Wednesday, October 3, 2012

Investor Post: Six Degrees of Reservation

It’s been a rough summer – for the economy, for VC, and beyond.  Maybe you have some reservations about entering angel investing in this climate.  Or maybe you’re an experienced seed investor, unsure of the approach that we take at Seattle Angel.  I thought about my own path, and surfaced six “reservations” that seemed worth addressing:

1.  “The VC and angel ecosystems are churning”

Though a little histrionic, this reservation isn’t way off.  The Facebook IPO took its toll, and it came on the back of a disheartening Kauffman Foundation report. For any new entrant into the seed capital market, this summer played like a public service warning on the dangers of hitchhiking; If you wind up where you don’t wanna go, it’s your own fault for riding with opportunistic strangers.

The top level news isn’t helped by the sheer statistics of traditional venture investment ROI. The Quilvest team captured my favorite recent graphical summary:

Everyone has something to say. From June’s direct guidance from the accomplished & intelligent Paul Graham, to last weekend’s sane but self-serving notes from Andy Rachleff, the message seems clear: seed-stage investment is at best high risk (which we knew), and at worst can be brittle, arcane, even fickle.  An indiscriminant angel can only do poorly. Who wants any part of this?

If you’re slowed by this shadowy picture, you’re not alone  Yet I remain deeply committed to Seattle Angel. Why?

-       Everyone involved with Seattle Angel shares your awareness of the long odds of angel breakthrough. This is not a vanity exercise; it’s an organization committed – long term – to both the companies we invest in, and the processes of learning, self-criticism & adjustment from which success is born.

-       Our day-to-day execution is based on rigorous due diligence and challenge to the participating startups – not prediction and insider gamesmanship.

-       Our unique structure allows accredited investors to leverage a comparatively low commitment of capital into a meaningful seed investment.

Of course none of this eliminates this reservation. But acknowledging it – and inviting you to work within a community of realists – may help you reconcile your own relationship with the risks and rewards of seed-stage investing.

2.  “Seattle has an established angel investing ecosystem. Why cloud that with another entrant?”

I have to admit I’m surprised by this reservation when I hear it from prospective investors.  Yes, it’s absolutely true that we have a rich seed investment infrastructure in the Northwest corridor.  And yes, if you’re ready to make a substantive impact, you should join one of Seattle’s premier angel organizations.  In fact, many members of Seattle Angel are also active in the Alliance of Angels, Seraph Capital, and others. 

The reason I’m surprised, though, is the misconception beneath the reservation.  Yes, Silicon Valley may have tipped toward a haphazard level of artificial seed-stage “competition” that inflates valuations and turns thoughtful investment into a kind of merit badge competition.  I'm a pessimist, but still don't see large risk of that here in the Northwest.  

More important, though, Seattle Angel has an allergy to those gymnastics.  We are an incubator.  Twice each year, we conduct a deep, highly structured pitch and due-diligence competition, timed to amplify the best work of Seattle’s more established funnels and funds.  We do so with an eye toward educating first-time investors, routing them toward the region’s seed-stage pillars, and expanding the overall startup capital environment.  It’s a role we relish, and are certain is unique.

3.  “I can’t predict winners.  People who think they can are naïve, confused, overly confident, or all three.”

To this reservation, I can only shout ‘One Of Us!”  Among the many great experiences I’ve had as an active Seattle Angel member is exposure to the work of Rob Wiltbank, who delivered an inspiring, data-intensive talk at the close of our Seattle Angel Conference in May.  If you haven’t immersed yourself in Rob’s research on seed-stage investment, I strongly recommend it.  A key theme in his decade-plus work: effectual principles.  Far beyond predictive ability, the following three factors weigh highest in determining angel outcomes:

1. Due diligence time: More hours of due diligence positively relates to greater returns.
2. Experience: An angel investor’s expertise in the industry of the venture in which they invest also is related to greater returns.
3. Participation: Angel investors that interacted with their portfolio companies at least a couple of times per month by mentoring, coaching, providing leads, and/or monitoring performance experienced greater returns.

At Seattle Angel, we seek to optimize both our organization and our process around these three principles.

4.  “Internet-driven businesses get too much attention and capital. If this region is to grow, it won’t be exclusively on software and internet businesses.” 

I know this reservation well.  Possibly like you, I’ve spent a lot of my life developing and leading consumer internet businesses. I not only know the territory, but I know how well it can lift and scale from an investment perspective.  It'd be as foolish to overlook Seattle's DNA in this segment as it would to overlook those economies of scale.  Seattle Angel does neither.

At the same time, half of the finalists in our May conference sat well outside this realm.  And in the run-up to the conference, innovators in manufacturing, retail, education, and medicine shared our mindshare with (equally innovative) companies focused on applications and platform software.  In our recruitment of investor expertise, and in our openness to applicants, Seattle Angel is extraordinarily interested in breadth.  Our bias, if we have one, is toward opportunity and growth – not a particular segment.

If you are someone who believes growth for the region involves a complex blend of businesses, you may find Seattle Angel a good entry or diversification point.

5.  “This isn’t a hobby. My time and portfolio matter.”

One of the weird truths about building a nascent angel organization is that some mistakenly view it as a “hobby”.  I thought that impression might end with our successful first conference. And to be honest, there are some things burned into the Seattle Angel way of working that might make this misconception linger. 

We're a group of accomplished Seattle investors – serious about the task of evaluating deals, and critical of both entrepreneur pitches and our own process.  But it’s true: we’re nota linen napkin crowd.  We live in startup culture, choose cardboard pizza over catering, and pinch our operating costs through a sieve.  It makes for some decidedly low-end events.  But it has also fostered an informal, open, fact-focused atmosphere – and enabled us to attract and retain investors that value IQ, experience, respect, and results over flatware and playacting.

More important than group dynamics, though, is the structure of Seattle Angel.  You will leverage a $5500 per-unit investment into an LLC and rigorous vetting process in which your insight and participation matter.  A convertible note worth 20-40 times that will seed the work of a startup you helped select.  Whether you are broadening your angel portfolio as an experienced investor, or entering the seed-stage ecosystem as a first timer, the Seattle Angel process offers you a unique opportunity to build your network, skills, and holdings. 

It’s not a hobby for us, either -- or the entrepreneurs we deeply care about.

6.  “As if the above wasn’t enough: the world economy isn't sound.  Why pursue angel investing now?”
Seeds don’t complain about a dismal rain, and growth doesn’t stop when it’s dark.  

There’s a wealth of new businesses starting in this region, at various stages of development.  Our intent is to grow all of the entrepreneurs who move through the Seattle Angel process, and to help you – as a first time or experienced seed investor – find a conduit for your expertise.

This is a remarkable time.  Whatever the reservations, I hope you can join us for the Seattle Angel Conference.

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