computing or Software as a Service companies (17 percent), and mobile startups (13 percent). A small slice were in energy (3.3 percent) and life sciences (2.7 percent). They were predominantly from the Bay Area (42 percent), with smaller contingents from places like New York, Los Angeles, Boston, Seattle, Denver/Boulder, and Austin. Some 19 percent were from outside the United States.

All respondents had either raised funds within the last 12 months or were planning to raise funds in the coming 12 months. Most said their firms needed relatively small amounts of money: only 9 percent had raised more than $5 million, and only 12 percent said they’d need more than that in the coming year. A full 58 percent had raised $500,000 or less.

So, who have these CEOs turned to for funding? About 59 percent said they’d already raised money from individual angels or groups of angels. Friends and family represented the next largest group of investors (32 percent), followed by early-stage VC funds such as True Ventures and First Round Capital (19 percent), traditional VC funds (17 percent), incubators such as TechStars and Y Combinator (12 percent), and, way down at the bottom of the list, super angels (9 percent).

[This paragraph corrected with new input from Dorsey & Whitney 10/12/10 9:05 am PDT] Asked who they’d likely turn to in the next 12 months, startup founders gave similar answers—angels (69 percent), super angels and early-stage VC funds (both about 38 percent), friends and family (26 percent), traditional VCs (22 percent), and incubators (12 percent).

“Angels are clearly the largest category by far for this class of investors at the early stage,” says Dorsey’s Hollifield. “They led by a country mile. A large number of entrepreneurs find that angels are in fact meeting their funding needs and that they expect them to be able to meet those funding needs going forward.”

That’s potentially scary news for venture capital firms, who used to be able to depend on the fact that entrepreneurs with relatively low capital needs in the early stage would eventually grow to the point that they’d require larger, multi-million-dollar infusions. These days, apparently, many entrepreneurs are betting that they can get all the way to an exit without taking venture money. “The survey kind of debunked what may be a common myth, which says that everybody is moving up the ladder from angels to super angels to early stage VCs to traditional VCs,” Hollifield says.

But the most revealing section of the Dorsey survey asked respondents to rank 16 characteristics of potential investors on a five-point scale ranging from very important (5 points) to somewhat important (3 points) to not important. It’s tricky to sum up these findings in a few words, as each question resulted in a distribution of answers across the scale. But here’s how the elements stacked up, in order of the percentage of respondents who assigned the elements either 4 or 5 points:

Dilution—percentage ownership required by investor 75.3 percent
Understands funding needs—offers no more or less money than required 70.9 percent
Speed with which the deal gets done 68.4 percent
Pre-money valuation offered by investor 67.5 percent
“I felt like they really wanted the deal” 62.4 percent
Number of board seats required 62.1 percent
Specialist in the space 61.4 percent
Liquidation preferences required 57.6 percent
Operational experience 53.6 percent
Ability to bring in customers 50.2 percent
Has resources to invest in future rounds 42.3 percent
Geographical proximity 26.4 percent
“We had an existing relationship” 24.5 percent
Brand name 24.5 percent
Understands global markets 19.9 percent
“I’ve raised funds with them before” 11.9 percent

If nothing else, these rankings show that startup entrepreneurs are thinking very carefully about who they want to take money from—and that they’re likely to walk away if they think that a potential investor is trying to take advantage of them in term sheet negotiations, or if the money is all the investor has to offer.

Ted Hollifield“Both Matt and I were kind of impressed,” Hollifield says. Respondents were “very focused on the operational expertise of the investor, and whether the investor was a specialist in the space. They especially told us that they are not impressed with brand names, which is relevant to both super angels and VCs….It’s indicative of a pretty high degree of sophistication among the entrepreneurs.”

A big law firm like Dorsey & Whitney is far more likely to be representing venture firms in deal negotiations than entrepreneurs. So why would they go to the trouble of surveying hundreds of startup CEOs?

Bartus and Hollifield say they wanted to get past the surface of the debates between venture firms and super angels and find out what entrepreneurs themselves think about the different classes of investors. Just as important, they wanted data that would help them advise their own clients.

Matt Bartus“One of the biggest questions we are asked by investors is to provide them with feedback when they don’t get a deal they were interested in and thought was a good fit for their fund,” says Hollifield. “They ask us what they should have done differently—what was it about the entrepreneurs’ decision-making process such that they didn’t get the deal? This data reaches beyond our anecdotal experiences to help guide those investors to be more effective in getting to the top.”

It’s an exercise that large venture firms must undertake, or risk losing out on being part of the next Google or Facebook, Bartus says. “One of the better debates that’s heating up is how to differentiate between companies that have low capital needs but have the potential to be another Facebook, and companies with low capital needs and low exit opportunity,” he says. “Angels are willing to invest in both categories, but VCs are really only interested in that Facebook category. I believe VCs are recognizing that they do need to compete at this investment level to pick up those promising companies.”

Wade Roush is a freelance science and technology journalist and the producer and host of the podcast Soonish. Follow @soonishpodcast

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3 responses to “Threat to VC Is from Regular Angels, Not Super Angels, CEO Survey Says”

  1. This survey is fascinating and helpful. It makes me think, this is such a good idea that it’s amazing that it hasn’t been done before (or, at least, not nearly as well). Kudos to Bartus and Hollifield!

    About the argument that “big venture firms make better business partners than super angels, thanks to their larger networks and operational experience.” Maybe so, but how about a third alternative: angel investing groups? Common Angels has over 70 members, with a lot of contacts and operational expertise. Most VC firms say that they’ll provide a lot of assistance; I hear that this is true more of some than others, and entrepreneurs should always do “reverse due diligence” to check out things like this. I have seen Common Angels members provide a lot of help, and I presume that the other angel groups are similar.

  2. Thanks, Daniel, for your compliment. It was appreciated, and I’m glad the survey was helpful. I would be interested to know how people view angels groups, and we may try to include that the next time we do the survey.
    Regards, Matt