Crowdfunding for start-ups: A durable trend or a bull market phenomenon?

Angel investing is red hot as is the concept of crowdfunding start up investment. Part of this phenomenon has been driven by the emergence of AngelList, the brainchild of Naval Ravikant. What started out as a way for a curated set of angels to invest in startups posting on the AngelList site has expanded to include the notion of Syndicates, investor groups headed by prominent angels who deploy capital pledged by themselves and others in a manner akin to a GP/LP construct. Syndicates have been thought by some to be directly competitive with venture capitalists, initially Micro VCs but then perhaps larger venture firms down the line. While Naval has consistently said that this isn’t his intention, it hasn’t stopped others from speculating about the end game for Syndicates.

A recent article in Fortune Magazine got me thinking about the compare/contrast between professionally-led angel syndicates (such as those on AngelList) seed stage venture firms such as IA Ventures.

While we invest in partnership with angels in virtually every seed stage company we work with, we are generally the largest investor and lead the round. We also frequently lead seed-extension rounds to support angel and Friends-and-Family financed companies, which need extra runway to hit key operating metrics and business milestones that will enable them to raise strong Series A rounds. This is the bread-and-butter of how we generally initiate our relationship with founders and their companies. When we invest in a company, we reserve multiples of our initial invested capital for follow on investment. In our experience, these reserve multiples can end up being 3-10x of our initial investment over 3-4 rounds of financing, before the expected cash-on-cash return of the later rounds fail to meet our growth criteria (as we are constantly asking ourselves: “Is the probability-weighted return of this investment greater than or less than investing in a new seed stage company?”).

If there is one thing I’ve learned in my 10+ years as a seed stage investor, it’s that plans seldom unfold as expected. This is why: (a) we seek to finance companies adequately from the outset in order to give them a chance to prove or disprove their early hypotheses; and (b) reserve significant additional funds should they be executing well but need more time to hit key Series A metrics and milestones, or the macroeconomic environment becomes hostile and external fundraising is a poor or non-existent option. Having the resources available to support companies during hard times can be the difference between a good company hitting the wall or hunkering down, continuing to build, surviving the downdraft and emerging stronger than ever (and particularly stronger than their less well-financed – and now dead – competitors). It is this dynamic that makes me wonder about the current heat around crowdfunding, and if it can survive a cyclical downturn in venture investment.

If Syndicates exist to push more angel dollars into the early stage ecosystem, that is fine. But it should be done with a cautionary note: unless Syndicates develop the ability to support companies when there isn’t an institutional investor standing by if times get bad, they aren’t likely to endure. The composition of Syndicates – angels – are generally the first to tamp down risk tolerance because their main source of making money is imperiled and their angel portfolio isn’t likely to generate meaningful returns any time soon. So really the behavior of Syndicates aligns closely with the behavior of their constituents, angel investors. This is precisely why I believe Naval is right: Syndicates aren’t truly competitive to venture firms in that they lack the reserve mechanism and the ability to extend time horizon. But they do provide access to successful and experienced angel investors, and this is a good thing.