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We’ve been witnessing an institutionalizing of angel investing in recent years.  For the most part, it’s good. There continues to be a gap in the market for stage appropriate seed investors, especially in the East Coast.  But it’s interesting to watch some of these funds pursue a predictable path of evolution. 

It’s goes something like this.  An angel investor writes a lot of checks and has some level of success.  It’s amazing how right out of the gate, and individual angel can get into many good deals with a bit of hustle and a willingness to deploy capital in small chunks.  They find themselves coinvestig with many great funds and getting a bunch of write-ups and some small wins.  ”Man, this is easy!”, they think. Those big funds are dinosaurs. I’m in way more interesting deals than many of them.  And I bet I could do even better with more money.

Some LPs agree, and the angel becomes a small VC (aka a super angel).  Maybe managing $7M-$25M. They continue to pursue their strategy of writing many small checks. But they quickly realize that this doesn’t work well. That $50K they have in the next hot company may yield a 20x, but it doesn’t move the needle on the fund. The logical strategy evolution is: “Ok, I must invest more per deal, and I must focus only on companies that have the potential to move the needle in my fund.”

Then, they realize something. Hey, it’s tougher to get into great deals now!  It used to be easy for investors to let me in for $50-$100K.  But now that I’m writing a bigger check, there isn’t enough room because I’m actually eating into another investor’s target ownership.  I need to work harder to encounter companies earlier, and I need to spend more time on each company to develop a reputation of being an excellent, value-added investor. 

To make matters worse, the Super Angel is not in a great position to lead many deals. They quickly realize there is a big difference in tagging along on another investor’s deals and leading one.  There is usually only room for one or two leads, and you usually need to write a meaningfully sized check to do it. 

The super angel also realizes that they need a follow on strategy.  “Guess what, investing heavily into your winners makes a lot of sense” they say. “I knew company X was going to be a winner, I should have put way more capital behind it!” . The funny thing is that this conclusion is made with incomplete data.  The angel only responds to the regret of the good companies that they wish they had invested more in.  They look back and say “it was obvious that this was the winner!”.  But it’s more difficult to know this prospectively than one would think, and the super angel does not have the scar tissue of throwing good money after bad that many VCs have seen happen themselves.

At this point, the portfolio is starting to get pretty hefty.  So the super angel starts thinking of scaling their team. More people means more mouths to feed.

So, here are all the motivators that have arised to raise a bigger fund:

1. Wanting to put more into each deal to make them meaningful

2. Wanting to be able to lead deals and get ball control

3. Wanting to reserve more to invest big in the winners

4. Having more mouths to feed and needing more fees.

So, what happens next? Viola! The next fund is a traditional VC fund with $50M/partner or more. Meanwhile, the VC is annoyed by the new crop of seed investors that somehow keep on getting into good deals with their small checks.

Parting Thoughts:

1. This isn’t immediately obvious, but as an individual angel, there is actually an advantage in terms of deal flow. You can invest at a scale where most investors will let you in, especially if you see an investment early and have a reputation for helping.

2. Institutionalizing is harder than it looks.  There are some terrific firms that have had the opportunity to raise much larger funds but have resisted in order to stick to their strategy.  But this is hard to do and many end up raising larger and larger funds or pursuing new strategies like growth or international expansion. 

3. Super Angels are VC’s. They are governed by the same incentives or anyone else managing money.  And have a tendency to look and behave more like VCs over time, unless they start out with a completely different strategy from the beginning and are very disciplined about sticking with that strategy (ie: Ron Conway, Paul Graham).

I was at a dinner last night with folks from local angel groups and other seed stage investors in Boston.

There were a few jokes about how “this isn’t Angelgate”.  But honestly, no one would ever mistake it for that - the conversation was far too lame. 

To be clear, there were some people at the dinner that I really like and respect. And there was a good discussion about innovating on the financing model for certain types of companies, which I think is a great insight by John Landry. 

But here’s the really SAD thing about this discussion.  Much of the conversation was so DEFENSIVE - e.g.:

“How do we protect ourselves from getting crammed down by VC’s?”

“How do we make money when the potential for blockbuster outcomes are low?”

“How do we invest when it’s so frothy?” (funny enough, it seemed like everyone was more conservative recently, so I don’t know where this so-called frothiness is coming from).

All real concerns - don’t get me wrong.  But here was the disappointing thing: No one was talking about how to fight like hell to get into more of the blockbuster deals that will really matter.  No one was comparing notes on how to build a stronger entrepreneneurial ecosystem or how to be creative about helping their portfolio companies succeed. 

Instead, a lot of time was spent belaboring the point that venture capital is so challenging as an asset class.  The mean return of venture was quoted several times.

Guess what, I don’t care.  We are not an index fund, and our goal is not to be average.  I want to spend time figuring out a way to invest in and help build a disproportionate % of the extraordinary companies.  Instead, I heard a lot more complaining about how to make more money in non-extraordinairy deals.

I see where other investors are coming from… I really do.  And maybe I’m just too young and naive, but I actually think that as a seed investor, I do have the chance to invest in the transformative businesses of tomorrow.  If I didn’t think that, I would be making a lot more money doing something else with my time. 

Luckily, there are some seed stage investors in Boston that do think this way.  Very few were at the dinner, the rest were not.  But it’s a small handful.  If you want to know who they are, I’m happy to talk offline. 

What do Admob, CafePress, Aardvark, Polyvore, and Xoopit have in common?  If you said that they were all backed by great VC’s like Sequoia, August, Benchmark, and Accel, you would be correct.  But did you know that they are also all backed by the same seed stage investor as well?

What these companies all have in common is that they are all portfolio companies of Harrison Metal Capital. With 3 exits in 2009 (Admob, Xoopit, and GeoAPI) Harrison Metal is one of the hottest of an emerging category of investors that some call “Micro VC’s”.  Harrison Metal isn’t alone in their success - there is Maples Investments (SolarWinds, ngmoco, Chegg), Founder Collective (Hunch, 20x200, Milo), and probably another dozen or so firms like these that have emerged over the past 5 years.

What these firms all have in common is a fund strategy and size that is both different from and complimentary to traditional VC’s.  Their investment strategy and sub $50M funds are well suited for the increased capital efficiency of certain sectors and the fact that larger VC’s have difficulty deploying capital in $1M chunks. It’s also a very attractive option for entrepreneurs in that it preserves option value. Mike Maples puts is best:

“Smaller up-front investments create a greater range of exit strategies where everyone wins. For example, if a business raises a small amount of initial capital, then exceeds its early milestones and decides to swing for the fences, it can then raise a larger sum at a higher price, while preserving ownership. If the business is not ready for rapid growth, it preserves the option for an exit at around $50 million, while still delivering a high return for investors.  This dual-track model is less available to companies that raise large amounts of money early.”

It should be noted that most of these fund aren’t shooting for mid-sized wins.  But their size allows them to do quite well with mid-sized wins, and it is well suited for consumer internet investments where it’s often very difficult to predict whether a company has the chance to be big enough to produce “venture returns”.

I think these firms are excellent investments (looking from an LP perspective).  Their strategies fit the times and inefficiencies in the market.  They also do wonders for their local entrepreneurial ecosystems by allowing more companies to get shots on goal and providing the help that sophisticated investors can bring.  They are continuing the work that great angel investment pioneers like Ron Conway who helped (and continues to help) great companies emerge.

As an investor at Spark, which currently invests out of a $360M fund, I am very excited about these guys.  Even though we also do seed stage investments, it’s great to be able to call on sophisticated seed investors that can partner with us and add serious value to companies on hiring, product marketing, and strategy.  These funds also bring a lot of excellent deal flow, and give companies great counsel on how to approach VC’ and how to hit the milestones that matter earlier.  This increases the pool of great companies that we have a chance to invest in and gives us greater leverage on the seed investments that we pursue.

UPDATE: Notch up one more exit for Harrison Metal - Google acquired Aardvark for $50M.

I’ve often heard that there is a shortage of seed-stage investment capital in the Boston area, especially in the consumer realm.  Nabeel Hyatt, founder of Conduit Labs put it pretty succinctly:

“This is in IMHO *the* biggest impediment to a stronger startup culture. There is no ecosystem of consumer angels in Boston, at all.”

There are quite a few large venture firms in our region, but not as many who will a) write a bunch of $50K-$250K checks to help a very early stage company get going or b) can invest in deals that might not have venture scale potential but is still a sound business.  Some venture capital firms are active in this sector, but for a number of reasons, can’t fill the void completely.

I was trying to do some research on this market, and found that it’s actually pretty hard to figure out who could provide angel funding in this town.  So here is a list of the folks that I know are active at this stage (with a bias for my sector of focus).

Professional Seed Investors

These are folks who’s primary goal as a business is to fund seed-stage companies.  This does not include large VC firms (ie: any fund with $’s / investing partner > $30M).

• TechStars Boston
• Founder’s Collective - no website yet.  But investors in a number of early stage companies in New York, Boston, and SF.  It’s run by Eric Paley and David Frankel
• CueBall
• LeadDog Ventures
• Bantam Group
• Launch Capital

It seems that there is clearly a dearth of players in this sector.  The groups above have wildly divergent strategies and typical check sizes.  I think the more groups like this that are successful in the Boston ecosystem, the better.

Angel Networks

These are networks of high net worth individuals that pool their resources and deal flow.  There are often coordinators for the networks, or set events when these angels come together to evaluate opportunities.  A lot of folks have discussed the pro’s and con’s of these networks, so I won’t get into that here.  Xconomy has a nice summary of these groups here.  I’ve heard that quite a few of the members of these angel groups also invest individually.

Individual Angels

If I were raising angel money, I’d try to tap value-added individuals first.  It’s a lot of work, but I think getting someone with relevant experience to commit money and time to your new company is very helpful.  As a venture investor, we love investing with value-added individuals. I also find that companies that have these sorts of individuals involved tend to make better progress before raising an institutional round.  This is an incomplete list, so please add more folks in the comments.  If anyone here would rather not be on this list, please feel free to email me directly at rob at sparkcapital dot com and I will remove you.

• Bill Sahlman - well known HBS professor and angel investor.  I don’t think his list of investments is typically published, so I won’t disclose them. But anyone who has taken his class knows that he has invested with Jeff Parker for years.
• Shikhar Ghosh and Guli Arshad - former entrepreneurs and executives.  Investors in companies like Skyhook Wireless and BzzAgent.
• Dave Balter - CEO of BzzAgent.  Investor in a few companies, also an active advisor to quite a few others.  Involved in Perk Street Financial and I believe Runkeeper.
• Steve Kane - Founder and CEO of 3 successful startups. Investor in companies including Pangea Media and Conduit Labs.
• Andy Payne - Successful entrepreneur and OpenMarket co-founder.  Investor in companies including fansnap and care.com and Shareaholic.
• Dharmesh Shah - CTO and Co-founder of HubSpot.  Investor in companies including Visible Measures and OneForty.
• Brian Shin - CEO of Visible Measures.  Investor in Shareaholic and Hubspot.
• David Cancel - Founder of Compete.  Investor in Shareaholic and involved in a bunch of other companies like Geezeo, Visible Measures, and FlipKey.
• Stephen Kaufer - CEO and founder of Tripadvisor. His personal investments are not widely publicized, but I’ve seen a few companies that he has invested in personally and he is listed as an investor at weddingbook.
• Scott Griffith - I have no idea if he is investing personally, but I know that he has helped companies as an advisor, including runmyerrand which recently received further angel funding.
• Don Dodge - Fomrer Microsoft executive and serial entrepreneur.  His personal investments aren’t that public, but he is an investor in CitySquares.
• Ed Roberts - Chair of MIT Entrepreneurship Center.  Investor in Shareaholic and Visible Measures.
• Bill Warner - Founder of Avid Technologies, investor in Posterous.
• Jean Hammond - Member of a few angel groups and founder of GoldenSeeds. Investor in JAM Technologies and Zipcar.

Anyone else I’m missing?  Please add them in a comment.  And of course, I’m always in the market to hear about early stage investment opportunities and get to know local angels better.