Why is there so much hostility between venture capitalists and angels? M-o-n-e-y.
A new survey says that the chief problem between angels and VCs is deal pricing. “Valuation has always been a major sticking point, but it stuck out like a sore thumb [in the survey]; it’s really the deal breaker,” says Tony Stanco, chairman of the group that conducted the survey, George Washington University’s Council on Entrepreneurial Tech Transfer and Commercialization.
In the survey, 78% of VCs cited “unrealistic company valuation” as a reason that a company with angel involvement would be unattractive. Half of the angels surveyed agreed with them. It was the most popular response from both groups.
Angel involvement in a company makes the company “unattractive” some of the time, according to 52% of the VCs surveyed. A small number of VCs (6%) said angel involvement makes companies “mostly” unattractive investments.
More than 300 VCs and angels participated in the survey. They overwhelmingly agreed that angels are beneficial to the venture capital industry. In fact, a higher percentage of venture capitalists than angels (94% to 72%) surveyed said angel investors are beneficial. Venture investors cite their own migration toward later stage deals as a compelling reason to value angel investors.
While the survey notes the “general foundation of goodwill and respect” between angels and VCs, 100% of VCs and 94% of angel investors agreed that the two sides could do a better job working together.
“In general, I think the VC industry looks at the angel industry with disdain,” one unidentified angel said in the survey.
James Geshwiler, a managing director with the CommonAngels group and chairman of the Angel Capital Association, admits that it hasn’t always been easy for VCs to deal with angels on pricing. “Angels fought tooth and nail for their positions and made VCs’ life hard, but it’s not like VCs were not exactly nice about it,” he says. He adds that the situation is changing as more angels organize in professional groups and become more sensitive to valuations.
Sometimes the dynamics of the market dictate differences in price that put the two groups at odds. Angels and VCs, coming to a company at different points in its life, simply arrive at different values due to the nature of the market, some say. “We can work pretty well with some VCs but they have some interests that are different than ours,” says George McQuilken, co-founder eCoast Angels. “Not better or worse, just different.”
Some blame the ill will between VCs and angels on bad experiences that VCs had with inexperienced angels during the tech bubble. “During the dot-com days there were a lot of very inexperienced angel investors who did a lot of incredibly stupid things and caused a huge amount of damage to potentially successful companies,” says Carol Sands, founder and managing member of Angels Forum.
Knox Massey, executive director of Atlanta Technology Angels, points out that while large majorities of both angels and VCs admit that the two groups need one another, majorities also find the experience of working together negative and agree that both groups need to work better together. “The harshness [in relations between angels and VCs] is because the market was cruel to everybody and there’s friction between the two groups,” adds Stanco.
VCs understand that natural conflicts occur, with no fault on either side. “Often in those cases you run into issues that make the company either difficult to fund from a venture perspective or untenable to take funding from an angel perspective,” says Bill Wiberg, a partner with Advanced Technology Ventures. “You find situations where there is not a comfortable middle ground where people think a deal can get done. Valuations of the angel round may be out of synch with what the current market conditions are and the deal that we would do might be so dilutive to the angel investors that they’re not getting credit for the work that’s been done to date.”
Ultimately though, some angels contend that VCs too often follow the adage that if you’ve got the power, you’ve got the right. “If you’re in a situation where they have all the power and you have none, you don’t need flexibility, you need mercy,” says McQuilken. “When doing follow-on investments, venture capitalists frequently don’t appear to act very nice towards one another. If a fund finds itself in an investment it can’t follow with its money it tends to get wiped out. We could easily find ourselves in the same situation. If I do I’m probably not going to be happy.”
Both VCs and angels point out that both side have different motivating factors and forces that influence them that may naturally lead to conflict. One of the most obvious is that while angel investors are investing their own money, venture capitalists have to answer to demanding limited partners. There’s no hurdle rate on one’s own money. Angels, for their part, may often be motivated by wanting a technology to take a certain path and are more likely to be motivated by friendships with a company founder than venture capitalists.
“There’s much more to angel investing than teeing the deal up for venture capitalists,” says Bill Payne, an angel investor currently serving as an entrepreneur-in-residence at the Kauffman Foundation and a self-described “recovering entrepreneur.” Payne says that VCs generally may have a very self-centered view of the investing universe and that angel investors are much more active. “Venture capitalists invest in about one-tenth of the deals that angels do. Angels make 50,000 investments per year; VCs make 1,500 new ones per year. There’s a huge discrepancy in the two groups.”
But the post-bubble era is bringing vast improvement both to the level of sophistication of angel investors and the angel community’s ability as a whole to communicate with its venture counterpart. One thing that has helped is that there are fewer angel investors out there. To the delight of VCs and angels alike, the less responsible and more troublesome angel investors were the first to get their wings clipped. “During the bubble there was a lot of angel money out there and a lot of individual investors got hurt,” says Blake Winchell, managing general partner with Fremont Ventures. “Because of losing resources or getting burned, a lot of people stopped doing angel investing. The ones who are left are the ones who continue to have the resources or didn’t get too badly hurt and were able to establish themselves.”
The cause of the angel investor has been boosted by the creation of the Angel Capital Association (ACA), which is the angel investor’s answer to the National Venture Capital Association. The ACA was started by the Kauffman Foundation in January of 2004 to help ensure that entrepreneurs had a steady flow of angel capital.
“I’m seeing it change on a constant basis,” says Marianne Hudson, the director of entrepreneurship at the Kauffman Foundation. “The relationship [between angels and VCs] is getting better. In some cases they’re referring deals to each other.” Hudson says that such cooperation was not the order of the day a few short years ago.
The formation of the ACA has allowed a lot of these angel groups to get together and talk to one another, Massey says.
“Sophisticated angels and sophisticated VCs work very well together,” says Payne, who agrees that the proliferation of angel organizations has been a big boost to relations between the two groups. “Many VCs really appreciate the level of due diligence that angels do, which was not the case 10 years ago.”
For their part, VCs need to communicate better with their angel colleagues, and not just on pricing issues, Stanco says. “VCs need to communicate to angels and know what they need,” he says. “Send them signals from upstream. If it’s a conveyor belt from angels to VCs, VCs should pass on signals to the angels so all these things line up. It’s not just pricing. It’s what areas are important, what areas are profitable, what areas should people invest in.”
Both angels and VCs say that strides are being made to develop a closer working relationship. Most are confident this will be successful. “Two years ago I was seeing the don’t bother us’ attitude, but now I see a desire for better relations on both sides,” Geshwiler says.