September 27, 2010
One recently recurring meme in Silicon Valley (and its mirrors around the investment landscape) is that “low” ($10m-$20m) exits are great — so long as the company’s cap table is structured in a way where all constituents benefit from such outcome. It’s obvious that a monotonic increase in a company’s valuation from $1.00 to $10m, made real by a liquidity event, is an unequivocally good thing, most likely for everyone involved. There does seem to be a systemic change worth highlighting.
Angel investors (in particular those with smaller funds) have fundamental incentives to encourage (or pressure) entrepreneurs to take a lower early valuation (and a priced round vs a convertible note), and then to subsequently consider lower, earlier exit opportunities. Such companies represent quicker returning, and frequently safer investments, where it’s also easier for angels to add more value (cool one-off perks, for example, go much longer way during the company’s first year, etc). Such exits also allow angels to redeploy capital faster, which generally fits better with their model. As a result, angels are implicitly pushing founders to aim towards lower, quicker, more realistic, and ultimately less disruptive/revolutionary products and services. After all, those crazy shoot-the-moon ideas are just that much more likely to fail.
One key criticism of the VC model (and resultant attitude towards startups and their founders) is that the ruthless Sand Hill Road crowd doesn’t really care about any one individual entrepreneur or their startup — they merely want to place enough diverse bets to have one or two pay for the follies of the rest, and then some. The positive externality of this behavior, however, is that VCs encourage (and indeed pressure) entrepreneurs to take more risks, delay gratification, exit later, to double- and triple-down, and therefore sometimes directly cause disruptive/revolutionary products and services to be created, or taken beyond where the entrepreneur thought they would or could go.
Neither of these two behaviors are new at all, and historically entrepreneurs tended to self-select towards the appropriate (for them) behavior just fine. However, the recent explosion of angels, the emergence of “super” angels, and their frequent self-positioning as antidote to venture capital seems to have tilted this balance significantly in favor of the former. Anecdotally, in my own angel investing activities I’ve most recently encountered founders that actually considered reaching out to corp dev departments of possible acquirers as a viable alternative to launching their product, less than 6 months after raising a convertible note.
Silicon Valley tends to go through cycles, and their causality is never entirely clear, but the correlations are often easy to see. At the moment, what amounts to lack of visible significant innovation seems to correlate with abundance of angel-funded startups shooting to get picked up for a fistful of dollars.
We should aim higher.