When Should a Professional Service Provider Consider Exclusive Service Contracts

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One Less Angel?

I have heard that the best way to get into blogging is to wait until something disturbs you and then write about it.  Well today I am disturbed about something I have seen recently in the world of angel investing that may end it for me.

I started angel investing almost two years ago by joining a local angel investor group.  My goal was to make money, of course, but I realized that first I had to learn more about the current state of the startup world, both locally and worldwide.  I knew that I could take two paths; one would be to sit back, be cautious, learn as much as I could and then selectively and carefully invest in some ‘sure things’.  Of course if we could tell which ones were the ‘sure things’ then it would be a piece of cake!  I took another, more aggressive approach, which was to pay my dues (literally) and learn by doing.  I have certainly learned a lot, and continue to learn.  The main thing I have learned is something my friend Jason told me, which was “Until you have an exit, angel investing is essentially a charitable contribution”.

At the same time, whether you believe we are in a bubble or not, it seems to me that startup entrepreneurs have now been conditioned that Step 2 in having a successful startup (Step 1 being think up a snappy name that ends in ‘ly’) is to raise a lot of money from angel investors.  Many of these entrepreneurs do not understand or care about the equation from the angel’s side, that even ‘sure thing’ investments are quite likely to fail.  Angel investing necessitates a high risk tolerance but insanity should not be a requirement.  In any event, I strongly feel that angel investors and startup entrepreneurs can and should coexist in a fair and mutually beneficial relationship.

This brings me to what has been bothering me.  I recently found out about a new startup, FundersClub (https://fundersclub.com/) that in preparation for the expected crowdfunding gold rush is enabling angel investors to invest in select deals at a much lower investment size (ex. $1-2.5K vs. typically 10-20x that amount).  My understanding is that they aggregate up to 95 or so smaller investments into one combined LLC investment.  If the minimum total is not met, the overall investment doesn’t close, a la Kickstarter.  

Initially I thought this was a good idea, and it may very well be a great idea (for startups) in the end.  It will enable non-accredited investors to crowdfund (at this time it is limited to accredited investors), and facilitate all investors to diversify their holdings more easily than they could at higher minimum investments.  The thing the is bothering me is that I noticed that the first 5 deals on the site all have the same terms, which in my opinion are terrible from the investor’s point of view.

In short, they all are raising on an uncapped, undiscounted convertible note.  I have seen arguments from both sides for and against convertible notes, and I personally feel they can be a good and fair way to structure seed stage investments.  The problem from my perspective is that in this case, the convertible notes are uncapped and undiscounted.  The entrepreneurs (and by extension the site) are offering investors to be allowed to invest in a note which will convert at the time and price of the next priced round, whenever that may be.  As an investor, aside from the fact that an uncapped note puts me at odds with the entrepreneur in terms of valuing the next round, the problem is that now I am risking my hard earned money much earlier than the investors in the next priced round (which may be more than a year off) with no corresponding reward.  I have thought about this a lot over the past few days and have come to the conclusion that this makes no sense.   

I can only view this new approach as one sign that angel investing may have ‘jumped the shark’.  Another possibility is that the upcoming crowdfunding boom is expected to bring a lot more suckers to the table, pushing traditional accredited angel investors aside.  I have been told that the terms on the site are the same as those being offered to and accepted by (presumably larger) investors not using the site, which is actually more troubling to me.  I have invested in a few convertible notes over the past year and have not seen any terms like this (yet?), although I have been assured that these terms are considered by some to be ‘standard’.  All I know is if this is indeed the direction of early stage angel investing, there will be one less angel around in the future.  What do you think?