Is This Economy Impacting Angel Investments? - 10/12/2008

Until recently, I would have said that I did not see a material change in the willingness of angel investors to make investments. At the venture level, data has also been indicating that generally, early stage investing was holding up just fine - as captured in a recent Price Waterhouse report:

VC investments in start-ups remained robust through the exit drought… This suggests a trends of more accelerated investment at both ends of the pipeline – in start-up/seed companies and in more mature companies… this continued funding appears not to be impacting VCs’ ability to feed seed companies and keep the pipeline full.

We will see how this holds up over the next few months, but this is certainly good news at the VC level. As far as individual investors are concerned, unfortunately I think that the situation has finally changed. Why? The reasons are probably many, but here are a few of the top ones:

  1. Cash is king right now. Everything else seems to be losing value, and in some cases dramatically over the past couple of weeks. Investors with cash are hesitant to part with it – and those that have investable assets tied up in mutual funds or stock portfolios are less willing to liquidate those investments to make new investments. Suddenly a 50k investment becomes a 70 or 80k investment, if it means locking in stock market losses on what was 80k in holdings just 6 or 12 months ago.
  2. Asset allocation. Many individual investors approach their investing strategy using asset allocation, meaning establishing a target investment model such as 40% stocks, 20% bonds, 10% real estate, 20% private equity/angel investments, etc. With stocks and related investments down significantly, some investors have suddenly become over-allocated in other investment types – such as angel investments, which are not liquid. As a result, the investor may contribute any new investment capital to the other investment types in an attempt to rebalance the overall target allocation.
  3. Early capital calls. I have heard rumors that some venture firms are starting to make early capital calls, a scenario that could be very bad for the venture market. What this means is that venture firms make an early request for installments of committed capital from the institutions and individual investors (the limited partners or “LPs”) that have signed on to participate in a fund. The VC firms may do this because they are concerned that this capital may no longer be available or won’t be available in the future. So they request the money now. This is basically like a run on the bank in the venture market, though in truth the money has not been loaned out as with a traditional bank. But the money could be sitting in other, depressed investments that the LPs do not want to liquidate or that now no longer hold enough value to be liquidated and fulfill the capital requirement to the VC firm. This would be a big problem as it would suck up liquidity.

Based on these factors and the general mood of investors I have spoken to, I think doing a deal right now will be harder than it was just a few months or weeks ago. But in spite of all this, history suggests that many of the strongest companies are started during times like this. As an example, earlier this week I attended the MIT Enterprise Forum in Manchester, NH, and Paula Long was interviewed for about 30 minutes. Paula Long is one of the founders of EqualLogic, a Nashua-NH based company that was sold to Dell, Inc. for 1.4 billion dollars in cash in late 2007 (according to VentureBeat, EqualLogic was in fact the largest *ever* all cash technology acquisition of a private venture backed company). EqualLogic was started 2001, during the darkest days of the post-Internet bubble, by three founders who had just left a failed start-up and didn’t have any new jobs. 7 years and 400 employees later, the company was sold for over 4 million dollars per employee. Amazing.

For the founding team of a new company, now is the time to put in the hard work, hang-in there, do not spend a penny more than you have to, and work hard to build a small number of key customer relationships – and of course, cling on to the relationships and customers you do have. Focus your story and value proposition on a problem customers are having in this economic environment. Mitigating risk, reducing costs, helping to keep good employees – these are all problems companies are facing right now more so than at any time in the past 5-6 years.

One bright spot is that the overall amount of new venture capital being raised seems to be holding up. In many cases, that capital will go to support companies already within the portfolios of venture firms – who will also need more support- but there will also be opportunities to make smaller bets on sound new ideas. Anyone that can secure customers and validate a business proposition in this environment is probably in a good position to get some attention, and given valuations are likely to be lower, investors that have cash are actually in a very good position.

When things start to turn around, which they always will – potentially very quickly when it happens – it will be too late to get new companies started and those that survive now have an opportunity to build on a validated business model and a strong foundation. But the next 12 months could be tough, hopefully not a nuclear winter, but it certainly will be harder and take longer to raise money for most companies.

8 Responses to “Is This Economy Impacting Angel Investments?”

  1. Susan Kishner Says:

    I’ve been reading along for a while now. I just wanted to drop you a comment to say keep up the good work.

  2. jstjean Says:

    Thank you, positive feedback is always appreciated

  3. Bill Morrow Says:

    Great article as ever, love your finger on the pulse analysis of what’s happening across the pond.

    I like your well-argued point about asset allocation, but what we are finding in Europe is that investors are also looking at the Beta on Risk on each asset.
    That is, they could well have 10% of their portfolio in property or equities, but they also account for the liklehood that they will ever see this money again!
    Angel investment is no less risky, but it is a relatively less risky bet than other assets.
    Our website stats are 31% up month on month with investors very very keen to invest.

    Keep up the great work.


  4. jstjean Says:

    Appreciate your comments and data points. I know investors first hand who face the allocation problem I mentioned, however maybe there is a counter-trend of investors (some possibly new to this class??) having had enough of the stock market and looking for some new options. I agree that an investor with a diversified portfolio can manage some of the risk, if they can handle the lack of liquidity. I would be very interested to see how the increased web site traffic translates into activity if it is possible to tell over the next few months.

  5. Moonaeneflany Says:

    Hi. Your site displays incorrectly in Mozilla, but content excellent! Thanks for your wise words =)

  6. jstjean Says:

    I used Mozilla as my main browser (v3.05), and I do not see any display issues. Please tell me what version you use and what you are seeing. If anyone else also sees issues please report them.

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