Stepping Back From The Angel Bubble

[ Photo courtesy of Fir0002/Flagstaffotos via Creative Commons License ]By Jason Calacanis

Everyone is talking about the startup bubble popping today thanks to a Wall Street Journal story that Fred Wilson responded to. You can read about all this on the awesome Techmeme aggregator here:  

No one can call a top to the market, but VC Mark Suster did last year, and I was right there with them letting folks know that I'm taking a "pause" on angel investing right now.

Why am I taking a pause and what do I think of this market?

A couple of reasons, and some related observations:

1. Decreasing dealflow: I'm not really on a pause, I've done a couple of deals, but I simply have too much deal flow. I've put a public pause out there to try and slow down the crush of inbound traffic. I know, that's a crazy #humblebrag, but it's true. The massive success of AngelList in aggregating these deals has decimated me. I'm the number four user on the system with around 4K connections last time I checked. Every day I get five to ten deals sent to me. That's 200-300 a month and that's only half my inbound. And I'm a part-time angel. The quality of the pitches is typically very good. In fact, it's as good as many of the angel deals I've already done. These are not bad companies -- they're great in many cases!  

2. AngelList is the big story: The most important startup I want to invest in isn't taking investors: AngelList. Angellist is a social network site right now and can't actually raise funds on behalf f companies. There is a Federal Law based on scams that occurred in the early part of the last century that prevents the offering of shares to the public. (your great grandmother may have lost her money in a gold mine in California so  you can't invest in the next Facebook!). When Congress lets AngelList do crowdfunding like Kickstarter does -- and Congress will pass this legislation, which Obama will sign -- AngelList is going to explode with activity.

SecondMarket and AngelList are taking over the entire funding process. Kickstarter will move into the startup space when Obama green lights an "up to $5M" in crowdfunding exemption early next year. In five years, most startups will raise 100% of their capital from these three services. We will even see a couple of startups go from formation to exit -- perhaps even IPO -- without ever going to a VC's office.

3. Passing on a deal creates more work: When you pass on a deal after meeting with someone, it actually creates as much, and typically, more work than investing! These entrepreneurs are taking my advice (from my podcast "This Week in Startups") of being relentless, and Mark Suster's advice on connecting the dots. That means my "no" is a challenge to send me a dozen emails after every minor victory. I love the entrepreneurial spirit, and I read the emails. Sometimes they do pull me in. But I've realized I can't run, and AND be an active angel. Angel investing is on the back burner for me for this reason and valuations.

4. Valuations are stupid: Angel investing has been a sucker's game for over a year. Angel deals should be at a $1M to $3M valuation and should be for $500 to $750K in my mind. Enough to work for six to 12 months. The deals being called angel deals now are $8M to $15M valuations (or uncapped notes with a 20% discount, which I won't do) and raises of $1.5M to $2M. That's really an A-Round in disguise. If you're looking to deploy $500K to $1M as an angel in 10 to 20 companies you will lose money at those valuations. You simply can't win if you invest at these valuations -- the math does not work. It's broken for angel investors.

5. Advisor over angel: Since there are so many folks willing to overpay, and founders don't care about my money but really just want to have me on their team, I've started taking advisor positions. It turns out I can be just as effective being listed as an advisor on AngelList and circulating deals. That being said, I'm turning down 19 out of 20 advisor offers because I'm taking those deals as serious as ones where I invest cash. I don't want to be known as someone who just takes equity in companies and doesn't help the founders (i.e., doesn't earn it). I typically take a point over two for three years of service. The founders can fire me if I suck, or I can quit if I don't think I'm being helpful enough. So far it's been a nice process.

6. Angels are running out of cash: As Fred Wilson points out ( ), angels typically move from excited when doing deals to depressed and worried when their investments start flaming out. Investing is absurdly hard work and all angels -- including myself -- underestimate how much work it is. If I could do it over again, I would have only done 10 or 15 deals, not 25. The only way I could keep up this pace is to raise a fund like all my friends are doing, but if all your friends are moving into investing, that means it's time to start companies.

7. SuperAngel/MiniVCs: These mini-VC funds (the $10M to $20M ones) are going to have a lot of pain in the future I believe. They will deploy $10M across 50 to 75 companies over two or three years, creating 10 years of hard work to clean up a huge mess of deals. If every company needs a couple of hours a month, well, you're crushed. Unless you just "spray and pray" and tell your investments to "stop emailing you," I don't see how these $10M funds go on to fund number two.

We don't know how the super-angel space is going to play out, but I think it could collapse on itself because you don't have enough staff to service all your investments. Maybe founders will be okay with just getting a big-name super angel on their investor list and not expect any more work from them?  However, as a founder, I've gotten the most value out of the hard-working VC firm that calls and emails me every week and shows up for every board meeting an hour early and stays an hour late. In my next companies, I'm only taking a small number of *active* investors (like Sequoia Capital has been).

8. Money vs. attention: Money is free right now, so attention from qualified investors is a scarce resource. I've held off on doing another round for Mahalo because we don't need the money and I would only take it from someone whom I've seen firsthand do a LOT of work for their startups (think of the effort Fred Wilson puts in, or Chamath Palihapitiya, Bill Gurley, the Spark Capital guys, True Ventures, Jim Breyer, etc).

After three startups, I can tell you the most important thing is not the money raised, it's who you get it from. This means the "spray and pray" crowd are just glorified golden stars for you to put on your next deck. Not a bad thing, but not a great thing. They're not going to put a lot of time into your company -- especially when you're down and need them. What's been great about working with Sequoia, as an example, is that when we got our asses kicked by the Google Panda update this year, our partner Roelof Botha doubled his engagement with the management team. Many investors might walk and focus on their startups that are winning at the time. You gotta respect the folks who do actual work and who don't have to. There are too many folks who don't have to do the work because of their name recognition, and who don't really put the time into their portfolio from what startups have been telling me.

9. There is an investing bubble, yes: Valuations are 50% to double what they should be up and down the funding spectrum. However, the market is so fluid now that you can build a company with $25M in revenue in two years -- that's crazy. The amount of money available is going down, so at some point this has to level out. I do believe that many startups will not be able to raise their next round because their angels are tapped out and the VCs realize they are startup zombies: not dead, but not really alive. That's a good thing, we need to prune the garden.

10. There is a startup bubble: There are simply too many companies going after the same space. Back in the web 1.0 days, the 20 copy cats flamed out with Today there are probably 200+ funded Groupon and Living Social clones, and I suspect we'll see something similar: wholesale collapsing of certain verticals with either one or two winners.

11. Consolidation time: Someone should create an investment firm that merges complimentary startups into something venture worthy. They should also start merging things that already have venture capital to make things really strong. and Klout should be the same company, and there are five music-instruction companies and 10 kid-focused iPad app companies I've seen this month. Putting two or three of these teams together might create a lasting company.

12. Air-letting is good: The air being let out of the bubble right now, and the frustration folks will have with the startups they're vested in, will create increased focus on current companies. That's great for everyone.

Actually, that just reminded me that I haven't heard from a couple of my angel investments in a while -- time for me to send a "How is it going/how can I help?" email.


PS - My iPad event is next Friday. A dozen tickets are left, please support the event and buy one here:

PPS - I'm doing a similar LAUNCH Social event on November 29. I'm looking for 25 startups doing awesome stuff to show their work and share their knowledge. Email me a screen shot, video or URL in confidence to if you're doing something rad and I will look at it (don't send a business plan!).

PPPS - Mahalo's first iPad App, Learn Guitar, is rocking it. I'm looking to do an educational iPad learning app with someone really, really high profile with a huge following (think Oprah, Ellen, Tarantino, Clinton, etc). Anyone know someone really, really high profile who would want to build an educational app to share their knowledge? Could be for charity or profit, but it has to be educational in nature (like "how to cook vegan" or "how to avoid a heart attack" or "how to direct a short film").

Wall Street Journal article: Web Start-Ups Hit Cash Crunch 

Fred Wilson's response: What We Are Seeing 

On Techmeme: