By Dan Rua
Special to TechJournal South

I remember my first presentation at the Chamber building, to a handful of Gainesville’s finest, extolling the virtues of grouping their investment dollars and expertise to manage risk and maximize reward. Inflexion had recently launched its early-stage venture fund and we saw a missing piece in the local entrepreneurial ecosystem – organized angels to seed tomorrow’s venture opportunities.

They say “in the land of the blind, the one-eyed man is king” so I hoped to bring some perspective and guidance from my venture experience outside Florida. My “one-eye” was first-hand experience with TIG in NC, The Dinner Club in DC and even Silicon Valley’s Band of Angels. It wasn’t much, but enough to share that organizing is the easy part, if a community has the dollars and business expertise to harness. Through the efforts of many (thanks David, Chris & Brent) we fed wine and cheese to about eight angels at that kickoff presentation and two of them left early to discuss a real estate project. However, at least three of those who stayed got it (thanks Lee, Steve and Carol) and blowing on those embers got others to come back for more meetings – reaching standing room only when I distributed model operating agreements and the angels got excited enough to take the handoff for group creation.

Fast forward three years and that angel group, now called Emergent Growth Fund, is backing great seed companies and helping build tomorrow’s venture successes. They are even spearheading a broad angel alliance to collaborate with peer groups across the state. Inflexion shares deals and diligence, and Emergent has learned the investing business as well as can be expected from a firehose. However, there is a dark side to angel grouping that I mentioned in that Chamber presentation, and a recent report brought it back into focus.

The University of New Hampshire’s Center for Venture Research (CVR) recently released a report on angel investing about which CVR’s Director, Jeffrey Sohl, commented “While angels are not abandoning seed and start-up investing, it appears that market conditions, and the preferences of large formal angel alliances, are resulting in angels engaging in more later-stage investment. This restructuring of the angel markets has in turn resulted in fewer dollars available for seed investments, thus exacerbating the capital gap and start-up capital in the United States.” In other words, if the lack of seed and early-stage venture capital funds wasn’t bad enough for entrepreneurs, the gap is getting even wider as angels join forces and take their dollars later-stage.

If we compare the angels to the venture market as a whole, who can blame them. For every Inflexion that is focused squarely on that seed/early-stage gap, there are ten funds that claim to be early-stage – if, by early-stage, you mean $2-3M in revenue. This trend was also captured in PWC’s Q4 2005 MoneyTree report, noting that “Later stage accounted for 45% of all venture capital dollars, the highest proportion in the 11-year history of MoneyTree research.”

Given the overall market trend, I’m not here to say whether the angel trend is good or bad for them. I do know it is bad for entrepreneurs and I have a couple ideas why the absence of true seed angels is bad for us all.

Group-think would have killed Johnny Appleseed: Once an angel group is created in a region, the days of $25K-50K angel seed investments are numbered. That first investment over a coffee table typically gets prototypes done and running room for raising a true early-stage round. However, if that angel belongs to a group they are likely to share the opportunity before investing and weigh group opinions heavily. Given that the opportunity is truly seed-stage it is likely Simon Cowell’d by someone in that group and individual investment chances drop considerably. The result is fewer funded seed opportunities at the top of the funnel to provide great deal flow to angel groups and venture funds alike. Suggestion: encourage angel group members to make individual investments and/or factor prior individual investment into the group decision process (e.g. thus encouraging angels to seed their favorites).

Icarus got burned going later-stage: Angels want what all investors want, maximum return for minimum risk. The hard part is finding your niche for uncovering the best risk/return opportunities. Because angels are inherently local and have deep social networks, their historical niche is finding local seed opportunities that haven’t hit VC radars, yet. They invest at seed-appropriate valuations, mentor the entrepreneurs and prepare them for venture capital rounds. When they do it well, the returns can outpace even the best venture funds. However, as angel groups flirt beyond that niche I have seen them fall victim to adverse selection. Put more directly, they get in the mediocre later-stage deals that venture capital funds couldn’t fully subscribe and they don’t get into the top later-stage deals that venture funds oversubscribe. There are always exceptions to the rule, particularly if you have a strong relationship with one or two funds who let you in a favorite deal. However, as an angel portfolio strategy, going later-stage invariably results in more bad deals than good. Suggestion: find deals before the institutional funds and develop a reputation for creating value before introducing to your “favorite” VCs.

These observations aren’t targeted at any one angel group I’ve encountered. In fact, I’ve been impressed with seeds we have growing across Southeast angel portfolios. All the angel groups have come a long way since those first meetings, but it never hurts to check your wings along the way…

Dan Rua is Managing Partner of Inflexion Partners (www.inflexionvc.com) and Author of www.floridaventureblog.com
VCFAQ is his recurring column on venture capital topics, with particular interest in entrepreneur questions/comments about the venture capital process. Email question/comments to dan@inflexionvc.com

Southeast Venture Conference, February 29 – March 1, 2012 at the Ritz Carlton in Tysons Corner, VA – Where Smart Money Meets Smart People.
www.seventure.org

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