Techpreneurship: Funding Food Chain

Jeff Amerine

Techpreneurship, with Jeff Amerine

(Jeff Amerine is an IA advisor, entrepreneurship educator, and officer with the University of Arkansas Technology Licensing Office. Each Thursday, his Techpreneurship blog will appear in INOV8. Drop him a line in comments.)

Venture-capital firms investing in angel funds? What?  Who’d have ever thunk it?

Historically, VCs have not always had the best working relationship or opinion of angels and angel funds.  In many cases, VCs worried that less sophisticated angels and angel funds would foul up the corporate-capital structure thus making later finance rounds more difficult or impossible.  It seems those worries are in the rear-view mirror, at least in Silicon Valley.

All trends in early-stage finance seem to begin in Silicon Valley.  Tomio Geron of the Wall Street Journal reported:

Silicon Valley venture capitalists often invest in the youngest startups. But now some venture-capital firms are partly outsourcing that investing to others. Venture-capital firms such as Norwest Venture Partners and Sutter Hill Ventures have been putting some of their money into funds run by “super angel” investors. Super angels, a growing class in Silicon Valley who invest their own dollars but also have raised money from others, typically put cash into the smallest startups at their earliest stages, a strategy known as seed investing.

The new approach comes as the fund sizes of some venture firms grow ever bigger. Many venture firms now have funds sized at more than $400 million. Some tend to invest $10 million or more in a start-up at any single time. That makes them less able to efficiently invest small slugs of money of several hundred thousand dollars or less, which is generally all that is needed by most nascent start-ups.

As a result, the experience of super angel Chris Sacca, a former Google Inc. executive who now runs investing firm Lowercase Capital, is increasingly typical. In June, Mr. Sacca raised $8.5 million from venture-capital firms and others for a fund to invest in the earliest-stage start-ups, particularly in the Web arena.  Venture-capital firms investing in angel funds “allows them to be more plugged into the seed community,” says Mr. Sacca.

The trend of venture capitalists offloading their seed-stage investing has gathered steam over the past few years.   And in May, prominent venture-capital firm Sequoia Capital disclosed it invested in incubator Y Combinator’s roughly $8 million seed fund. Aside from the potential financial gain, Sequoia wanted to support new entrepreneurs through its Y Combinator investment, said Y Combinator partner Paul Graham.

By putting their money into angel funds, venture firms get valuable business intelligence into the newest technology trends, says Mr. Ravikant. “Whatever’s hot in venture capital is hot in the seed community a year or two before,” he says.

So here’s my view.  The VCs are using experienced angels and angel funds as a means of risk sharing on pre-seed and seed-stage deals that would otherwise be too early for them to consider.  Smart strategy?  I think so.

This approach will help close the early funding gaps while at the same time providing access for later stage VC funding.  The law of large numbers is in play. VCs are placing a bunch of really small bets via angel proxies with the knowledge that some of them will hit, and when they do the VCs will already know the management teams and will have a leg-up for later rounds.

Will this approach spread to the “fly-over” states like Arkansas?  I suspect we have more ground to cover before the trend hits here.  To make that happen in Arkansas, we will need a few more really successful techpreneurs, who can become “super angels,” and a few more angel funds with winning track records.

Stay tuned, the funding food chain appears to be getting very interesting….again.

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