Early stage cleantech investments: Is there an angel vs VC debate?

Had an interesting 3-way discussion/debate last night on twitterstream with @cleantechvc and @ataussig. Both I highly respect as colleagues, and consider them smart investors and thinkers in the cleantech space. The topic revolved around when/where should angels or VCs invest. I have a feeling we agree with each other more than it seemed on twitter. Regardless, it was interesting to have a back and forth conversation limited to 140 characters per statement. How the world has changed!

@cleantechvc has written a blog post on this today and I think you should read it to get a perspective on our conversation. I am writing up some additional thoughts below to share since some of you asked.

I think this whole discussion about angels as somehow pitted against VCs has been totally blown out of proportion. I have a feeling some of it started in the IT sector where some angels may have tried to create a market for themselves by taking an anti-VC stance – and that may be affecting other sectors as well where entrepreneurs are trying to understand when, where, how to approach the right investors for the right dollars.

I personally do not buy into, or want to give much airtime to the angel vs VC debate. It’s a waste of time. Both are investors, both complement each other, and much more often than people might think, collaborate closely together on successful startups. Look at Ron Conways and Desh Deshpandes of the world. (I feel I should add I do know a bit about cleantech angels (despite being a VC with a relatively large fund) because my last startup did, after all, raise more than $20m from angels…and it was a cleantech startup).

Let’s talk about some myths that surround early stage investing:

  • Myth #1: VCs want to shove money into capital intense businesses. When and where this myth originated is unclear to me. I am a young VC and clearly can’t even speak for my firm, let alone all VCs. But I do speak to a lot of VCs and I don’t see anyone complaining they can’t find enough capital intensive deals. VCs look for successful companies, and the metric they use is to find large exits. Hey – if you can bring me back $100m for just $1-5m in investment, you are my favorite person on earth! Come hither…We do seed projects all the time, not because we think they will one day require $50m in investment…but because we think they are disruptive enough in large industries to warrant a high exit valuation.
  • Myth #2: VCs look for 10x, that’s it. While 10x returns is not a bad metric to keep in mind, it is not enough. VCs are also looking to bring back large sums of money back to their fund (regardless of size of fund). As I have said before, I am more interested in building multi hundred million dollar (say, billion dollar) companies, and the least amount of money you take to get there, the better my returns look. But let’s look at the math that @cleantech VC kind of hinted at. He suggests entrepreneurs should not go to VCs if you are looking to raise <$10m. Let’s assume we take that number of $10m itself as the investment amount needed. If investors get to own approximately 50% of your company for $10m, you will still need to build a $200m company to give a 10x return to your investors. If you look at history, it would seem that you as an entrepreneur better be trying to build a $500m company at least to have a chance of hitting a $200m exit 5-8 years down the road.
  • Myth #3. VCs are not interested in service businesses. I have been asked multiple times how I think about service based companies. VCs are open to service based businesses, but they look for reasons why that particular business could scale rapidly and capital efficiently. I am not an expert here but this is the simple math I do. A service based company would probably have a comp of 1x revenue on exit. If that is the case, and you think you can build a $100m service revenue company (e.g. energy efficiency services) in 5 years, you better give me 100% of the company for $10m, or 50% of the company for $5m, to have a shot at getting a 10x return. A tight fit, no? Even in such a case, I am more likely to tell my partners this is deal can more realistically only get us 6-7x return since entrepreneurs are often (as they should be) overly optimistic. Many VCs, including us, would take a serious look at such a business but obviously much would ride on the specifics of the team and situation. This is an example of a company where angels that are very happy with a less risky investment netting them 5x return over 5-7 years would also be a good (perhaps better) fit.
  • Myth #4: Angels are not looking for home runs. Angels are also making financial investments at the end of the day, and while your friends and family might write out a check because they love you, or simply because they want to give you a shot at it, more sophisticated angels and esp those who have a capability of providing you a bit more help in addition to money are also looking for big commercial successes. A 5-10x exit is a 5-10x exit, and angels want such exits (see example above). That said, it is also true that few angels in cleantech believe their startups will only require <$5m to reach exit. It is more likely that they are thinking that with $5m angelish investment they can take the company to a place where they can raise some more growth equity at much higher valuations to prevent significant dilution.
  • Myth #5: Angels are somehow in competition with VCs. Strong angels develop good relationships with other investors (VCs ad other big angels) who they can introduce their CEOs to if and when the situation needs it. My angel investors were regularly in consultation with investors like KPCB, Firelake capital, Rockport capital etc to have them take a look at us in case we thought their money would bring more value to us than our high net worth individuals. When time arose they did make those introductions, and we did not take a VC investment but certainly started a business development deal with one of their portfolio companies.
  • Myth #6: Money is a commodity (so take cheapest money). Well, money can some times be a commodity but an early stage investment should not be that. Good entrepreneurs are also always thinking ahead and planning for what their path could potentially look like a few years out…and managing their investors/BoD expectations along the way. They also try to carefully understand what they need besides money and who can bring that value to them. Such entrepreneurs often talk to angels and VCs simultaneously at the early stages in the company to flush put their thinking, and to develop alliances. Depending on what help they need in terms of business intro’s, key hiring, board mgmt etc, they might try to get an institutional VC signed up even if angels are able to cover their costs. Just to give one example, I have heard often from executives we are trying to recruit into early stage startups that one key factor for them was the fact that the startups were backed by strong investors (not just financially, but also in terms of relevance to the industry). In my startup’s case, we felt in 2003 not many VCs really had a clue how to evaluate us, and not many brought much to the table in terms of intros/BD efforts etc that our esteemed group of sophisticated angels could not. So we stayed with the angel group that included key executives from our industry.

Again, I do not want people to somehow walk away thinking that I am advocating all kinds of entrepreneurs should look for VC funding. Not at all. We did not do so in the company I co-founded. But when you are deciding on (a) who to talk to in your early days to get feedback, and (b) whose money to take if you do have a healthy interest from investors, pay close attention to all the issues you will face as an entrepreneur and don’t get caught up in the hyperbole. All set and done, I want to see passionate entrepreneurs succeed in building businesses that also make them rich along the way. My job at GC is to “look for entrepreneurs who want to change the world and build bigger companies”.

My twitter handle is @bznotes.


2 Responses to Early stage cleantech investments: Is there an angel vs VC debate?

  1. Friend says:

    Thus spake the Mehran Man

  2. Gorazd says:

    Nice article. I completely agree.
    However, maybe the product vs. service base industry is in some clean tech ventres not so different… Especially if services are backed with strong IT and if srevice includes strong IPR protection.
    This situation is close to our case (www.in-wheel.com) and our financial estimates show over 10x opportunity.
    Br, Gorazd

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