July 18th, 2017 | By: Marcello Miranda | Tags: Funding
Just a couple of weeks ago, I closed my first ever investment in a private Silicon Valley startup. I didn’t go through the standard procedures though: while I did conduct my due diligence, I did not get pitched face-to-face in a nice conference room, negotiate deal terms, or seal the deal with a firm handshake.
Instead, like many other educated folks who are excited about startups but don’t quite have the wealth to be accredited investors, I invested through a crowdfunding campaign.
There’s a storm of hype building around this new equity crowdfunding model, which allows middle and even working-class people to invest in a startup by the tens or even hundreds of thousands, without many of the onerous regulatory and accounting issues that so many investors would normally require.
One question has been on my mind though: are these equity crowdfunding investors “angel investors”? Do we have the right to carry that title?
It may seem like a matter of semantics, but let’s be honest: there’s an enviable air of prestige surrounding the term. And, as our favorite sexual harasser Justin Caldbeck recently illustrated, being a startup investor often grants an all-too-abusable degree of power.
Moreover, the culture of a startup ecosystem like Silicon Valley revolves around a common set of memes. The term “angel investor” has been in the lexicon for around 40 years, and as crowdfunding becomes an increasingly mainstream funding choice for startups, it’s only prudent that we should have a shared idea of the norms and expectations surrounding it.
So let’s delve deep into what the term means, and what makes equity crowdfunding unique.
There would be no angel investing or crowdfunding without driven, talented entrepreneurs. Startup founders are the ones who build great teams, seek out investors, envision world-changing business ideas, and most critically, execute on those visions. An angel investor’s value is largely measured by his or her ability to meet founders’ and portfolio companies’ needs.
Based on my discussions with founders, there are three primary ways in which investors can provide value beyond the size of a check:
A. Sector expertise. Though an investor is unlikely to be as knowledgeable in an industry as a passionate founder — one who may have spent hundreds or thousands of hours immersed in their field — some expertise is crucial. A tuned-in investor can point out competitors and help devise strategies.
B. A great network. Partnerships, exit opportunities, follow-on investments, inside information on competitors, new hires… the potential benefits of an investor with a strong network cannot be overstated.
C. Operational experience. Through board seats or mentor roles, investors with prior managerial experience can steer founders away from decisions that may harm company culture, operational efficiency, or personnel.
In an ideal world, an angel investor would be able to provide value add in one or more of these ways. With that in mind, let’s answer a few critical questions.
A: Investopedia, the premiere “finance dictionary” on the web, isn’t entirely clear on this.
Angel investors must meet the Securities Exchange Commission’s (SEC) standards for accredited investors. To become an angel investor, one must have a minimum net worth of $1 million and an annual income of $200,000.
Some angel investors invest through crowdfunding platforms online or build angel investor networks to pool in capital.
On one hand, Investopedia equates angel investors with accredited investors. On the other hand, it refers to crowdfunding and other methods of pooling capital as angel investing activities.
We could make the case that Investopedia simply hasn’t caught up to the changes initiated by the JOBS Act (the act which legalized low-income equity crowdfunding in the United States) In any case, Investopedia doesn’t get into the nuances, so it’s hard to draw a conclusion from this definition alone.
A: It’s hard to gauge how often accredited angel investors actually provide value add to their startups, as opposed to just being “dumb money.” To date, no one has polled quite enough founders to have a sense of that.
But is it true that these wealthy investors do provide value add on average? If my startup experience and personal conversations with entrepreneurs are any indication, the answer is yes. Many angel investors are independently wealthy, with enough business experience to offer crucial insights into a company’s long-term vision and operations.
Arguably the greatest value add wealthy investors provide is network centrality. Advice is helpful, but nothing beats tapping into an investor’s contacts to secure follow-on investors at a critical moment of growth.
Naturally, wealthier investors with an entrepreneurial background are more likely to have built up relationships with institutional investors and fellow angels. In this way, wealth is strongly correlated with investing value add.
Of course, many wealthy investors do not necessarily have an entrepreneurial background, and even those who do may not have much to offer. Research suggests that even angels with substantial industry experience are no more beneficial in helping companies succeed than generalist investors, unless they remain actively involved after the round closes.
Only about 50% of traditional angel investors are ultimately successful, despite these advantages. Can crowdfunding investors do better?
A: Most people who pour money into startups through equity crowdfunding platforms are, unfortunately, what the startup community would consider “dumb money.”
In other words, investors who can provide capital, but do not have the sorts of entrepreneurial, managerial, and/or financial insights that founders often want from investors.
Despite the derogatory term though, there’s nothing particularly wrong with dumb money, and in many cases, it can be a founder’s only option. Startups in under-hyped or very specific verticals may find there are no accredited investors with any worthwhile expertise to offer. In which case, pursuing traditional angel investors may be a waste of time.
Does this mean equity crowdfunding investors have nothing to offer? Of course not. While most aren’t likely to be CEOs, or (in the case of many well-renowned angels) ex-CEOs with large exits under their belts, there is value in other types of experience. Shocking, I know.
The typically middle-class investors in this category can come from virtually any background, and have similar operational insights and sector expertise to their wealthier counterparts. Additionally, despite losing ground over the years, the middle-class in the United States remains massive: 43% of the population as of 2014.
Meaning, these investors may very well be in the target demographic for the startups they invest in, or even be effective community influencers. This makes them well-equipped to inform founders on matters of consumer engagement, and as investors, they are incentivized to offer their insights. Additionally, the middle-class includes many people in low-level managerial positions, with networks potentially as robust as those of wealthier investors.
One thing to keep in mind though: the very structure of equity crowdfunding makes it difficult for individual investors to have access to founders. This is necessary, given the high number of investors, but it certainly limits opportunities for investors to meet founders face-to-face and provide meaningful support.
A: On the surface, the biggest differences are the fundraising process itself and the effects these investments might have on a startup’s cap table.
Fundraising from angels is not all that different from fundraising from VCs. The co-founders reach out, cold or through their networks, set up individual pitch meetings with prospective investors, wait for due diligence, and if everything looks good, discuss and settle on investment terms.
It’s a different ball game with equity crowdfunding. There, it’s a public spectacle, where founders put their pitch decks on blast for the world to see, and term sheet negotiation is nonexistent. In many cases you can even watch the funding pool grow in real-time as the due date approaches, and feel vicarious joy (or sadness) as a funding round closes successfully (or doesn’t).
Even in the case of accredited investor ‘angel syndicates,’ which also pool individuals’ funds together, the process is far more private and low-key. Of course, these syndicates can also negotiate more favorable deal terms. Arguably, this process is much more elegant. Given that there are career investors involved, that shouldn’t come as a surprise.
The other major differentiator is the types of founders and companies that equity crowdfunding attracts. No question about it: most founders, given the choice, would not pick equity crowdfunding as their first source of capital.
Why? Opportunity cost. In 99.9% of instances, Eric Ries is more valuable as an investor than Joe Schmoe with no fundraising or founding experience under his belt, and there may not be room in a funding round for both.
It could mean the founders are disagreeable, have a bad reputation in the Valley, or smell bad. But more likely, their companies just don’t fit the astronomical return profiles most VCs and sought-after angels strive for. Even that may not necessarily be true though, based on the quality of startups I’ve seen so far, and the interest that even big-name angels like jason have shown.
My belief? Founders choosing to fundraise through equity crowdfunding simply fall outside the scope of what most VCs and angels are comfortable or experienced investing in.
Though it pains me to admit it, I and my fellow crowdfunding investors don’t quite qualify for angel investor status.
Some of the very qualities of this new model of startup investing that make it possible in the first place — like restricting information access, board control, access to the founders, and so on — preclude the formation of any sort of deep, meaningful founder-investor relationship.
Additionally, forcing investors to choose from the limited selection of companies vetted through platforms denies them much of the self-determination that wealthy angel investors use to find nascent startups.
Though my experience so far has been nothing short of stellar, it irks me that I can’t invest in a startup at all unless it’s made available through their site (notwithstanding ICOs, which I suspect will become a lot more popular among middle-class investors soon).
In any case, equity crowdfunding in its current state does offer valuable lessons about startup due diligence and, as communities begin to form around these groups of non-accredited investors, the importance of networking as well.
Perhaps most importantly, if done right, it can be a fabulously effective tool for wealth creation. Startups can yield returns in the range of 1000x for their earliest shareholders; it’s very likely some shrewd investors will get rich from crowdfunding startups and become accredited angel investors themselves. At which point they — unlike many other angels — will already have substantial investing experience.
So, while crowdfunding investors may not be angel investors per se, there’s a good chance they will be. It’s only a matter of time.
Startup/VC enthusiast. Consultant at @Roamcoliving. Recovering hashtag addict.