Getting to "yes" in a world of "no"…

As a UK entrepreneur looking for finance, I’ve managed to meet a good number of angel investors (130+), encompassing the good, the bad, and (indeed) the ugly faces of capitalism.

For all their differences, many have strikingly similar attributes:-

  • the Home Counties mini-mansion;
  • the trophy wife (yes, to surely nobody’s surprise most UK angels are male);
  • the small ‘Me Plc’ working office;
  • the constantly beeping Blackberry;
  • the enthusiastically overachieving hobby/-ies;
  • …all paid for by having cashed out their interest in some financial services variant right at the top.

When you meet them, they’re almost all relaxed, powerful, lovely blokes: and I’m not just saying that to kiss their virtual <whatever>s, they really are – basically because they can afford to be. That easy state of being is precisely what their success has bought them.

Yet the burning drive that pushed them to wherever they got to still smoulders not far beneath the now-comfortable surface, and they typically look to startups for a kind of surrogate adrenaline rush (which is perhaps a bit of a paradox, given that startups normally take several years to succeed or fail). All the same, I can’t help thinking that most of them will lose money from angel investing. And the reason for that comes down to what I call “the problematic wisdom of angels”.

You see, there are – broadly speaking – only five main investing paths UK angels tend to follow:-

1. Confetti mode – “Invest in almost everything that comes your way

Many angels start out like this, throwing small (£10K-£20K) lumps at a fair few of the entrepreneurs resourceful enough to network through to them. Investing like this can give angels a great buzz. However… they soon find themselves with a scraggy portfolio they simply don’t have the time or attention to follow. How would you track twenty £15K punts, particularly when they might be on your books for 5/6/7 years? It’s a tough one.

2. Goldilocks mode –Not too big, not too small, but juuuuust right

Many angels end up here: they still look at (OK, ‘skim the first page of’) every proposal that comes past, but are aiming to invest in £25K to £40K (occasionally £50K) tranches – their “house rules”. ‘Too small’ can’t justify the amount of effort needed to get on board (even if most do expect entrepreneurs to buy them lunch, ha!), while ‘too large’ is just too dangerous in what will always be a volatile asset class (which, of course, is why the returns from successful startups are so high). The problem is that, for most angels, this is still too small to warrant leading a round, but it’s still a large enough tranche that they can frequently feel the urge to micromanage the entrepreneur (which, incidentally, has been shown to cause startups to underperform). Should £25K buy an angel a seat on your startup’s board?

3. Go big or go home – “Small investments are for wimps

At the other end of the scale to ‘confetti mode’, some angels take a high-risk, bet-the-farm approach by placing large amounts (say, £100K+) into startups so as (presumably) to get all the upside of a single investment winning big… to multiply yet further the proverbial “home run” of VC speak. Even though the downside – one angel told me rather ruefully how he had lost £235K on a single investment – is almost too bad to consider, I can easily see how the stars of future wealth could firmly fix themselves into an angel’s eyes. Once you’ve convinced yourself how unbelievably good startup X is, why not take the whole round all for yourself?

4. Stick to the knitting – “Invest in what you know

Rather than trying to finesse the size of the investment (as per 1/2/3 above), many angels instead buy into the much-vaunted “smart angel” mindset: the notion that their deep experience and extensive contacts in industry X and/or market segment Y and/or business structure Z dramatically increases the effective value of their investment. (To be honest, this frequently comes across as a negotiating tool to help them argue for a better price: I’m not aware of any research supporting the suggestion that such “smart angels” are significantly more successful than so-called “dumb angels”.) In fact, sharply limiting the number of proposals to areas in which they have ‘history’ probably makes their portfolios more fragile (i.e. more susceptible to market shocks), as well as forcing them to invest in lower-quality investments to scale up their portfolios to a reasonable size. This narrow focus can then lead them to make sizeable single-startup investments (‘go big or go home’-style), which is normally a fairly bad idea.

5. Hydra mode – “Pool or syndicate investments with other angels

In many ways, this is an optimal approach because angels somehow always manage to completely fill their available time, so ‘sharing the load’ in some way would seem sensible. However, syndication comes at a high transaction cost – much higher levels of due diligence and raw contractuality are needed in order for angels to work in a group, because it’s essentially a mutual mini-VC fund. What doesn’t gel so well is that most angels paint a heroic mental picture of themselves as solo hunter-gatherers – yes, although angels like to preach the virtues of teamplay to entrepreneurs, they’re rarely keen on applying it to their own investment practice. How can they reconcile the self-justifying notion that they got rich as a result of their own personal merits (whether or not this is actually true) with the idea of surrendering control to a group of their peers?

* * * * * *

Effectively, each of the above five patterns of behaviour represents a ‘strategic decision’ – yes, a business school “strategy” – about how to invest: small size only, mid size only, big size only, close to (business) home, or syndication. All of these (even #3!) are totally rational… and yet they all largely miss the point, which is that startups are not West End musicals.

You see, startups pretty much all share a basic set of building blocks – products/services, markets, customers, development, promotion, uptake, overheads, runways, distribution, etc – which every half-decent exec summary should cover. So when they’re all built from the same conceptual Lego, why should angels even need an investment strategy? Why not treat each proposal on its own merits?

I believe the reason for this perceived need for a strategy lies in bookshops. On their Business Section shelves, you can find countless titles claiming to teach entrepreneurs how to perform an angel-attracting ‘waggle dance’: they baldly assert that anyone with half a brain and a book token should be able to use their templates to knock together a “killer business plan” without great trouble.

And many do.

I suspect that the resulting deluge of plausible-looking (but ultimately content-free) ‘killer business plans’ has gamed the whole system: it has caused angels to disbelieve that whole class of document – in fact, cynicism and doubt have become the default position. Business plans have been relegated to the fiction department, while few angels or entrepreneurs have any tangible idea of what Business Plans V2.0 should look like (in whatever brief gap that lasts before they too start being gamed).

For me, ‘wisdom’ – which I define as explicitly knowing less to try to implicitly know more – is far too often used as a cosy theoretical retreat from the difficulties and political compromises of the world: which is, of course, why business school platitudes usually fail when applied to real-world situations. Hence to me these angel “strategies” come across as typical of B-school high concept investing wisdom – they look great on paper but fail miserably when applied to real startups and real portfolios. Yes, there are things angels should aim to avoid (unbalanced portfolios, too many board seats, unmanageable portfolios, etc), but none of these should be considered so overwhelming that they should be allowed to dominate their overall thinking.

My point is that, contrary to the five investment behaviour patterns described above, there is probably no universal answer to the challenges of angel investing. In fact, there is precious little “investment by walking around” (i.e. actually meeting entrepreneurs) going on these days – and despite the moves to disintermediation everywhere else in the digital economy, it is puzzling why UK angels and UK entrepreneurs now seems further apart than ever. To be brutally honest, I would expect that more UK entrepreneurs are now connected to Dave McClure (yes, the D-man even follows my tweets, bless his sweary heart) than to UK angels, which I think speaks volumes about the structural problems this side of the Pond.

Hence the key contradictions of UK angels are that (a) for all their rejection of business school / templated business plans, they still rely on business school / templated ways of thinking when judging proposals; and (b) for all their espousal of disintermediated business models, they still (for the greatest part) fall in with pay-to-pitch angel networks. Sorry, but from where I’m sitting, if that is what currently passes for “angel wisdom”, it seems to me a very problematic kind of wisdom indeed.

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