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Frothy Times for Web Angel Investing

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The startup was just four months old when it closed a $2.5 million angel round of funding last month from 10 name-brand investors, among them angel funds, individual entrepreneurs — even a venture capital firm. Formspring’s premise is a kind of blogging in reverse; users set up a profile and invite anyone to ask them questions. And it’s seen rapid adoption, to the tune of 50 million uniques a month and more than 300 million questions answered to date.

But premise and adoption numbers aside, such a long list of investors putting money into a jumbo-seed round so early on is not uncommon these days. Don’t blame it on too few investments driving up demand, however; on the contrary, there are many young companies taking lots of money from lots of investors. We find ourselves reporting on another early-stage funding round for an Internet or mobile startup every day. Whereas a year ago…nada.

CB Insights shows growth of 33 percent from Q1 '09 to Q1 '10. It uses an index instead of raw deal count numbers because angel investing is so opaque.

There isn’t much in the way of comprehensive statistics on angel investing, but the numbers that are available back this trend. U.S. angel investment deal flow was up 33 percent year-over-year in the first quarter of 2010, according to CB Insights. And angel investors themselves cite a return to frothiness. I interviewed a passel of them about when it started, why — and what it means for the future of today’s crop of companies.

‘Trigger-happy, But Not Irrational’

“I haven’t seen this level of startup activity (and angel investing) in SV since ’98,” PayPal and Slide founder Max Levchin tweeted back in March, an observation he reiterated during a recent discussion. “I’ve probably made more investments in the last month than in the previous year,” he told me. “I’m suddenly trigger-happy. And I am not irrational.”

Early-stage investors agree that things started picking up in the fourth quarter of 2009, and were going full steam ahead by the first quarter of 2010. Levchin’s PayPal and Slide compatriot Keith Rabois reports having invested in five companies this January, compared to none in the fourth quarter of ’09. The first Google employee to go angel, Ayden Senkut, told me he’s made double the amount of investments this quarter as he did during the previous three-month period. And there are no signs of a slowdown.

Slide CEO Max Levchin thinks today's startups are poised to disrupt incumbents due to fundamental shifts in the technology environment.

All of which has had an impact on valuations. From a price perspective, “There are no longer deals to be had,” said Jeremy Liew, managing director at Lightspeed Venture Partners and an investor in companies such as Flixster and RockYou. Indeed, multiple angels said that entrepreneurs now open angel rounds at $750,000, whereas 18 months ago it was unusual to see anything above $500,000.

Investor Posse(s)

The larger rounds are often provided by a larger number of investors. And there do seem to be more total investors in the angel market. Jessica Livingston of Y Combinator, the pioneering three-month intensive startup program, said that investor attendance at its latest Demo Day in March was up 50 percent from the previous session, held in August 2009.

Jessica Livingston of Y Combinator said 50 percent more investors showed up to the program's latest Demo Day.

The startups presenting at Demo Day were swarmed — but in fact there was so much advance interest that a quarter of them already had money in the bank before the day even kicked off, according to Livingston. Whether it be former Googlers, former PayPal peeps, or just folks with some money who’d like to be tapped into what’s hot, there are a lot of people these days willing to cut checks for tens of thousands of dollars.

“When I first started doing this I was the only ex-Google angel, and today there are anywhere between 20 and 40, and that’s just Google,” said Senkut, whose Felicis Ventures has about 50 active investments. There’s even one angel team, Mixin Capital, that was started by the Y Combinator alums who sold Zenter to Google and invests almost exclusively in Y Combinator startups.

So many investors on the hunt lead to what Rabois called a “dogs and cats round, with everyone piling on.” Formspring’s round of 10 named investors is just one example. Though Rabois, who serves as EVP of strategy for Slide, said he was “dubious” as to whether that was a good thing. “When there’s lots of people involved, nobody’s accountable,” he noted, never mind how many patrons an entrepreneur then has to please.

There’s also increasing collaboration between angels, through organizations like AngelList and the Angel Forum as well as Y Combinator and the many startup camp copycats it’s inspired. (Increased knowledge sharing might also be partly to blame for the mini-swarms of me-too companies we see these days. There’s a reason they call it groupthink.)

And new incubators and seed funds are popping up all over the place. For instance, the video embedded above is from a tour I took of Kicklabs, a soon-to-open space in San Francisco’s SOMA neighborhood set up by Transmedia Capital in partnership with the building owner. They’re planning to give startups free rent and access to advisers and resources (and a pretty sweet in-office slide) in exchange for the equivalent of a $25,000 share of each company.

Shortest. Recession. Ever.

So why now? Why are there so many companies deemed worthy of receiving money and so many investors willing to give it to them? The simplest reason is that the overall economy, after cratering in the fall of ’08, is showing signs of recovery. Even if the market isn’t righted again, investors’ public company stocks are moving in the right direction.

Call it the shortest recession ever, as I discuss in the video embedded below with SoftTech VC‘s Jeff Clavier, who himself has made 75 consumer Internet investments in the last six years, 48 of them in the last two and a half. He had four exits in 2009: Mint to Intuit, Mixer Labs to Twitter, Ohloh to SourceForge and DanceJam to Grind Networks.

Clavier came by our office studio to talk about the state of angel investing. “There was a handful of us six years ago and now there’s a legion,” he said. One of the factors that prompted Clavier to start investing was how much cheaper it had become to start companies, given web infrastructure and monetization tools. And that’s only more true today.

Another factor is that starting a company has a cool factor — especially these days. “You see people from Wharton coming out to Silicon Valley now” is how Rabois put it, whereas a few years ago, “a lot of those people would have been at investment banks.”

The Race to Get in Early

To be fair, the economy is not out of trouble yet, and neither are later-stage Internet companies. VC funding numbers are still depressed, with first-quarter stats for Internet-specific U.S. investments showing a 14 percent quarter-on-quarter decrease in dollars and a 19 percent decrease in the number of deals, according to PricewaterhouseCoopers and the NVCA.

Keith Rabois, EVP of strategy for Slide, invested in five companies in January, compared to zero in the fourth quarter of '09.

Still, there are some notable larger and highly sought-after venture funding rounds — like the yet-to-be-closed but widely reported bidding war for Foursquare, and competitive deals closed by former Facebook employees’ companies Asana and Quora.

Asana and Quora are both pre-launch — aka, the kind of companies that would normally be getting angel funding. “Because of the excitement around microcap and seed investing, venture capital firms are being more active in the space as well,” said Senkut. “The valuations are going up too fast. They feel like they may need to have a better grasp on the seed stage.”

And after a long IPO drought, there appear to be some viable exits approaching IPO-style valuations available to startup shareholders. Google, after not buying a single company for nearly a year, has acquired nearly 15 since last August. And there’s an active secondary market for employee and early investor shares, led by Russia’s Digital Sky Technologies, which has made deals to buy common stock in Facebook, Zynga and Groupon. Those companies are part of a small pack that see active secondary market trading, both privately and facilitated by sites like SecondMarket and SharesPost.

Nature or Nurture?

Are today’s web and mobile startups any different or better than those of the past? Investors contend that they are, for a few reasons. First of all, there’s a working theory that companies borne out of the hardship of a bust cycle are better grounded, if only because they’re not swept up in the hype of a boom. Secondly, many of today’s early startups actually have revenue before they seek funding, whether from commerce, subscriptions or coupons. Or, like Formspring, they have incredibly viral and mainstream adoption that seems to promise long-term value.

Aydin Senkut of Felicis Ventures has 50 active angel investments.

And thirdly, as Max Levchin put it, “Every decade or so you see enough of a buildup in technology capabilities to enable things that change the world in fundamental enough ways that incumbents can’t take advantage of and startups can.” That’s why he invested in the social payments startup WePay, which he hopes will take on PayPal. The behaviors the company is trying to address are fundamentally different than those of 10 years ago because broadband Internet has become a much more significant part of our life since then.

But there are downsides to so much money being spread around. More funding buys an entrepreneur a bigger runway, but also increased oversight and higher expectations. The result will be that many similar companies will have trouble co-existing, and the most crowded segments will see consolidation. There’s no way all these companies will succeed.

Lastly, increased excitement around early-stage companies is also responsible for an imbalance in the tech job market. “I do not have a single company that is not hiring, and I do not have a single company that is not finding it difficult,” said Senkut. “Anyone worth being hired as an employee is starting their own company.”

For some, this kind of frenzied, frothy atmosphere will be all-too-reminiscent of the dot-com bubble 10 years ago. At this accelerated pace, it’s possible that the shortest recession ever could be followed by the shortest boom.

Crashing wave image courtesy Flickr user jenny downing.

39 Responses to “Frothy Times for Web Angel Investing”

    • I just started fundraising in Nebraska. It will be interesting to see if national trends are affecting the more isolated markets. I’ll report back what I find out.

  1. People are going to be looser with their money if they have more of it lying around, especially those investors with capital gains taxes to deal with. So as the economy bolsters so will new investments.

  2. People are going to be looser with their money if they have more of it lying around, especially those investors with capital gains taxes to deal with. So as the economy bolsters so will new investments.

  3. In general, I’m worried that this bubble is bad news for most of the people involved.

    I’ve done about 10 angel investments in the past couple of years, and there is definitely a trend towards higher valuations and more competitive deals.

    The problem is that every investment asset class obeys Newton’s Law: “For every action, there is an equal and opposite reaction.”

    The logic many follow goes something like this:

    1) As an asset class, angel investments have delivered a great historical return.

    2) Therefore, we should allocate more funds to angel investing.

    The result is more money chasing the same number of deals, which changes the valuation equation. Deals are getting done at higher valuations.

    But hey, you may say, even if company valuations are up, if you exit for $200 million, does it matter whether you paid a $2 million or $4 million premoney?

    Unfortunately, the answer is yes. If you pay twice the price for an asset, for the same eventual exit, you’re cutting your returns in half.

    If the premoney valuations double, that attractive 20% long-term annual return that angel investments returned suddenly turns into a much-less-interesting 10%.

    My response has been to be extremely disciplined at passing on deals, even attractive ones, if the valuations exceed the traditional limits of seed stage investments.

    I predict that those who do not follow the same discipline will eventually come to regret that decision. To quote Casablanca, “Maybe not today, maybe not tomorrow, but soon and for the rest of your life.”

    • Chris, you have hit the nail on the head. I was asked today why early stage investment has become frothy. I think the following combination of factors apply (some are obvious, I hope not all of them are):

      The markets are up and the relatively well-to-do are feeling like they’re close to whole on losses they had seen in their portfolios, so there’s relief and a desire to become a bit more financially adventurous.

      There are few sectors of the economy where it looks like there are investment gains to be made from today’s levels.

      As a result of “democratizing” technologies, there are more high-tech startups with stories which are, at least on their surface, compelling.

      Innovations in distribution mechanisms (facebook, iphone/ipad, other “social”) make it possible for startups to appear compelling without having to actually solve the distribution problem in a novel way, just assume garnering success on one of these platforms.

      The high-tech pitch/presentation process has been “hacked.” Thanks to excellent advice and coaching available from the likes of Nivi and Naval, Fred, Brad, TechStars, Y Combinator, and the like, entrepreneurs are learning how to effectively address the traditional areas of investor concern over risk. I’m seeing more and more bullet-proof, 10-slide decks, which say all the right things to get an investor excited. It isn’t clear, though, that having learned to express themselves well in an investor’s language has nailed the entrepreneurs ability to really think through the risks and evolve a plan with great promise and chances of success.

      • Joshua Greenough

        Get set to hear moaning by newly funded seed / A round start-ups trying to recruit talent. Anybody who is funding a company of 2-5 people should be very wary of not having most people be strong technical contributors during the first year or more.

        If you want the growth industry look for more people to get back into part-time recruiting, new companies flush with new cash will get desperate for talent will overbid. This is a good summer to have graduated with a CS degree.

      • Rob Forrest

        ” I’m seeing more and more bullet-proof, 10-slide decks, which say all the right things to get an investor excited.”

        Mind sharing one with an East Coaster?

  4. HI Liz,
    Great post, Loved the movies and examples.

    I think that each entrepreneur should find his fit based on his DNA, personal abilities, personal growth and his team.

    Its part of the company core strategy, how big you build your company,the needed technology, the market and user acquisition, how much time you have etc.

    i was wondering, is there analytics of average success of incubator based start-ups vs traditional angle/vc funding ?


      • Hi Liz, Thank you! this is interesting.

        I think that there is another point here, we are mostly talking about investments for silicon Vally based companies, its more difficult to succeed in the incubator when you are not there. same for angles, i think that Max Levchin told once that he only invest in companies which are close to where her lived, and it makes sense, the daily ongoing connection is so important in the starting life of a startup.


  5. Hooray, the recession is slowly halting while the economy is gaining momentum. Consumer spending is going up.

    Good news for businesses. Hope the dollar rises past 1.50 so USA stuff can be real cheap over the summer months.

    I’m no market analyst, instead a regular consumer.

  6. I’m seeing deals which are close to fully subscribed for very very incipient companies, with 2-3 million dollar caps on a convertible with no participation and no discounts or warrant coverage.
    This is probably the best time for a startup to be raising and or seed capital since 1999, if not the best time ever when one factors in the amounts needed to build a viable company nowadays versus in a decade ago.
    Heady and exciting times indeed!

  7. Great post, Liz, and great analysis of what’s really happening on the ground right now.

    It is indeed a frothy time. We’re seeing incredible opportunities but also lots of investment interest, shorter deal time-frames, and lots of great angels in the markets.