Boston Angel Investors

I attended a conference today that was intended to match startup companies with angel investors and to promote the idea of seed-stage investment by individuals (i.e., “angels”).

Background: The popular understanding of venture capital is that the professional venture capitalists fund brand-new companies who are developing new products and services. In reality, professional VC funds are too big and too risk-averse to do seed-stage investments. A “small” fund with $200 million in assets must invest $5 million or more in each company so that it doesn’t end up with too many investments to keep track of and too many board meetings to attend. Three bright engineers working out of a basement aren’t capable of applying $5 million in capital and the VCs certainly don’t want to take the risk that the widget won’t work or that customers won’t need it. So a company getting VC funding usually has a working product and at least one paying customer.

Who then funds the startups? Rich folks who’ve been successful in some earlier enterprise and who may have some knowledge of the market or technology. These “angels” take risks that would cause professional VCs to wet their pants and, ideally, provide useful advice and introductions to the startups.

The speakers at the conference were very effective in discouraging anyone from becoming an angel investor. To be successful, one needs to make at least 25 investments and be actively engaged in each one. I.e., one needs to do nearly all the work of a professional venture capitalist, but take a lot of personal risk and not get paid anything (the professional VC will get “2 and 20”, i.e., 2 percent of the fund every year for expenses and then 20 percent of any returns, so a VC firm with a $1 billion fund gets $20 million every year in fees even if no investments are made).

Asked if it wouldn’t make more sense to apply capital in rapidly developing countries such as Brazil and China, the speakers responded that being an angel was more about having fun than getting a good return on investment. (Not sure whose idea of “fun” included sitting in board meetings with frustrated entrepreneurs, but personally I would rather be flying a helicopter or going to the beach.) In fact, the speakers said that it was quite likely that one’s angel investing returns would be lower than a passive investment in an S&P 500 index fund.

Nobody had thought about the question of whether Boston in fact needs more angel investors or venture capital. Nobody could point to an example of a good startup that had been unable to obtain funding. However, there were examples of startups, notably Facebook, that had moved to California because of superior access to capital and other resources out there.

Conference attendees noted that angel investors tend to come out of a related industry and that it was hard to fund consumer-oriented Internet services here in Boston because hardly anyone here had been successful with such a company. By contrast, in Silicon Valley the streets were littered with the wealthy idle founders of PayPal, eBay, Yahoo!, Google, and similar companies. Silicon Valley also had a deep well of startup management talent from such ongoing successes as Hewlett-Packard and Intel.

Nobody at the conference could answer a macro question: With the US private GDP shrinking, why do we need capital at all? Capital is required to finance growth. The only part of the U.S. that is growing significantly is government and the government can print money if it needs capital. With private GDP shrinking and billions in venture capital chasing the remaining startups, returns on investment are bound to be low (and indeed VC returns have been dropping). It is not clear why the U.S. needs even the VC funds that we have, much less additional angels piling in.

Nor could anyone answer a micro question: what evidence is there that the Boston area has ever been a sustainable place for startups to fluorish? When the skills necessary to build a computer were extremely rare, Digital Equipment and other minicomputer makers were successful in the Boston suburbs. As soon as the skills for making and programming computers became more widespread, nearly all of the new companies started up in California, Texas, Seattle, etc. When building a functional Internet application required working at the state of the art, the Boston area was home to a lot of pioneering Internet companies, e.g., Lycos. As soon as it became possible for an average programmer to download SQL Server and Microsoft Active Server Pages and work effectively, Boston faded to insignificance.

Currently the successful startups in Boston are in biotech, which requires the highest average skill and education level of any sort of company, and in high-speed networking gear, e.g., the equipment that telecoms purchase for their main switching centers. Could it be that as the pace of knowledge and skill dispersal accelerates, Boston will become even less prominent in the world of business?

5 thoughts on “Boston Angel Investors

  1. Let me take a stab at ” With the US private GDP shrinking, why do we need capital at all?”

    While GDP may be shrinking in the aggregate, it is not shrinking in the particulars. As you rightly identify innovation and opportunity exist in say biotech. Having read your work Phillip I am sure you expected such a response, surprising that no one even bothered an attempt.

    Call me foolish, but I have put a substantial portion of my capital to work in a startup consultancy entirely focused on moving the survivors of this recent economic storm off of heavy bloated infrastructure onto nimble, lightweight IT.

    So far so good…

  2. David: Your point that while the Politburo and Gosplan in Washington, D.C. allow some companies to die (though not GM and Chrysler!), new ones are constantly starting up is of course valid. So we definitely need some sources of capital, e.g., the Politburo-sponsored banks on Wall Street. But every part of the U.S. financial system, from venture capital right up through investment banks, is sized for an expanding private economy. That means it is oversized for the economy that we have. Which means that the returns to additional capital should be very small.

    Another way to look at it is that a new source of capital is competing with the U.S. government and its corporate welfare recipients. Wall Street banks are able to borrow money at near-zero interest rates. Given their still-high leverage, they can earn record profits even if their actual investments return only a few percent. So there is no reason for a private investor to expect much more than this kind of return.

  3. Owen: TripAdvisor (started and still run by my buddy Steve Kaufer) has been owned by Expedia of Seattle for many years.

    Boston is still an attractive place to start a high tech business due to the schools nearby. And I don’t mean MIT and Harvard, but rather Northeastern, RPI, WPI, Olin, where you can still find people who like to write code. It will never have the influence over the computer industry as it did in ’60s and ’70s. It’s now a “top 5” rather than a “top 2” location.

    A high tech business is much easier to start in the US than in Brazil or China due to access to markets, customers, engineers, stable legal system, taxes etc. The US is still the best place to be an entrepreneur.

    For large growth, any company has to branch out of the municipality and eventually their country of origin.

    I agree with Philip’s basic point that Angels and VCs are unnecessary for the vast majority of applicants. They do have a place in a rare combination of idea, team, and need for large amounts of capital in a short period of time. Even in a recession, there is the need for innovation and interesting technology, irrespective of Federal debt.

  4. David: I didn’t mean to imply that “Angels and VCs are unnecessary”, only that we might already be fully supplied with Angels and/or VCs. And I agree that the U.S. is a great/easy place to be an entrepreneur, given the large number of VC funds looking for places to invest. But the flip side of that is perhaps that the U.S. is not a great/easy place to be a new angel investor. With so many other angels and VCs already out there, one cannot expect to see the better deals or returns higher than an index of global bonds and public equities.

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