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?
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. The hardware engineers who built what turned out to be a flawless Dell were no match for the world’s software engineers, who have created video editing software that will run only on 64-bit operating systems.