How to Predict an Angel Group’s Outcomes
VC firms won’t disappear. Angel groups still might.
I am on a lot of pitch event email lists. One I recently received contained the following message about how founders can be successful with their raises:
The difference wasn’t the science or the spreadsheet.
It was how they told the story.
I have seen this message rehashed for many years. Advisory voices continuously offer it up to a persistently renewing pool of founders, most of whom still fail to raise capital. There are even consultants for-hire, with communications and creative writing backgrounds, who sell story-crafting as a service to founders.
Does it feel like I’m going to now tear the advice apart? I’m not. I’m going to put it in its place (chronologically).
There is a very old concept in salesmanship that we can all relate to. Would you rather sell a product that needs to talk its way through the customer’s door, or a product that “sells itself”? A startup likely to succeed, with solution-market fit as I last wrote about, an experienced team, and other advantages is rather easy to construct a story around. If the CEO struggles with pitching a value proposition that already sells itself, the solution isn’t to recraft the story, it’s to replace the one telling it.
But the vast majority of startups who aren’t likely to deliver ROI to investors do, indeed, find it challenging to tell a compelling story. Sadly, they miss this signal to scrap their value proposition and start over. But I wonder, when advised to get better at storytelling to raise capital, do founders walk away grateful for the advice? How many advisors can offer practical suggestions for how to improve the story when doing so, without straying into dishonesty, depends on the quality of the underlying value proposition as it actually exists?
I have witnessed a CEO flub a pitch for a pretty solid value proposition, occassionally. I regularly witness inherently, structurally, hopelessly doomed startups (when one is looking at quality signals) raise money from my angel peers due to a masterful pitch. Not only does the pitch artist tell a motivating story, such are adept at knowing what information to include, what not to disclose, and don’t stray into direct dishonesty.
I may not love the fact that failure to disclose risks is not considered unethical behavior in our activity. The excuse is that America has operated on the legal principle let the buyer beware. In our activity, that means it’s the job of the investor to uncover what the startup fails to disclose. But due diligence is a different topic.
Should great storytelling be a part of a startup pitch? Of course it should. But that should never be what opens doors or closes deals, pretending it to be a primary measure of startup success. Rather, it should be the last step of the vehicle assembly, the clear coat on the exterior paint that adds a bit of shine to an already exciting machine.
So, consider storytelling put in its place, chronologically.
Yet, this is all preamble to the title of this article.
What most troubles me is the reaction I get whenever I appeal to those who lead audiences of founders and angel investors with messages like the one quoted above. See, whenever they lead with these messages, they usually cannot help but press down aspects of fundamental analysis (“due diligence”) in order to raise the priority on their replacement advice. Above, the author essentially said that the quality of the underlying value proposition is NOT what matters, it’s how one tells an emotive story about solving a theoretical problem.
Is such careless advice consciously intended? I generally don’t believe so. Advisors care, usually quite a lot, about their ecosystem constituents. Rather than carelessness, I think it is cluelessness – being unattuned to fully appreciate the damage their mis-prioritized advice is doing. We must unpack this, because when mis-prioritized advice is regularly proliferated with good intentions, why needs to be understood in order to untangle ourselves from parroting it. (To be careful and specific, advising better storytelling is not the problem. The problem is elevating it above validating the value proposition, which critically involves analysis of problem and solution approach (science) and multiple dimensions of customer behavior and market data.)
What’s really going on? I say over and again in many circles: follow the money. Whenever anyone offers advice to a general audience among us, it is always useful to consider how the advisor gets paid in order to consider potential bias. There are many voices coming from all directions who speak into our ecosystem who are not investors with their own money. These get paid wages as workers in, or fees for services rendered to, founders and investors. Does this impact their judgement and advice? It would be naïve to think otherwise.
It gets even more cloudy when we consider some of those voices who are both investors and workers pursuing earned income and investment income simultaneously. There, we must ask where the majority of their income is derived, and how soon.
This does not mean that, categorically, advice from non-investors and also-investors cannot be trusted. It would be irresponsible to conclude this. Rather, it is to understand the context of advice offered and compare it with wisdom that agrees or disagrees with the core mission of startup investing. What is the broad spectrum view we should consider here?
VC Firms get paid for performance. If their investments do not consistently return substantially more capital than that invested, those firms stop being able to raise new funds and die. Almost any new LP to a VC fund asks for and receives track record data about the fund and/or the management.
But I have watched angel networks persist beyond 25 years without returning >1X net capital invested by the network and most of its members. They always seem to be able to find new investors (often new to being investors) to replace the ones that they disillusion and churn. Angel groups seemingly don’t need to prove track records with ROI. They usually don’t offer a comprehensive review of actual realized results in their own storied membership presentation slides. When asked, they highlight their best exits, but no angel group leads with comprehensive whole-portfolio (every investor, every investment) performance. They don’t even track and have the data to be able to. (But their hook remains – experienced operators sense they know what the data would say if they had it – and it isn’t good.)
Ironically, we could easily conclude that perhaps angel networks need to pay more workers with earned income for investment performance to improve this condition, but then they would simply become VC firms. Instead, our forebears thought it good to carve out certain SEC exemptions and create a capital layer willing to invest at an earlier stage and take more risk, theoretically generating higher investment returns.
What was clearly not foreseen is how many angel groups, accelerators and other seed-stage ecosystem contributors this exempted framework would inspire to build a system that rewards transaction volume ahead of investment returns. As a regulatory matter, by not permitting anyone to get paid based on investment selection, we essentially remove the logically critical mechanism that keeps everyone focused on investment outcomes. VC GPs must invest well to keep operating. Not so for angel networks. Unfortunately, the exemption regulation does not address or impede finding other ways for actors in the system to be paid, so many actors have flooded into the system to be paid in all kinds of ways that have little or nothing to do with investment returns.
By this, many people, investors and especially non-investors, have carved out salaried jobs to run angel networks and accelerators. They get paid to maintain meeting cadence and volume of presentations, uncorrelated with investment quality. Many more have created consultancies in law, accounting, finance, entrepreneurial education, software tools & systems management, and more to sell services to founders and investors that revolve around fundraising activity, not ultimately concerned with investment outcomes. Successful raising, not successful exits, generates the cash flow that pays for all this work. This has extended further to angel networks being riddled with “members” who are not there to build high-quality investment portfolios, but for any other reason. Adding insult, some active founders join angel networks to find an advantage to getting invested in, not invest in other startups. We can give some grace to members who do have an active investment history that decide to jump back into founding or managing a startup – the order of operations matters here.
Taking all this into account, it is no wonder messages like I quoted above get sold and bought, over and over. It’s the activity that counts, not exits (not really no matter how much lip service goes to hoping for exits).
And to my theme, it also explains why appealing to the authors of these messages sounds grating, falls on deaf ears, gets met with resistance and pushback, and erodes relationships with serious, intentional angel investors. Asking the advisors to reconsider what they are really saying, somewhere deeply in themselves, feels like a threat to their livelihood and their freedom to pursue it. They would ask” ‘who do any left among us, being discerning investors, think we are? “Purists”?’ (Connoted negatively)
It’s comical, a purist seems usually to be someone accused of returning to a core mission and reason for existing, especially when it has become watered down and polluted. But there is no end to the moralization that those carrying the dirty water can pour on whoever may be trying to right a leaky and listing ship. Stand in the way of someone’s right to tax an activity and prepare for a duel.
The VC industry (professional firms and fund management) are essentially, properly structured. Get paid for achieving the goal. Fees up front for access, facilitation and communications, back-end carried interest that motivates choosing investments that return profits. The angel industry? It is not well-ordered at all. It is filled with activity but broadly, persistently dissatisfied with actual investment returns. This is because it was unwittingly set up to fail, being self-defined and built by so many who can make money in it without investor returns.
Thus, my tag line. VCs aren’t going anywhere, even when they suffer periodical cycles where they don’t seem to be going anywhere, if you catch my drift. Funds fail and churn, but the investors don’t – they migrate to better managers.
What about angel networks? They churn members constantly (who leave the activity permanently). Thus, group and network survival depends upon new investors continuously being found who don’t know what’s actually going on, willing to hear and believe a good story about how great membership is and all the ancillary benefits. Just don’t ask about ROI.
And, as soon as that novice investor’s membership begins, he or she can start enjoying messages about how founders can tell them better stories, getting them excited about writing checks to help them close their raises (and keep all the promoters and rent collectors employed) – exits be damned. Rinse. Recycle. Repeat.
If, as a prospective and expectant investor, you see a lot from an angel network that points to investing in and closing rounds, and little about pursuit of regular exits and return of capital, you are almost guaranteed to be disappointed by your long-term results. Investment success among these angel portfolios, quite literally, relies upon blind luck. Indeed, you may meet a few long-running investor-members of that network who already know it’s just highbrow gambling, and they like it that way. That’s why it’s fun (to them), and there is nothing to fix. They already have enough money to burn.
Ahead of further discussion and debate, I do believe that for angel investing to survive for future generations, reform is sorely needed that returns significant accountability to the original mission of all financial investing by definition – positive ROI.
There is room for many people providing all manner of advisory and management services. But, they need to be the add-ons to a healthy functioning system, not the owners of a system functioning primarily for their health. If that means that transaction volume might come down to improve quality and there is not room for as many of them, this is not somehow inherently wrong. It is healthy and normal when unbalanced markets get right-sized as a function of free market economics. That won’t prevent ones being displaced from getting angry about it. Their ire can’t be the deciding factor.
The only individuals who should be holding the conversation and making decisions, as policy, regarding how capital gets deployed are committed, long-term, portfolio-building investors. The primary voice that investors should listen to for feedback is founders and the primary voice founders should listen to for feedback is investors. This is not somehow unfair exclusion of all others. It is the only way to maintain mission focus and an efficient operational cadence so that everyone involved can enjoy a sustainable ecosystem, feeding anyone who actually contributes to efficiency and mission results.
Related Post (learn more): Capital Raised vs. Wealth Created | Startup Ecosystem™