The Crowd’s Money Can Dominate Early-Stage Investing, But Only If The VCs Get Their Cut

Part 2 of my series on equity crowdfunding originally published on Techcrunch back in March.  Check it out here.

Is Equity Crowdfunding A Threat To Venture Capitalists?

With the SEC just having lifted the ban on general solicitation, the question yet again becomes: how will the equity crowdfunding industry evolve?  For a pretty comprehensive answer, keep reading…

Part 1 of my series on equity crowdfunding originally published on Techcrunch back in March.  Check it out here.

Customer Satisfaction Rankings of High-Volume Investors w/ Higher Investment Thresholds (>$30M Total Raised, >$5M Raised in Last 2 Years)

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For a full explanation of the methodology, go here.

VC Customer Satisfaction Scores - Exhaustive List

The list is too damn long to convert into images and post here so I’ve put it in a Google doc here.

For a full explanation of the methodology, go here.

Customer Satisfaction Rankings For All 93 High-Volume Investors

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For a full explanation of the methodology, go here.

Why are you and I going to become angel investors, why now?

It’s now actually possible

Thanks to the JOBS Act, a lot more investing activities are actually legal.  Startups that don’t want to incur the cost of SEC registration (read: all of them) are now allowed to publicly tell us they’re raising money.  Further, they’re now allowed to have four times more shareholders and soon even accept investments from unaccredited individuals without drawing the SEC’s ire.

That sets the stage for equity crowdfunding, online marketplaces that package startup investment opportunities, facilitate one-to-many communication between the entrepreneur and prospective investors, and then act as the broker in the investment transaction.  Importantly, they pool our investments together so that we can participate even with checks as small as $1,000.  FundersClub has staked an early lead, but SecondMarket has begun to dabble, and Wefunder has jumped into the unaccredited space even before the SEC has issued its guidelines.  There’ll be dozens of others within the next few years.

Equity crowdfunding sites are basically just a new kind of angel group.  What’s significant is that we’re all members no matter where we live or who we know. 

Despite these fancy new investment brokers, the startup equity market is still effectively closed to most of us.  Sure it’s easy enough to find an entrepreneur looking to raise money for a seemingly interesting business, but how the hell do I assess whether this opportunity is compelling in relation to the other 500,000 or so startups kicking around?  Historically, if I didn’t spend at least half my day immersed in the ecosystem sourcing deal after deal and collaborating with industry insiders, I couldn’t know.

Enter AngelList.  It has torn off the shroud and laid bare all of the activity in early stage fundraising.  Who all has raised and is currently raising money, what traction and social proof they’ve accumulated, and the relationships that connect us to these projects and each other.  All without leaving my couch.  AngelList has already made huge strides in democratizing deal flowThe story of Transcriptic’s $2M seed fundraising is a harbinger of days to come as AngelList’s growth and continuous platform development add further transparency and access to this once entirely opaque market.

Angel capital might not be as bad of an asset class as you think.

As I mentioned earlier, there’s a popular contention among many VC’s and entrepreneurs that angel capital is dumb money, that it’s more hobby than profession, and that the returns have to absolutely suck.  But do they?  Maybe not. 

No clean data exists.  All we have are various samples of self-reported returns from angel groups.  In 2007, Robert Wiltbank of Williamette University compiled the best data set I’ve seen.  He contacted 276 angel groups, got 86 to participate, then received data from 13% of their members or 539 investors reporting results on 1,137 exits.  The investments were made between 1990 and 2007 with 65% having occurred after 1999 and 62% of the exits occurring after 2004.

The grand result: 27% IRR or 2.6X over 3.5 years.  In 2009, Wiltbank undertook a similar study of English angel investors that yielded similar results.  The Center for Venture Research conducts an annual survey of ~50 angel groups in which investors report comparably high returns.  Relative to any benchmark, whether VC, other alternative asset class, or public equities, these are stellar returns.

Obviously, the potential for bias in these results is enormous, but can we at least assume for the moment that responses were honest and accurate?  If so, then it suggests attractive returns among highly engaged angel investors (angel group membership, avg. of 20 hours of due diligence per investment - Wiltbank study) are more common than we might have thought.

So is angel capital dumb money?  Aggregate returns aren’t knowable.  But other factors are worth considering: it’s not subject to a 2% and 20% fee structure, that’s certainly not stupid.  Also, let’s be blunt – of course it’s going to look stupid relative to VC!  More than half it goes to seed-stage investments compared to around 5% ($ basis) of VC.  There’s just a lot less to know about a business at the seed stage.  That level of uncertainty calls for greater diversification across many more startups than a VC portfolio would contain.  The combination means that of course it will be easiest to get a seed check from an angel.  That’s the model.

And even if angel capital is either just a crap asset class or we suck at it, it’ll take years for each of us to figure that out.  Assuming at least 3 years to build a diversified portfolio, 3.5 years to exit each investment but 5 years for the winners, concrete answers will take almost a decade.  Incorporate learning curves and changing market dynamics and we could spend half our lives thinking that maybe we should quit our day jobs.

Startup investing is sexy as hell.

Did you know that in 2005 Jim Breyer personally invested $1M in Facebook at a $100M pre-money valuation?  That’s a tidy several hundred times multiple in 7 years.  Or how about that in 1999 Ron Conway invested in Google at a $75M pre and did a 300X?  Every big company has these stories.  They become legends and serve as inspiration for you and me to get in the game.

Want to know the bitch about Facebook?  I was an avid user probably before Breyer had even heard of the company.  If only there’d been a way for me to invest!  While my hindsight-laden bitterness is ridiculous, it’s easy to imagine the temptation we’ll face when finally able to invest in businesses of which we’re impassioned early adopters. 

As soon as the first crowdfunded company makes investors 10X their money, the media will swoon and New Angel capital will pour into the market.  We love new (40”), we love audacious growth prospects, we love getting rich quick.  Last year Americans spent $60B on lottery tickets.  Public market asset classes simply can’t capture our imagination the way this does.  And that excitement will help blind us to the realistic returns and risk profile.

What the hell is a SpaceShipTimeMachine?

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First of all, welcome to my blog!  Glad you could make it. 

As far as I’m aware, there’s no such thing as a SpaceShipTimeMachine.  It’s gibberish.  I was trying to reference this Mad Men scene where Don Draper unveils the Carousel ad campaign for Kodak’s high tech slide projector.  In it he says:

This device isn’t a spaceship, it’s a time machine.  It goes backwards and forwards.  It takes us to a place where we ache to go again.

It’s awesome.

I find technology and the commercialization thereof unendingly fascinating.  Many of us are consumed by the quest to make things faster, smaller and better and reap the rewards that accompany success.  But I love the sentiment that it’s also a quest to create ways that help us live life more richly. 

I used this silly URL in tribute to that sentiment.  Or maybe I just like Mad Men a little too much.