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The Changing Nature of Angel Investing

Evan Burfield

Cofounder & CEO, 1776

When I raised my first angel capital in 1996, I was 19 years old with no professional experience. I walked into the office of a government contractor with a pitch deck and a vision for a product. I had a rudimentary mockup of my product that allowed you to click and drag-and-drop. I walked out with $1 million.

A scenario like that was rare in 1996 but it’s damn near impossible today. If you live and breathe startups, it’s obvious how difficult it has become to raise money on an idea without validation.

Now it’s beginning to impact investing models as well. While venture capitalists still pump tens of millions of dollars (or more) into companies to drive growth, VCs almost never write checks into startups without strong validation that their business models will scale. As a result, the job of funding seed-stage startups has fallen to a widening spectrum of angels, super angels and seed funds.

The new angel investing spectrum

I find it useful to think of angel capitals along a spectrum of evolution.

“Country club” angels sit at the traditional end of the spectrum. These angels often made their money as founders or executives of non-disruptive businesses—or as dentists or accountants—but are excited at the opportunity to invest in a “home-run” startup in which they can personally make an impact. They might make one or two investments per year, often writing checks of more than $100,000. Back in the mid-90s, angel investors were country club angels, who still exist in every major city around the world. They continue to represent significant amounts of capital and often have deep connections into traditional industries.

Now, though, digital angels form a new cohort of investors. Digital angels usually made their money as founders or VCs with high-growth startups, namely ones that made heavy use of the Internet. They understand the significant uncertainty inherent in high-growth startups and prefer to build diversified portfolios that give them many “swings of the bat.” Even many dentists, accountants or lobbyists are learning how invest as digital angels and forgetting about the country club. They’ll probably start by writing you a check for a lot less than $100,000, and only after you’ve proved your “traction.”

Your idea has never been less interesting

Today, traction—the data that validate your hypotheses—is what matters, because money follows traction around the world. Traction demonstrates that your idea has real potential—and that your team can execute it.

For many startups, traction and revenue will be nearly synonymous; few angels will dismiss meaningful and growing revenue. In other cases, though, traction might mean letters of intent from enterprise customer or weekly active users or number of transactions. As a result, having a promising product, built by a credible team, around a strong vision is table stakes for having a conversation with a digital angel.

The only catch? Sophisticated digital angels almost certainly have heard of your idea already, even if you haven’t pitched it to them. After all, if shifting technology and industry trends make an idea obvious to you, then the same idea is almost certainly obvious to other people around the world. At the same time, the barriers to building products around those ideas are getting lower and lower for all the same reasons. It’s now easy for a sophistical digital angel to scan through deal flow to see who else is pursuing a similar concept.

Transparency is pervasive

From AngelList and LinkedIn to tools such as TrackMaven, Compete or Alexa, an angel can quickly learn an incredible amount about your startup, your competitors, your network, and your traction. AngelList has done for deal flow what Facebook did for keeping up with your friends. The site has transformed deal flow from an activity requiring active intention into one where you can sit back and let it cash come to you. Similarly, the availability of data to inform deal selection has also exploded in the past few years.

At the same time, deal terms and documentation essentially have been open sourced. Coalescing around a set of terms and documents that are fair and reasonable reduces everyone’s transaction costs and improves fundraising efficiency. Unfortunately, this also makes it very hard to raise capital on non-standard terms. If you’re raising capital, make sure you’re familiar with standard deal terms.

What it takes to win

With that said, there are also some standard rules of thumb that can help you move forward with raising capital outside of family and friends.

  • Product. You need a product that solves a clear, compelling problem for a well-understood target customer. If you can’t explain the customer, their pain, and your solution in a few simple sentences, then you’re not ready.
  • Capital Efficiency. You need to show through your prior actions and forward plans that you can build an operational business for a reasonable amount of capital. If you’re a consumer-facing mobile or web app, then that’s probably well less than $1 million. If you’re selling to enterprises in a complex industry, it may be a bit more, but probably not.
  • Revenue Model. You need to be able to explain how you’re going to make money. The more your thesis is validated by actually making some money, the better. Ad revenue is a much worse answer than license fees, subscription fees, or transaction fees.
  • Distribution. You need to explain how you reach your target customer in a way that makes economic sense given your revenue model. The more complex the industry—such as education, health, energy, or cities—the more evidence you need that you have the juice to access the market.
  • Team. You need a team with the key skills necessary for success but no more. If you’re at the seed stage, then you don’t need a chief financial officer. You need key functional skills. If you’re operating within a complex industry, then you also need domain expertise. If you’re planning to create a device and app for measuring insulin levels in diabetics, then someone on your founding team needs to know a lot about insulin and diabetes.

Before you start raising capital, though, make sure you’ve done your homework. You have access to many of the same tools as angel investors. Use them.

After all, today’s game of raising angel capital is relative one: it’s always better for you to know your competitive set and what’s happening in the market better than the people to whom you’re pitching. It’s important to show that your startup can make money and scale, but also that it can do it better than other startups in the same space competing for capital.

Evan Burfield is the cofounder of 1776.

Evan Burfield

Cofounder & CEO, 1776

Evan Burfield is an entrepreneur, investor, successful author and regulatory hacker. He is the founder of four companies including 1776 and has helped build startup ecosystems on six continents (and…