How Emerging Startup Ecosystems Can Get More Angel Capital off the Sidelines

There is a lot of discussion about what we can do as an emerging startup ecosystem to move dollars off the sidelines and get more people into angel investing.

So far, much of the focus has been on investor education so that high-net-worth individuals (HNWs) can begin meeting founders and writing direct cheques into startups.

After ten years as an angel, I believe this approach is incorrect. Here’s why…

Angel Archetypes

First, there are two general categories of angel investors:

Group 1 - Passion-focused: those passionate about a particular industry, technology or team and want to support it, where financial returns aren’t the primary motive (e.g. exited founders, startup employees, tech & finance execs).

Group 2 - Returns-focused: those interested in the venture asset class as a means of portfolio diversification and who aspire to catch the next unicorn (e.g. doctors, lawyers, dentists, real estate agents, etc.).

Group 1 is already in the market, up-to-date on the latest technologies, and likely familiar with venture financings. They have a solid ability to evaluate and invest in emerging companies and welcome the opportunity to help at an operational level.

Unfortunately, this Passion-focused group represents a tiny percentage of the ecosystem since achieving a large company exit (and subsequently creating dozens of HNW angel investors) takes many years to materialize.

Concurrently, Group 2 (representing a much larger percentage of the prospective angel market) often lacks the time or background to establish quality dealflow, construct a successful portfolio and manage ongoing investments.

In many cases, they write a handful of cheques, each of which goes to zero, and they walk away with the perception that angel investing is a waste of money. This results in less capital for founders and high churn where angels are most needed.

As a result, there has been a strong push in the form of educational initiatives to inform and encourage Group 2 investors to join the asset class.

However, like anything, achieving success requires a full-time commitment, which most of these individuals can not maintain since they are busy running legal practices, agencies and medical offices.

Solution

Group 1 is already well on their way, and because they aren’t as focused on returns, they are less likely to abandon the asset class if their portfolio underperforms.

Moreover, most of these individuals can hone their abilities through the plethora of information widely available online and in books.

For people in Group 2, educating and encouraging them to become individual angel investors is putting the cart before the horse (in my opinion).

Instead, since this group is predominantly returns-focused, the primary goal must be to expose them to the asset class while also generating early wins to effectively demonstrate they can achieve attractive financial returns relatively quickly.

As individual angel investors, this is not possible by writing cheques with 7-10 year maturity horizons.

However, by shifting the focus from individual cheque-writing to backing emerging managers, they can gain exposure to the asset class with greater diversification, a lower risk profile and are more likely to experience near-term markups in their portfolio.

Whether it’s angel groups with vetted dealflow like us at Allied Venture Partners , Startup TNT or emerging VC funds like Weave VC , Tall Grass Ventures or Metiquity Ventures , the big push at the early stage of the startup ecosystem should focus on getting Group 2 LPs to back emerging managers, not direct investing.

As a downstream effect, new angels will have learnt from experienced managers, improving their skill set and (if they choose) can more confidently write direct investments into startups. Additionally, angels will realize fewer losses, thus improving the durability of capital at the early stages and establishing a self-sustaining ecosystem flywheel.

TL;DR: we can improve the durability of angel capital and generate better returns for investors by getting more HNWs to back emerging managers, not encouraging them to become individual cheque writers.

What does this look like in practice?

Educational programs that help aspiring Group 2 angels evaluate and select emerging fund managers (instead of direct investing).

There are very few resources on this topic. Yet, it’s one of the most impactful levers that (if applied correctly) can produce an asymmetric upside effect in jumpstarting a sustainable early-stage funding ecosystem.

Organizations like Allocate are improving awareness in this space, but much work remains to be done.