Recently, in the flurry of the Angelsoft 3.0 launch, Fred Wilson wrote a lengthy, thoughtful, and generally positive post about the platform in his blog A VC. One of his readers, writing under the nom-de-blog of T. R. Teller, wrote a pretty harsh attack on either the platform or the whole concept of angel investing (it was a bit hard to tell the precise target of his ire).

In the interest of responding to, and clarifying, some of the points he raised, I answered his post in some detail. Fred has suggested that my response was worthy of a full blog post on the Angelsoft blog itself, so here is what I wrote:

T.R, let’s try to look at this calmly, since we are all ultimately on the same side here, trying, as I wrote in Angelsoft’s mission statement, “to get more smart money into more good deals.” I clearly understand your frustration with the challenges of getting early stage companies funded, but let me try to respond specifically to each of the points that you’ve made:

Oh, I’m sure that more than 98.7% of the deals presented to you are “unfundable.”

The essence of a free market economy is that sellers may offer anything they want for sale, at any price the feel is appropriate, and buyers may buy, or not, anything that is offered for sale at a price THEY feel is appropriate. In a free market with perfect information, if no buyer is willing to purchase something on offer, then by definition the price is “too high”. The inverse is that if there are ready buyers but not enough product, someone will step in and offer products until the market clears.

Historically, the angel funding ‘market’ has been highly IMperfect. I’ve likened it to an investor and an entrepreneur running around a football field in the middle of the night wearing dark sunglasses and earmuffs trying to find each other. With Angelsoft, for the first time we have actually managed to create a more perfect market: there are over 11,000 accredited investors who are taking the time to participate in angel investment groups precisely because the WANT to invest. Why else would they be here? At the same time, with the Angelsoft ‘Community’ we have provided a way for an entrepreneur to place his or her plan, completely with summary, video, et al, directly in front of these investors.

Logic, and the theory of free market economics, say that if 11,000 willing buyers can look at the presentation of a plan and decide not to invest…yes, it probably IS “unfundable by objective, economically-motivated angel investors”. (Note that it may still be fundable by friends and family members, or by strategic investors, all of whom are motivated by something other than pure, stand-alone risk/reward economics.) Bill Payne (one of the most respected angels in the country, and an Entrepreneur in Residence at the Kauffman Foundation for many years), has written a good post on what kind of things make a deal ‘fundable’.

My guess, in fact, is that a full 100% of deals that come your way are, strictly speaking, “unfundable.”

Not at all! I have personally invested so far in two deals that I found through the Angelsoft Community, and have brought half a dozen others in for screening to the angel group to which I belong.

One of the things that is not intuitive at all is how the economics of angel investing work. While most entrepreneurs wouldn’t begrudge an investor an annualized return of, say, 25% on his or her invested capital, given the risk of early stage investment, the surprising, and probably terrifying, fact is that in order to achieve that kind of return, angels need to target getting back 30 times their money on each deal! While I’m sure that seems virtually sociopathic, I’ve written an explanation of angel economics that may prove helpful in understanding it.

I mean, why would an entrepreneur with a demonstrably fundable idea go to some wannabe angel network for small change, especially when you’re wasting 99% of your time saying “No Thanks” to the 99% of crap your nervous-nelly network of near-anonymous plungers has deemed “unfundable.”

It is a question of supply and demand, and what other options are available. If an entrepreneur can personally fund his or her idea, then there’s no need to seek angel funding. Likewise if he or she has a well-heeled family or circle of friends who are willing to provide financing. But if the idea requires outside financing, things get quite a bit tougher. Banks are not in the risk-taking business, and will simply not provide startup financing. Venture capitalists fund an even smaller percentage of companies seeking funds (MUCH smaller: last year, VCs in the US funded about 1200 startup and early stage companies; angels funded about 50,000).

So the question of “demonstrably fundable” may not be quite as clear-cut as it may appear on the surface. If no professional (or semi-professional) investor, having seen the proposal, is willing to fund it, I think that in a free market one would then have a hard time describing the plan as “demonstrably fundable”. I think it’s pretty hard to describe investors as “nervous nellies” unless you compare them to something else. I’m assuming that you would not invest your own money in a “hot prospect” from Nigeria that arrived via email, so would that make you yourself a “nervous nelly”, compared to someone who was naive enough to do so?

As for the “near-anonymous” comment, that is a function of each angel group. My own group, New York Angels, proudly lists our members on our website (including folks like Esther Dyson, Gideon Gartner, Josh Kopelman, and other well-known investors), as do many other groups.

I mean, if you want to throw figures at me showing how you’re investing millions and closing a dozen deals EVERY WEEK, then I might admit your method is interesting. Then I might admit your group isn’t a bunch of total posers.

I’m a little confused by this one. How on earth could anyone, angel or vc, possibly look at enough deals, or do enough careful due diligence, to close a dozen deals a week?? I don’t know of anyone or any entity in the history of investing that has had that kind of bandwidth. Our own group, New York Angels, has invested about $35 million during the past six years, and closed about fifteen deals this past year. I, personally, have invested in over 70 startup companies so far. I think it would be pushing things to call us ‘posers’.

I mean, please do let me and everyone know if that’s the case — you’ll likely see higher quality entrepeneurs try their luck with your screwball process!

While I’d certainly agree that the process is far from perfect, calling it ’screwball’ might be going a bit far. At Angelsoft we’ve tried to make it as streamlined and rational as we can. What suggestions would you have for us to improve it?

But as it is, you’re all talk, no walk.

I think that’s unfair. Simply looking at the stats shows that over 11,000 investors are participating and actively looking for investments, and have reviewed deals over 100,000 times. According to the most recent statistics from the Center for Venture Research, angels in the US last year invested $26 billion, into mostly early stage companies.

For all the investors in your network, you don’t represent real capital, you haven’t proven investment acumen, you don’t have impressive returns to show off, you don’t have success stories you can point to. You even admit you barely expect to break even.

It’s important to remember, as others here have noted, that Angelsoft itself is not a network; we are simply a software platform that services networks of angels. But that said, given the numbers above, I think it’s pretty clear that the 412 organized angel groups using Angelsoft clearly represent real capital. The metrics and risk of early stage investing are such that, as I previously noted, fully half of all investments fail. Nevertheless, according to a study released last year, angels investing through angel groups have been averaging a 27% internal rate of return on their investments. Compared to just about any other form of investment, including bank deposits, stocks and hedge funds, that’s actually quite good. As for the ‘break even’ mention, I think that might be a misunderstanding of the context. Most angel groups are not-for-profit as a group, and operate at breakeven. Their goal, however, is to help their members make a profit on their investments, which, as the statistic above shows, they usually do.

You’re not investors, you’re a social club.

Again, Angelsoft is neither an investor itself, nor a group, we’re simply a software company. But for the angel groups who use the platform, social discourse is in most cases absolutely one of the reasons that members join. But since there are a lot better clubs to join, there’s no reason for accredited investors to join angel groups unless they really want to invest [grin].

I mean, for all these reasons and more, most capable entrepreneurs wouldn’t even acknowledge an angel outfit like USV as anything more than glorified bloggers/lookie-loos.

To be clear, USV is Union Square Ventures, one of the most respected professional venture capital firms in the country. They are not an angel group; Fred Wilson, a partner at USV, was simply writing an objective blog post about the Angelsoft platform…which he doesn’t even use!

Why in the world would they take AngelSoft — or any of your dubious peers — any more seriously?

It’s precisely because there are so many sites which purport to ‘connect’ entrepreneurs with investors that we have released Angelsoft 3.0. Now, for the first time, entrepreneurs (and everyone else) can look at real, live statistics on the system. They can see that over 11,000 accredited investors and venture capital firms are actively making use of the platform to review and collaborate on funding deals. That’s why (we hope) they will take us seriously.

T. R. I hope this answers the points you’ve raised, but I’d be happy to continue the conversation either here in blog, here in the Angelsoft blog, or directly by email. Thanks for raising taking the time to comment!

Originally posted as a comment by davidsrose on A VC using Disqus.

David S. Rose :: Sep.06.2008 :: Angelsoft 3.0, Entrepreneur, Industry Stats, VC ::