Angels of the Apocalypse: Angel investors created a bubble. Could crowdfunding make it worse?
- By Cromwell Schubarth & Greg Baumann
The extinction will unfold as a glut of startups fail to secure Series A funding from venture capitalists, said researchers and investors like Ron Weissman of Band of Angels, the oldest angel group in the U.S.
Mortality among angel-funded companies is always high (A Harvard study last year found 75 percent of startups die.). But the current bulge of companies facing a funding crunch, Weissman and others said, is being amplified by an investment bubble.
That froth was caused by a shift of money toward social media and consumer startups that could be started on the cheap, a proliferation of incubators and accelerators, and the irrational exuberance of some callow angel investors.
“They thought being a VC or angel was cool or hip,” said Weissman, a 15-year, early stage veteran who chairs the Band of Angels’ special industry group for software. “Many had money to burn and it looks like they were intent on burning it.”
On top of that gold rush mentality, the new prospect of Ma and Pa investors investing in seed-stage companies through crowdfunding threatens to spray yet more money into a system that even professional investors inflated to bubble proportions.
In the U.S., as many as 1,400 startups that were funded in the past two years will be orphaned when venture capitalists deny them additional funds, according to a December report from CB Insights. The funding crunch will result in the loss of a billion dollars in the U.S., foretelling a bump in Silicon Valley’s startup body count.
Only in a startup ecosystem as singular as Silicon Valley’s would the prospect of hundreds of millions of dollars lost and hundreds of companies at risk provoke debate as to whether the die-off will even matter.
Angel investors as influential as Dave McClure, founder of the 500 Startups incubator, as early as 2011 tweeted “the ‘Series A Crunch’ is a f------ sham, and should be exposed for such. sure some startups may hit the wall but a 1000 more will thrive.” (McClure’s characteristic expletive sanitized.)
The angel retrenchment, however, has potential to exact a real toll on Silicon Valley and its early stage investing community:
- A certain number of angel investors will lose a lot of money — more than usual.
- An angel bubble distorts the marketplace, creating me-too competitors that drag down the most innovative startups by creating consumer confusion.
- Too much investment in one sector drives up valuations of seed-stage companies, complicating growth when they seek Series A venture capital investments.
- Incubators and accelerators that funded a disproportionate number of losing companies may face existential threats that dry up resources for entrepreneurs.
Weissman — whose flannel suits, wire-rimmed glasses and publishing credits (“Ritual Brotherhood in Renaissance Florence”) indicate a scholarly bent — already sees signs of an angel pullback. Veteran investors are more reticent to place money with social, mobile and local startups, he said.
Startup entrepreneurs validate that pullback.
“The crunch only applies to companies that don’t have monetization,” said Paul Biggar, a serial entrepreneur who is working as founder of Circle Continuous Integration. “Enterprise is the new sexy and there will be no problem à la a Series A Crunch for those companies. Otherwise, it’s totally real.”
Bubble’s beginnings
However badly the apocalypse hits entrepreneurs and angels — accredited investors who by definition can afford to take a bath — the event isn’t on the same scale as the $3 trillion bust that rocked Silicon Valley in the dot-com era.
But the same psychology animates it, Weissman, 62, said. Many angel investors feel the allure of a scene, the same way average investors bought into dot-com hype.
“It was the newly minted angels,” he said. “The hipsters. The ones who think it’s cool to spread money around, like the companies they came from.”
Many of those companies were consumer-facing software startups in the social, mobile and local sectors, so the new angels were more inclined to invest there, he said.
“What’s going on out there is a certain class of startup over the last few years has been able to get somewhere meaningful with a small amount of money,” said Ian Sobieski, a founder and managing director of Band of Angels.
The increase in angel funding wasn’t matched by an increase in Series A funding. Sobieski defines the resulting crunch as a limited problem.
“We’re just talking about one slice of a big pie,” he said.
But the success of some early stage
software companies set the stage for a rush of investment, said Bob Ackerman, founder and
managing director of Allegis Capital, which focuses on Series A
funding.
“You have a combination of market psychology, gold rush mentality, and
relatively lower barriers to entry,” Ackerman said.Air supply
While the current angel apocalypse may need to grow by an order of magnitude to constitute a threat to Silicon Valley’s economy, the prospect of crowdfunding may provide the hot air needed to inflate a true bubble.
President Barack Obama signed the Jumpstart Our Business Startups (JOBS) Act in April, creating a mechanism that would let ordinary Americans — not just accredited investors — lay bets on seed-stage companies.
The Securities Exchange Commission is late delivering proposed rules that would govern crowdfunding platforms but could have them ready before the year is out.
Even with regulatory protections designed to keep individual investors from betting the farm on dicey startups, the stage may be set for too much money being pumped into too few good ideas in Silicon Valley.
“With crowdfunding, you can imagine a bubble developing where you have a bunch of Instagrams and the idea that there’s quick riches right around the corner,” Sobieski said.
The history of speculative bubbles fuels those concerns. For every crowdfunding proponent who says that markets are self-correcting, there’s an example of greed-driven booms and busts in tulips, dot-com startups or residential mortgages.
“From the investor side, we think it will be very difficult to determine legitimate offers from ones that aren’t,” said Bob Webster, a spokesman for the North American Securities Administrators Association.
Sherwood Neiss, a principal at Crowdfund Capital Advisors, helped shape parts of the JOBS Act and is working with regulators to shape the SEC rules so people don’t put too much at stake using the new investment vehicle.
He doesn’t think crowdfunding will distort the early stage funding market.
“Just because there is this new opening doesn’t mean there will be a mad dash to invest,” he said.
Weissman compares the potential surge of average investors’ money into crowdfunding to the end of the dot-com era, when the public could buy stock in venture capital companies.
“The last stage was mom and pop wanting a piece of the action,” he said. “I see the JOBS Act doing the same. It’s the final stage of the angel cycle we’re in.”
As long as crowdfunding doesn’t massively distort the angel funding cycle, most investors say the current cleansing is a part of life in Silicon Valley. After all, the ecosystem is built on economic natural selection, with weak investors and entrepreneurs getting weeded out.
“A young guy . . . can’t find follow-on money and he has a real hard month and his self-esteem is crushed,” Sobieski said. “He does it three times. I’d say that can be a net positive. It’s good to have three resurrections by the time you’re 26.”
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