Sustainability Issues in Angel Investing

1
Sustainability Issues in Angel Investing

• Ian Patrick Sobieski
• Managing Director
• Band of Angels and Band of Angels Fund, LP.
• April 26, 2006

2
The Strategic Market Opportunity for Angel Groups

• VC was once novel
• Venture Capital model developed over time
• Current VC is fundamentally not structured to do
  seed investing
  
• Fund Size/Partner force dollars deployed
• Dollars too big for stage, may always be too big
• What About Small Funds?
• Successful seed VCs will abandon niche
• Acute shortage of small funds
• No traditional VC will maintain brand as a seed
  investor

3
VCs Exiting Early Stage
of All VC Funds
Source NASVF and PWC-MoneyTree
Source National Venture Capital Association
4
Cambridge Associates Returns VC

• The bust was painful
• Top 140 Funds as tracked by CA
• 1998 Total Value/Paid In 1.04
• 1999 Total Value/Paid In 0.60
• 2000 Total Value/Paid In 0.73
• Most 1999 funds nearing statutory end of new
  deals
  
• Fund raising climate bleak
• Flight to Quality (Sequoia, KP, etc.)
• Number of active VC Funds will shrink

5
Angel Investors Dominate Seed Market but shift
will not benefit them much long term

• Angels dominate seed investing
• University of New Hampshire, Center for Venture
  Research
  
• Angel invested 18.1 billion in 2003
• Same as venture capitalists
• In 42,000 ventures
• Primarily in seed and start-up rounds
• 200,000 currently active angels
• But no brand equity is built
• Activity of individuals
• Fundamentally Fractured activity
• High turn over
• When Market corrects competitive balance of small
  VC vs Angel will be restored

6
The Strategic Market Opportunity for Angel Groups

• Angel groups ARE structurally suited for this
  niche
  
• Dollars/deal, Longevity, Flexible deal structure
• Angel groups can establish brand equity for
  constituent angel activity
  
• A sustained angel group, over time, will
  establish local brand in this niche with all that
  accrues to VCs that have this in theirs
  
• Better deal flow
• More term leverage with partners and VCs
• Better IRR
• The virtuous circle
• More headaches! Because now you have something of
  value and everyone will want a piece.
  
• To achieve this, you must endure

7
Sustainability Challenges for Angel Groups

• External Threats
• Competition from Small VCs
• Best deals are scooped
• Competition from individual angels
• Your group must provide something that an
  individual cant get on his own
  
• Competition from other angel groups
• In recruiting members yours must be more
  attractive than others
  
• Internal Threats
• Members become inactive, members quit
• Leader become tired
• Incentives are misaligned
• No Liquidity to Members

8
Case Study in Evolving Model The Band

• 12/94 Founded, 12 Members
• 12/95 100 Dues, 25 members
• 12/96 250 Dues, 49 members
• Deal staffing support needed, no budget
• 12/97 500 Dues, 71 Members
• More volunteer staffers not sustainable
• 12/98 750 Dues, 98 Members
• 12/99 1000 Dues, 135 Members
• Venture fund

9
Case Study in Evolving Model The Band

• 2000 Bust
• Membership decline
• 150 in 2000 to 93 in 2003
• 22 deals in 991/2000 to 7 in 2003
• 2004 Both founders pass away
• 2005 105 Members
• 12 Deals in 2005
• 7.2 m invested

10
Case Study in Evolving Model The Band

• 6 Month Moving Average

• Transitioned from personality to process
• Asked members what they wanted from group
• Responsive
• Asked more of members
• 3 new committees
• New employee
• Broadened sense of ownership of group

11
Angel Investing Can be Profitable

• Band of Angels
• Formed 1994, 100 Members
• High Tech Background Only, Symantec, Logitech,
  National Semiconductor, Sun, Apple, HP, etc.
  
• Invested 100M in 140 Startups
• 50M Side Fund (No angels)
• Track Record
• 9 IPOs all listed on Nasdaq
• Digital Think 401
• Keynote Systems 201
• 33 positive exits
• Sandpiper Networks (1B Sale),301
• Recent too Genitope (200M) Novacept (300M)

12
Good for the gander but not for the goose

• IRR story impressive
• Sell holding after 6 months 57.2
• Sell holding after 1 year 17.4
• Never sell holdings 10.1
• 125M generated on 80M invested
• Even including all of the bust the Band has made
  a lot of money, but
  
• most was concentrated in IPO liquidity
• minority of members in home runs
• majority in singles or in money losers
• nature of model is that only a few members are
  in any particular deal in a game of home runs
  then, most individuals are left behind
  
• So, most angels lose money?
• Is Angel Investing Foolish?

13
Comparable Analysis
14
Different Models for Providing the Similar Types
of Things

• Fun!
• Improve deal flow
• Web site, reputation, deal screening
• Better terms through pooled negotiation
• Collective due diligence
• Member Education
• Professional manager help
• Networking events
• Social events
• Platform to work with VCs
• Institutional Support (memory, data)
• Better IRR?
• This is a lot of work!
• How to pay for it?

15
Potential Sources of Cash

• Percentage of transactions
• Charge Companies to submit and/or present
• Membership Dues
• Sponsorship
• Management Fees on Fund
• Kaufmann Foundation

16
Potential Sources of Cash Continued

• Percentage of transactions
• 3-5
• Pros 5M investment 250,000
• Cons probably illegal
• Charge Companies to submit and/or present
• Filing fees (50?250)
• Presentation Fees (100?3000)
• Pro 36 deals/year 108,000/year
• Cons
• Selection bias in companies
• Administrative headache to collect

17
Potential Sources of Cash Continued

• Membership Dues
• Angel Members (100?10,000)
• Service Providing Members (3,500)
• VCs (100?5,000)
• TAM 150,000
• Sponsorship
• Large Firms marketing 25,000 /each
• Medium Firms deal sourcing 10,000/each
• Exclusivity means TAM 150,000/group

18
Potential Sources of Other Compensation

• LLC Carry
• Company specific option packages
• Side care fund carry
• Business Equity
• Pride of Ownership
• Sense of Place
• Sense of Belonging

19
Most Popular Angel Group Models

• Member Led Network
• Share the work on sourcing, diligence, deal
  making and monitoring
  
• Often paid admin support
• Dont require much cash
• Modest dues and sponsor often enough
• Sustainability challenges
• Burn out
• Management by committee
• Aligning economic interests of staff, volunteer
  leaders and members
  
• Threat from services of paid-Manager led model

20
Most Popular Angel Group Models

• Paid Manager Led Network
• Full time professional managers coordinate or
  perform sourcing, diligence, etc
  
• Sustainability Challenges
• Higher costs to support manager
• Increasing number of customers
• VCs, service providers, finders, consultants,
  entrepreneurs
  
• Increasing services demanded
• Thin margin, small compensation for the work
• Tough to scale
• Manager focus drift away from deal consumption

21
Most Popular Angel Group Models

• Manager led Pooled Fund Network
• Members contribute to fund and deploy capital by
  majority vote
  
• Sustainability Challenges
• Small cash flow
• Manager led Side Fund
• Manger raises funds from others invests alongside
  angels, and subsidizes group
  
• Sustainability Challenges
• Customer becomes LP!
• Potential to alienate Angel members

22
In evaluating the sustainability of your operation

• Are you spending more than you take in?
• Is your customer getting his moneys worth
• Are you able to maintain deal flow and member
  activity?
  
• Are people who are making the system better
  being rewarded correctly?
  
• Long term vs. short term
• Are incentives aligned
• What is your competition doing? Need to do
  more?
  
• Are your customers aligned with your activities
  and processes?
  

23
Three Mature Models

• Tech Coast Angels
• Member Led
• Membership Fee Supported
• Sponsorship and VC Affiliates Fee
• 1 full time employee
• 120k in sponsorships ?my guess

24
Three Mature Models

• Kieretsu Forum
• Manager Led Network
• Affiliate Network
• Substantial dollars on top line from
• Fees
• Companies
• Sponsorships (diff levels)
• Building real equity in brand and firm
• Pays for big staff, more than 12 regional heads
• Meetings are FUN High energy!
• Charity Focus

25
Three Mature Models

• Individual Investment Decisions
• A new LLC is formed for each investment
• The only asset in LLC is the stock, warrants, or
  bridge notes of that one start-up
  
• A carried interest can be charged to pay a
  manager and other expense
  
• Closed Meetings
• VERY tight knit

26
Small Funds vs. Angel Groups

• Small Funds have
• Few staff, smaller deal flow
• Are easier to run focus on deals
• Institutional
• MUCH Better economics
• Angel Groups
• Much broader networks and deal flow
• Unwieldy to run focus on many other things
• Poor Economics
• Trend toward angel related funds combines these

27
Trend toward Side Funds

• Advantages
• Fee helps pay managers and expenses
• TAM on all other legal fees 400,000
• 2.5 Fee on 20m Fund 500,000
• Provides extra capital to group
• Provides stability (10 year life or more)
• Disadvantages
• Makes it more a business culture clash
• Raising a fund is HARD!
• 30 of ACA members have funds or are planning to
  raise one
  
• Having a fund has damaged some angel groups
• Servicing the LP customer
• Neglecting the vital angel constituent

28
Looking for the right Fund Model

• Pledge Fund
• Minimum buy into fund gives coinvestment right
• Manager makes fund investment decision
• Automatic Side Fund
• Members invest in fund
• Continue to make individual investments
• If threshold is reached then fund invests.

29
State of Angel Groups

• Angel groups provide solutions to process
  challenges
  
• Number of Angel groups growing rapidly
• Most angel groups are
• Many are not sustainable
• Some revenue sources misalign incentives
• Some models have mis-scaled (not misaligned)
  rewards
  
• Running a group is a lot of work they require
  nurturing
  
• Time and pressure damage groups
• Chances of survival increase with robustness
• What motivates angels to join groups, do
  diligence together, make investments?
  
• Over time, how many services will they come to
  expect? How many flavor of angel is there?
  
• But do angel groups actually help IRR?
• Does it matter?

30
Sources of Group Robustness

• Among Angels
• Conviviality
• Perceived value given in excess of taken
• Personal enjoyment
• Ethnic or personal Bond
• In business model
• Understanding of who customer is
• Value given to customer
• Alignment of incentives or attitudes
• Source of revenue that is predictable

31
Predictions

• More funds associated with Angel groups
• A standard business model will develop for
  angel groups
  
• Some mix of fee, fund, and sponsor
• Rise of a class of managers
• Some kind of economic sharing across entire
  group
  
• Hybrid angel groups that have many properties of
  angel groups as we know them but the stability,
  longevity, and upside economics of VC Funds
  
• When a model has been developed and is common and
  standard when there is third party data to
  report IRR performance of groups Angel Investing
  will be an Industry
• But the threat to this is the last question Will
  this still be fun? Do angels want to let this
  happen?

32
Acknowledgments

• James Geshwiler CommonAngels (Boston),
• John May New Vantage Group (Washington, DC),
• Sue Preston Seraph Capital Forum (Seattle),
• Lou Anne Flanders-Stec Piedmont Angel Network
  (Greensboro, NC),
  
• Bill Payne Vegas Valley Angels (Las Vegas),
• Luis Villalobos TechCoast Angels (Southern
  California),
  
• Tom Walker Oklahoma Investment Forum (Tulsa)
• Marianne Hudson - Executive Director of ACA

33
Thoughts, Questions, and Discussion

• Ian Patrick Sobieski
• Managing Director
• Band of Angels and Band of Angels Fund, LP.
• Contact
• ian_at_bandangels.com
• 275 Middlefield Rd,
• Menlo Park, CA 94025