Some well-known investors – namely Benchmark partner Bill Gurley and Andreessen Horowitz co-founder Marc Andreessen – have recently sounded the alarm about a tech bubble. The fear is that huge valuations and quick cash burns by tech startups are out of control and will derail the startup market. While the claims make great headlines, the angel investors I talk to don’t see it quite that way.
Instead, they see a much more nuanced situation – based on geography and industry. The Angel Capital Association recently conducted an informal survey of members to ask whether they are seeing increased valuations and burn rates among the startups they work with. While many in Silicon Valley and some in Washington, D.C., and New York said yes, angel investors elsewhere in the country weren’t seeing the same thing – yet. They are concerned, however, that a bubble mentality could creep across the country.
“The current exuberant market is primarily a Venture Capital-driven phenomena focused in a few geographies. It has been fanned by the media, which has had a ripple effect in the angel-backed market,” said John May, managing partner of New Vantage Group in McLean, Va., in responding to the survey.
The median pre-money valuation for 2014 angel group deals actually is up about 20 percent – $3 million compared to $2.6 million a year ago, according to the Halo Report, perhaps adding fuel to the bubble belief. But that median valuation is still $3 million – not out of line – and deal sizes are down slightly. This means angel groups are helping companies keep expenditures down. The report also shows that angel group investing is done throughout the country–considerably less concentrated than VC investments, which are largely in Silicon Valley.
While many angels are not investing in startups with high valuations, they are worried about the crazy burn rates, which could put companies out of business. Some stories out of Silicon Valley are staggering, especially for hot tech companies: CEOs driving expensive cars, startups locking into long-term leases in oversized office spaces, and rising salaries for top talent.
“The bubble is in the plans the companies have for the money. I’m seeing more companies trying to raise a smaller amount (6-8 months of runway) with the idea of spending it all while getting enough traction for a Series A. Companies used to raise more and husband it carefully rather than spending so rapidly,” notes AngelList Chief Investment Officer and San Francisco-based angel Kevin Laws.
Although the craziness is not universal among industries or geographically ubiquitous, angel investors are finding that Silicon Valley is influencing deals elsewhere more than ever before. Many startups from all over are trekking to Silicon Valley and quoting Silicon Valley valuations in their fundraising back at home. Couple that with increasing media coverage, data availability, internet communication and discussion about early stage investment, it’s highly likely that the bubble will trickle into other regions.
Best Practices to Minimize Burn
Sophisticated angels, luckily, have ways to protect themselves, the companies they invest in, and the startup ecosystem. Many are already engaging in these best practices which help minimize expenditures of young startups to reduce cash burn. These include:
- Strategies to protect against ridiculous valuations. Get the valuation right in the first place by understanding the principles of valuation and market activity in your region. More than a few angels in the ACA survey said that startups quoted valuations that were twice the amount for their region and stated that they would get that valuation in Silicon Valley. The reaction? Angels suggested the entrepreneur raise capital in Silicon Valley instead.
- Set realistic plans for spending funds. Additionally, make monthly adjustments based on milestones and performance. Angels emphasize this is critical to building a successful company with real revenue and appropriate spending.
- Be active on the board and ensure discipline among company leaders. Active angels take board seats, monitor cash runway, and make the milestones necessary for raising more money explicitly clear.
- Insist on regular financial reports. Valerie Gaydos, who leads Angel Venture Forum in Washington, DC says, “Before investing we set the record straight that we expect regular reporting….and give them examples of what is expected in those reports. If they can’t abide by the reporting requirements to shareholders in a way that we want, then don’t take our money.”
- Meet regularly with entrepreneurs to monitor, mentor and track milestones. “Angels provide vital coaching and mentoring that, on average, purges excesses out of any operating budget,” said Ken Kousky, leader of BlueWater Angels in Michigan.
- Approve budgets and insist on dialog if major changes are included. Some angels are insisting on monthly briefings on budget to actual expenditures.
Most of these good practices provide the foundation for building strong relationships between investors and entrepreneurs. My key takeaway from the survey is that angels are working to maintain sanity by partnering with entrepreneurs to keep cash expenditures to a reasonable level and mentoring them to keep them on track. Hopefully more investors can do the same and by combining forces together we can hold back the risk of a tech bubble happening across the country.