ANGELS IN THE ARENA, part two
In keeping with the theme of my previous post, “Angels in the Arena,” VCs are more like Caesar. Imagine the scene from Gladiator. You’re Russell Crowe and VC is the emperor.
Are you not entertained?
Venture Capitalists work in an entirely different way than angel investors. VCs are running a business and have a far greater level of responsibility for the outcomes of their investments. They raise money from organizations that control massive funds – pension funds, university endowment funds, etc. VCs make promises to these organizations that they have unparalleled knowledge of certain high-growth industries, and that they can make enormous returns by picking which companies to invest in.
This is the main differentiation between VCs and Angels: VCs are not investing their own money, whereas Angels are.
When all is said and done, an Angel doesn’t answer to anyone (except perhaps their spouse!!), which means they could invest in ludicrous ideas without much consequence, aside from losing capital. Venture capitalists are not afforded this luxury, and cannot operate quite so freely. After all, they are servants of the suppliers of funds, and must have defensible reasons for making investment if they ever hope to continue their careers.
This means that external validation factors are extraordinarily important when securing investment from venture capital. Venture Capitalist Anthony Lee of Altos Ventures provides one of the more apt descriptions of how this manifests itself:
“There are essentially three factors that venture capitalists look for when evaluating a deal. The first factor is market size: the market that the entrepreneurs are tackling must be large enough – typically over $1b – to make the risk worthwhile. The second factor is team: the team must be seasoned and have some standout experience in relevant positions under their belts. And the third and final factor is traction: the venture must have achieved a compelling level of adoption and use by real third-party customers or users. At the seed stage, entrepreneurs are expected to have at least two of these three points. If the team is relatively inexperienced, [assuming the market is sufficiently large] the traction is especially important.”
One unfortunate side effect of the reliance on external validation points that I have personally witnessed is the prevalence and engineering of so-called ‘vanity metrics’: metrics which are usually extraordinarily impressive when first encountered, but may not indicate anything about the actual viability of a business opportunity.
In February, I listened to an entrepreneur for a SaaS venture tell a VC how many pageviews his website got without mentioning conversion rate, subscription growth, or anything else that actually confirmed that the business was viable. Pageviews! If that is your go-to traction metric for a SaaS venture, something is definitely wrong. But the traction metric was received positively and the entrepreneur successfully raised a seed round of capital for his venture.
In general, Angels are often necessary at the early stage, and can make great additions to a startup’s team. VCs are important to have on-board as a company matures, since it can be extremely valuable to have an ally who hears everything about what is working and what isn’t in your industry’s more mature players. When it comes time to exit the company, either through acquisition or IPO, VCs can be quite valuable if their network is sufficient to make the critical connections necessary for these events.
At the end of the day, adding value can mean long nights of coding; adding value can mean advisory guidance and introductions; adding value can mean sales and marketing; adding value can be as direct as adding dollars to the company’s bank account as an investor.