Are Angels Really Stifling Innovation?

November 3 2010 2 Commented

Last week, Tom Foremski  suggested that the angel strategy of commercializing innovations and then rather quickly selling the startups was stifling innovation.  In doing so, Tom referenced Max Levchin’s recent blog in which he suggested that while this strategy makes money for the angels, it tends to discourage building breakthrough companies.  The implication is that early exits to the buyers such as Google, Apple and Cisco limit the full exploitation of such innovations.

We can all provide examples of large companies that have acquired exciting startups to exploit their innovations in only those applications of immediate interest to the acquiring firm, or even shelving the technology to extend life of existing product lines.  This is nothing new. 

What the observations by Mr. Foremski and Mr. Levchin miss are the realities of the marketplace:

  1. Growing startup ventures to full potential in the past required lots of VC money.  But, the venture capital model is troubled, at least based on the inability of many fine firms to raise new funds.  Substantially less venture capital is available for growing high-tech, innovative startups.
  2. Large public high-tech firms acknowledge that they are not particularly good at commercializing new technology and are rapidly acquiring startup companies, rather than expanding R&D capabilities.
  3. And, these same large, public high-tech companies have hoarded boatloads of cash, some of which is earmarked for just such acquisitions.

Angel investors, especially those in angel groups, are skillful at recognizing outstanding innovations and at helping startups stay off the rocks during the early stages of commercialization.  But very few angel groups can provide portfolio companies with more than $2 million for growth.  When startups need more capital, entrepreneurs and their angels have two choices:

  • Attempt to find VCs interested in the business vertical with cash available to invest.  Knowing these VCs will likely want to invest very large sums (>$20 million in many cases), the entrepreneurs and angels realize that taking huge investment also increases the time to exit from perhaps 2-3 years for an angel-only deal to nearly a decade for the traditional VC deal.
  • The alternative is to sell the company to a complementary firm with lots of cash for expansion.

So, the choice for angels and entrepreneurs is one of risk and reward.  Sell the company now for $20 million in a market full of potential buyers or wait 5-10 years looking for a much less likely huge exit with many fewer acquirers willing to pay considerably north of $100 million.

Angel investors in the US continue to fund 10-20,000 seed/startup companies per year, investing about $20 billion in new and existing portfolio companies.  In doing so, angels are contributing significantly to the commercialization of exciting new technologies and are likely to do more of the same in the future.

The realities of markets today may, in some case, be stifling blockbuster innovation via startup companies.  But, those innovations would not be funded at all, were it not for angel investors.  Let’s celebrate the contribution that angel investors bring to the commercialization of innovations and to our economy and not bemoan changes in the market that are beyond our control.

It’s a GREAT time to be an angel.  Find a group and jump in!

2 Responses to “Are Angels Really Stifling Innovation?”

  1. We should never forget that very few entrepreneurs are capable of fully commercializing their innovations. Most do not have the knowledge, experience, networks or often, even the motivation, to do so. Even if they had access to the funds, most would not be able to execute a growth plan beyond a dozen people. Thus providing a robust exit strategy for them is the best way they can be rewarded for their innovations. Angel finance for strategic exits is an excellent way for the entrepreneur to cash up and do more of the same and it is a very attractive investment for the angels. At the same time, the innovation is put into the hands of a corporation which can exploit it, which is far better than it sitting on a shelf being wasted or sitting inside a struggling firm which cannot execute on its potential.

  2. Basil Peters says:

    I agree with Bill and Tom.

    IMO Tom Foremski is missing some fundamental shifts in the economy:

    1. Big companies are not good at innovation – startups are (as Bill states above).

    2. Big companies, and even medium sized ones, often have so much cash it’s a problem. (And with what’s happening to US dollar, sitting on cash is itself a problem.)

    3. Big companies are good at growing businesses from being worth $10, 20 or $30 million to being worth hundreds of millions – as Tom describes above.

    4. Many of the most successful companies are spending more on M&A than R&D.

    5. The way our current economy works best is for entrepreneurs to innovate and for big companies to scale up the businesses (as Tom said).

    I suggest that trying to fight the macro-economic fundamentals is much more likely to prevent the growth of breakthrough companies.