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James Hong

Thursday, September 23, 2010

Random ramblings on #Angelgate

Hey everyone, I just got back from my yearlong world trip, and man have things changed!

i was thinking a bit about the whole angelgate thing. i think it boils down to the model that a successful angel has traditionally needed 2 things to be successful : 1) good dealflow and 2) skill at picking the right deals.

Things like YC and naval's angel.co thing are having the effect of commoditizing the dealflow, making high quality deals accessible to way more people than in the past, making it so people who USED to make money just by having that dealflow exclusively now have to somehow become better deal pickers to maintain decent returns (since commoditizing the dealflow means valuations and terms get worse for investor as long as there is an excess supply of angel money out there)

instead of trying to become better pickers, the angelgate people are trying to find ways to maintain the old status quo on deal economics. Recently, I started thinking maybe I would stop doing deals that had convertibles in them. And indeed I did start saying no to more deals. But despite that, I still chose to do a few more deals.

the increased levels of transparency and the commoditization of dealflow make angel investing a lot more like investing in the public equity markets... the price you have to buy in may already be pumped up, the terms might not be as preferred, etc.. but IF you can pick the winners, it doesn't really matter. That's a big IF to rely on though!

So all of this just means these angels need to become more picky on what deals they will do. This will no doubt have the effect of dropping valuations a bit too, which they should like. But then again, maybe a lot of the angel funds prefer doing lots of deals because like some VCs, they are starting to like the management fees a little too much? Basically, by having lower valuations out there, the angel funds don't have to be as choosy which enables them to deploy more capital faster -> more management fees. Nice little conspiracy theory, although my friend Vu points out to me that the majority of super angels are already set financially where the management fees are not as impt to them as they might be to a younger career vc.

But honestly, I think there is nothing people can do about this. It's an increasing efficiency, not decreasing efficiency, that entrepreneurs have been raising prices... prices may have just been suppressed by the difficulty entrepreneurs used to have in identifying and meeting potential angel investors. It's basically like an auction house where all of a sudden, more people are being let in to the auction to bid. Of course prices are going to go up, so caveat emptor.

So if you want to make money as an angel, you might have to take the shittier terms and just hope you are better at picking companies... or figure out a way to add value and get in cheaper, like YC does. (It's no wonder that YC is ok with these trends since they are still taking a decent chunk of the companies BEFORE the angel rounds.. and the fact that so many YC companies don't seem to regret it indicates it is probably a fantastic model). Maybe all the angels should pool their funds and just start a YC competitor.

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If all the angel rounds are now being done at venture level valuations and scale, maybe this is a sign that angels are going to be squeezed out entirely.. Plenty of good vc firms are now willing to chip in 100-200k into startups just for what they perceive as the social obligation option value. Perhaps in a year, YC companies will just go direct to those vc's. So the new model becomes JOIN YC AND EAT RAMEN -> RAISE 500K FROM A FEW VC'S WHO DON'T MIND DOING LOTS OF SMALL NOTES FOR THE OPTION VALUE -> RAISE FULLER VENTURE ROUND. Angels might be getting squeezed out?

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One friend who is a high profile angel mentioned to me that he hates convertibles because the long term/short term capital gains clock is delayed. That is a very valid point, although who knows when LT cap gains rates are going to raise back to the same as short term, the way the country is going.

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The other thing kind of weird is that all these people who are being labeled as "angels" are actually VCs. If you are investing other people's money, you aren't an angel anymore, and especially if you are doing deals at the valuations these people are putting in at.


It will be interesting to see what happens if/when the economy and the public markets hit the shitter again though. A LOT of angels will pull out of doing deals, and things will start moving back towards the angel investor's favor (possibly just back to where this all started :) )

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