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02/03/2010

Don't Take Angel Investments From VCs

The guys over at Venturehacks have come up with an excellent idea to create a curated list of tech-focused angel investors.  While I fully support the project, I did notice that the list of “angels” includes a number of GPs at traditional Venture Capital firms.  I know many of the GPs and they are all great people and great investors, but this situation reminded me of one of my critical fundraising rules for entreprenuers:  Don’t take angel investments from VCs. 

Why not? you ask.  Well let me tell you a story to illustrate the point:

I once knew an entreprenuer who took a small angel investment from a well known VC firm.  Things went well and the entreprenuer went out to raise to raise a formal Series A.  The VC that invested in the angel round tried to the pre-empt the Series A fundraising with a low-ball term sheet, but the entrepreneur thought he could do better and politely told them “thanks, but i’d like to test the market”.  The response of the VC was swift and furious. For all intents and purposes, they basically told the entrepreneur that he had better take their low-ball offer because if he didn’t they wouldn’t invest and if they didn’t invest he basically had zero chance of raising money because every other VC that looked at the deal would assume that the reason the angel VC wasn’t investing was because there was something wrong with the company.  The entreprenuer, to their everlasting credit, stood up to the VCs’ blackmail tactics and eventually raised a Series A, but not after the Angel VC withdrew their EIR (who had been serving as an advisor) and then invested in a competitor and installed the EIR (with all his inside information) as COO.  I kid you not.  True story.

Now this is an admittedly an extreme example of the perils of taking angel money from a VC, but the basic lesson holds:  If you take money from a VC in your angel round, at a minimum you expose yourself to the huge risk that the VC will not want to invest in the Series A which will make raising your Series A much, much harder.  Also, having a VC in your angel round can scare off other investors who will assume the VC has the inside track to lead the round and therefore will not bother doing any work.  Thus, if at all possible I reccomend leaving VCs out of your angel round, even if they are just making a personal investment.  That said there are a few “super angel” VC firm’s, such as Angel Investors, Softtech, etc. that are OK to take angel money from because it’s well understood in the VC community that angel investing is their primary focus and thus there are no expectations that they will lead Series A rounds.

Now I’m sure there are plenty of examples where a VC invested in an angel round and everything worked out fine, but from the entreprenuer’s perspective why take the risk unless you absolutely have to (i.e. no one else will give you angel money).   If you have taken angel money from a VC or individual partner, by all means don’t advertise the fact to potential Series A leads.

I am going to suggest to Nivi at Venture Hacks that they divide the list into Angels and early stage VCs or something like that such that people at least known which side of fence the different investors are on.

Update:  One other reason not to take angel money from VCs which was pointed out by Healy Jones in the comments I think is worth highlighting.  If you take angel money from a VC, any new VC looking at doing your Series A round will be sorely tempted to contact the angel round VC and try to collude to keep the valuation down.  This has actually happened to me before and I think it's yet another good reason to steer clear of VC firms in your angel round if you can help it.

February 3, 2010 | Permalink

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The thoughts and opinions on this blog are mine and mine alone and not affiliated in any way with Inductive Capital LP, San Andreas Capital LLC, or any other company I am involved with. Nothing written in this blog should be considered investment, tax, legal,financial or any other kind of advice. These writings, misinformed as they may be, are just my personal opinions.