Note: this post was originally published as a guest column on Fortune Term Sheet on December 4, 2013
No topic fuels more discussion and debate within the early-stage investment community than the dynamics between VC and angel investors. Are they natural enemies or complementary players in an increasingly diverse funding ecosystem? Or both?
AngelList's introduction of syndicates has added several new twists to this debate—the notion of angel as lead investor, the potential to crowdfund Series A rounds and implications for subsequent VC rounds. In the back-and-forth over which funding routes are most advantageous to startups, some investors and pundits are going so far as to suggest one model will flourish while the other fades.
As a serial entrepreneur turned VC, my position on syndicates is somewhere near the middle of the spectrum—but certain aspects concern me deeply, particularly VCs who are peeling away from proven strategies, and the unfounded claims of signaling risk with VC seed investing.
AngelList's syndicate platform is an innovation on the VC model, but one with many parallels to traditional venture. In this scenario, the lead angel is essentially a micro VC, playing the part of an active fund manager, similar to VCs managing capital invested by limited partners. The primary difference here—and it's a big one—is that the traditional VC model operates on a fund basis, while an angel syndicate has a deal-by-deal carry for fund managers. Angels can make a profit off of one deal, and a loss off another.
Angels stand to benefit from increased access to deals and decreased risk, but the angel-entrepreneur dynamics shift dramatically from the pre-syndicate model. With more dollars in play and one angel acting as lead investor, the entrepreneur will have to take a leap of faith. As an entrepreneur, I'd want to know whether the angel has experience as a lead investor. How many syndicates will this angel form, and how many deals will he/she do? In a scenario where the angel's risk is largely mitigated by the syndicate and there are any number of shots on goal, how sure can I be of getting—and keeping—their attention? Another very real risk is artificially high valuations, inflated by an exuberant syndicate, that could all but cut off access to VC funding in future rounds.
At this point, there are more questions than answers. Ultimately, I don't think angel syndicates will succeed or fail. Rather, I think some will succeed and others will fail. Those that succeed will probably become… VCs.
While angels are acting as micro-VCs, there are plenty of VCs being lured by the capital-light, spray-and-pray approach favored by certain angel investors. Capital constraints, coupled with early successes for a handful of 'super angels,' have created a tendency for some VCs to move away from the storied business model of funding disruptive innovation in favor of the path of least resistance, in the form of a larger number of small, capital-efficient investments—usually consumer internet or software. Unfortunately, this overcapitalizes one sector at the expense of others, and to the detriment of innovation. Me-too deals for a quick turn is not what our industry or our economy needs. This risk-averse approach is a departure from what works best about the traditional VC model: Partnering with entrepreneurs to fund disruption.
The final point I'd like to get across is not based on a new claim or trend, but rather the perpetuation of a dangerous myth: Taking (seed) money from a VC is a kiss of death. NEA has always done seed investments, among them breakout successes like Data Domain (IPO in 2007, acquired by EMC for $2.4B in 2009), Tivo (IPO in 1999) and The Climate Corporation (to be acquired by Monsanto for $1.1B). But setting aside the outliers, our most recent class of seed investments demonstrates an equally important point. On the tech side of our business alone, we look at over 300 seed companies each quarter, and to date we've invested in over 50 of them. Based on the 35 seed rounds we participated in from March 2011-July 2012, more than 50% have gone on to raise Series A rounds either from NEA or other firms.
In most cases where a VC does not participate in a subsequent round, it is most often because the company has pivoted in a way that either no longer fits with the original investment thesis or is directly competitive with other companies in the portfolio. In these situations, others firms may be a better fit to fund the Series A. If a company takes a seed investment and cannot raise an additional round, that company (and any doubtful angels) must look inward for the explanation before looking outward.
As the debate continues over angel vs. VC funding, we need to remember that these are two sides of the same coin. It's unfortunate that some of the discussion has taken on an adversarial tone. The right outcome here is for angels and VCs to partner in a way that enables entrepreneurs to get the most out of the network and resources each brings—both in the early stages of company formation, and later when capital needs intensify. The truly successful VCs and angels (and maybe even syndicates) will always be the ones who stay focused on the values and actions that continue to foster innovation and disruption.