The Mirage of Angel Investing

The exuberant funding environment resulting from ZIRP had an under-examined second order effect. A rapid rise in new angel investors. Abundant capital at nosebleed valuations created mouthwatering paper returns. Even CPG companies were getting tech multiples. It was so widespread that non-participation felt irresponsible, borderline stupid. Anyone with disposable income, that should have gone into an ETF, added “Angel Investor” to their LinkedIn and joined as many syndicates on AngelList as possible. VC firms further fanned this fire by leaning hard into a new kind of scout program - angel schools. Curriculum and community to teach angel investing. The stated goal is noble - democratize access to a thriving asset class - early stage venture. However, underneath the hood, its driven by risk offloading, incentive divergence, and poor returns.

First, the concept itself isn’t new. Firms used to call this form of community led investing “scouting”. Networked operators writing small exploratory checks in startups under a firm's banner. The money came out the funds coffers through a dedicated vehicle. Scouts were in it for carry sharing, co-investment, and the allure of a track record. The firm is buying an option into a large volume of promising startups upstream from their strategy. Without eating into the firm's management fee. Scouts get the economic upside without risking personal capital and keep their day job. Startups get a larger surface area of investors through domain experts with access to funds.Under the guise of democratization and education, the new “Angel School” model offloads risk entirely onto the new angels. The underlying model is starkly similar. Create a community of people investing in early stage companies. Tech operators, wannabe VCs, your dentist. The firm benefits in a similar way from a higher volume of startups being sourced by these wannabe angels in their Slack group. But there’s an added benefit. Now, these angels are bringing these startups into my CRM on their own dime. Instead of investing out of a dedicated scout fund, they are risking their own capital to benefit my funnel. A fund’s only real cost is managing a community and organizing some educational videos and events. Far cheaper than running a scout fund. But wait a second, potential angel investors WANT this. Why split carry, when I can write my own check and boast paper returns to rival Ron Conway, Jason Calacanis, or Chris Sacca in 18 months. But these returns are a mirage.

Individual public market investors with more “perfect” information rarely beat the stock market. Private markets are worse. Limited information rights, lack of standardized reporting, no governance or mandated access to management team, limited protections against downstream professional investors flooding the business with preference and cramming angels to common to drive their own return, and a decade (or more) of illiquidity. Investors in ZIRP era got accustomed to rapid markups, flimsy governance, and easy to get into ever expanding rounds. Just get into the round if A16z is investing and enjoy the ride. Founders Fund is talking to them? Quick write an angel check fast and expect a quick markup. Angels created from 2020-2022 are in for a rude awakening with markdowns, liquidation preferences, pay-to-plays, and startup shutdowns in the next 2-3 years. The "Angel School" model effectively shields venture firms from risk, setting the stage for a potential wave of failed angel investors who lack the required understanding, support, and risk management facilities. Do these new angels internalize the magnitude of risk they are absorbing? History would suggest that they don't.

Unlike public investments with stringent rules and investor protections, private investors need to fend for themselves. The lack of transparency and oversight can make it easy to get caught up in the hype and overlook the danger of potential financial ruin.I am not a gatekeeper. Tech companies are creating the majority of their value in private markets and then getting dumped on the public through farcical IPOs and SPACs. If it’s legal for people for play the lottery and lose money at the casino, they should have access to private markets (not that they are equivalent). However, offloading risk on retail angel investors under the guise of idealism bothers me. It gives me echoes of the money pit that was equity crowdfunding. Another model that promised democratization, but ultimately led to a selection bias of poor companies that could not raise institutional capital dumping their shares on unsuspecting retail investors.

This isn’t meant to be self-serving. It’s not an intellectual of elevation of professional investors like me. In fact, I was one of those people who thought the way to break into venture was by building a track record. So I worked three jobs and took a big chunk of savings and “invested” it in equity crowdfunding, directly into early stage startups, and syndicates on AngelList. Then proceeded to lose all my money, almost rightfully so. Now having a professional lens on how these returns and exits are generated, it’s clear that the Angel school model, and equity crowdfunding, is not architected to drive returns. It’s a casino for enterprising, well intentioned smart people. The house always wins.