What Angel Investing & Florida Condos Have in Common

Posted on Nov 14, 2010 | 92 comments


It’s really hard to zig when the whole world seems to be zagging.  One of my favorite quotes I learned in high school was:

“Nonconformity is the Highest Form of Social Attainment”

It was written as the yearbook quote of the smartest seniors as I was finishing my freshman year.  It has always stood with me.  I have had a low bullshit meter.  I remember it even way back in kindergarden when my Saturday school teacher tried to tell me about Noah and Adam & Eve.  Those stories didn’t sound that plausible to me.  Much to her chagrin, the other slogan I have always lived by is

Question Authority.”

When the masses start all running one way without questioning “why?” – and when it defies any logic I can figure out in my head – I call bullshit.

And so it happened that between 2000-2008 I was the biggest buzz kill at dinner parties.  While many of my friends bragged about their 5 condos in Florida I kept talking about how the real estate market was in a bubble – their gains an illusion.  I pointed to several Economist articles I had read that mapped historical prices of real estate for 400 years and how on average property values grow at no more 1.5% above inflation yet in many markets in the US & Europe prices were rising at 10-25% per year.

“Yeah, but there is a shortage of supply.  People always want to buy near the water and there is limited supply.  The fundamentals are different now!  You’re stuck in the past.”

Ahem.

The price of property has an inherent value tied to two factors: 1) the rental rate you could charge for your property and 2) annual salaries in a given geography.  For reason number two people pay a higher price & rent in New York than they do in San Antonio, Texas.  Yes, there are some factors that can affect property prices beyond these two factors (e.g. a high portion of vacation homes or a market changes in demographics such as age) but income (and the employment rate) has the highest correlation in most markets.

At dinner parties I was wrong for several years but I stuck to my guns.  The numbers just didn’t make sense to me.  I kept pointing to the artificial gains in the Nasdaq in 1999 and said, “just because you bought in Feb ’99 and sold in Sept ’99 for a large gain doesn’t meant the asset was correctly priced.”  My message to everybody at the time, “Sell!”

And so Buzzkill Suster continues.

The dinner parties now are filled with self-righteous angel investors bragging about how many deals they are in on.  They have marked-up paper gains propped up by an over excited venture capital market that has validated their investments.  For now.

Logic tells me the following:

  • It is hard to make money angel investing. I have called it a “mug’s game” and I mostly try to avoid it.  The best angels will do very well just at the best real estate investors did well in good times and bad.  But the masses have now entered the market and everybody fancies themselves an “angel investor.”  It is the new calling card.  It is the new cocktail party conversation.  We list it on our bio’s as bragging rights.  We jockey to make sure the press release has our names on it.  It is slowly becoming Florida Condos.  And it’s driving up prices beyond their inherent value.
  • There are too many deals.   For venture capitalists this isn’t troubling.  Too many angel deals just means more to watch and invest in for the ones that do succeed (if the VCs can get in at reasonable prices).  But all of this increased company creation has to go somewhere.  Arguement one says, “the world is different now.  It costs less money to start companies so the world should have way more startups.”  I’ve heard the “world is different” argument in every bubble I’ve ever seen.  It’s true that it’s cheaper to start companies now and cheaper to get distribution.  Most of these companies will not get big enough and earn enough profits to pay big enough salaries for teams.  People only put up with “ramen profitable” salaries for so long before they become disenchanted.  Argument two says, “big companies can’t innovate anymore so Google, Apple, Microsoft, etc. will continue to buy up this talent as a form of R&D.”  That is true – in a booming market like we’re seeing now.  Remember it was only 2008 where Microsoft and even Google were laying off employees.
  • Many may simply hit the wall. If the “forever ramen profitable” or “startups as a source of M&A innovation” arguments don’t hold then we’re likely headed for one big brick wall.  That would mean that the increased number of new business startups will lead to a “funding gap” of deals that can’t get financed.  We haven’t hit that wall yet for three reasons: 1) not enough elapsed time, 2) the VC market is frenzied now, too and 3) we haven’t seen a market downturn since the volume picked up.
  • Great businesses take 7-10 years to build. People often talk about what makes a great investor.  I always say, “if you’re judging actual returns on a 3-year timeframe you’re looking at mostly failure.  This is the time it takes for a bankruptcy or asset sale to occur.  Or a quick flip.  Any of these scenarios aren’t great outcomes for investors.”  The reality is that the “big winners” in business that drive extra-ordinary returns often take 7-10 years to materialize.  Dan Munro linked to this excellent article in the WSJ in the comments with real data to prove the point.  The problem is that this is longer than the average economic cycle, which means you need to be able to manage in good times and bad.  Bad times often require more capital but ironically this is when capital is dried up.  Bad times are when M&A halts to a trickle and this is when many businesses are rushing to get exits.  If I judge the success of the “angel boom” by the last 18 months it is a resounding success – at least on paper. But I’ll judge the angel class of 2009/2010 on a 7-10 year time horizon.  We’ll re-compare notes then.
  • Investors are conformists by nature.  I believe that huge financial, productivity and technical gains come from new innovation rather than derivative thinking.  This requires novel thinking.  Yet nearly any entrepreneur who has an idea that other people aren’t doing will tell you that it’s hard to get investors excited.  Instead investors are looking for the next flash sale, private sale, game dynamic, social games that rely on mobile platforms with geo-fenced, location aware offers.  That is conformity.
  • People buy at the wrong times. Most of my MBA classes were a waste (since I had studied economics as an undergrad) but one totally changed my thinking.  It was an investment management class.  The professor showed that there is a big increase in volume of buyers as a market peaks and a big increase in selling as the market is falling.  He said that data suggests people prefer to “buy high, sell low.”  And so it goes in tech investing.  I saw VCs doing crazy things in 2007-08 when I first entered the VC market – crazy prices, limited due diligence, large funding rounds.  I avoided much of this.  in 2009 the market was completely constipated as investors focused on triage.  I was very active in 2009 / early 2010.  The market is over-heating again with people chasing deal.  It’s like “market amnesia.”  I must also say that all those angels who hid their checkbooks in 2008/09 are now back with a vengeance and paying higher & higher prices.  Same with VCs.  And now everybody is an angel.  Even people who haven’t had good exits, gained experience in their careers or have enough deep pockets to last a market downturn fancy themselves as angels.
  • I’m skating where I think the puck is going.  I’m not giving up on the market completely.  I am avoiding “frenzied” deals for all of the reasons Roger Ehrenberg talks about in his excellent blog post.  I’m trying to pick themes that I think will map to macro trends over the next 5-10 years.  I’m spending a lot of time looking at video production & distribution because I believe this will form a larger basis of the future Internet and I believe that Hollywood & television will face large, disruptive forces.  Plus, as I live in Los Angeles it is where some of the smartest talent thinking about this space resides.  I’m looking at how the digital living room will change media consumption.  I continue to be excited about the Mobile Web (as distinct from the Mobile App).  I still love B2B application.  I am really bullish on data-as-a-service.  I will write about some of these topics soon.

Why should you care?

If you raise money from experienced sources – whether angel, micro-VC or VC – you will be better served in scenarios when the market corrects, where your large competitors launch hostile offerings or where things end up taking longer than you had expected in order to show progress.  Mine is not an argument for VCs over angels – it is for sophistication over credulity.   In boom times anybody’s money will do.  I’ve lived through two tech market corrections at close range.  The first money to pack-up and head for the door is always the least knowledgeable / least committed to the long-term of our industry.

Note: If you’re new to angel investing you may be interested to read my series on what I believe it takes to be successful – each of these links is an article:  Access to the Best Deal FlowDomain KnowledgeRelationships with VCsDeep PocketsAccess to Buyers.

  • MITDGreenb

    And doctors who want to use their spare cash to “invest” in tech companies… not necessarily healthcare tech where they might actually know something or someone. I met such an individual at a recent networking event. He had no experience in tech or the web, except as a user, but was “open to investing in all sectors.”

    C'est la meme chose.

  • http://twitter.com/wfjackson3 Willis F Jackson III

    I haven't even finished reading this and I already know this could be written about me. My friends actually nicknamed me Buzz Killington, after the character from Family Guy, while we were all still in school.

  • http://byJess.net Jess Bachman

    Well the true winners in every frothy spectacle is… the spectators! It's quite entertaining from the sidelines.

  • dereklicciardi

    The one thing I can't get past as I watch stocks like Ford hit 52 week highs for the past couple weeks is the unemployment rate hasn't changed. I can only assume that whatever has sent the market into a frenzy will end in short order and I don't buy the argument that it was the change in Congress on election day that caused this uptick.

    Whatever is causing the angel market to boom is doing so against a consumer market that doesn't have alot of disposable income. Are investors assuming that the unemployment rate will magically fix itself before their investments hit the 5 – 7 year mark? Where's all the money coming from to purchase the goods these companies are making? With unemployment so high, I'm afraid of a supply side surplus sticking a sharp pin in what seems to be a short term market bubble. When that happens, valuations drop, funding gaps happen and the current bubble ends.

    Taking it one step further, is bubble economics the trend of the future? It seems to be the way investment works in these hyper social connected days. Could investing become not really caring about how the bubble is happening and more about how to get an optimal piece of it? How's that not gambling? In the end, the unemployment rate in the US is my hangup. Until that's solved, all these gains that the market is seeing seem to be paper gains. Sure some will make money but I'd be scared to put money in right now if you can't go through another downturn. You would think that formal investors (VC/Angels) would understand the risks but from your article it seems as if they are barely better than regular people investing their 401Ks using Facebook suggestions as the reason to invest.

  • Kylepearson

    I was SO close to bringing up Angelgate, but I felt it would be in poor taste :)

  • http://stonebusinesslaw.com Ethan Stone

    The stealth decrease in the accredited investor thresholds are something that few people have noticed but has presumably had a big effect over time (although not the last few years). The current accredited investor thresholds were set in 1982. If they had been indexed to the CPI, they would now be around $450k income or $2.3m assets. Put differently, if they had wanted to put the thresholds in 1982 where they now are (inflation adjusted), they would have set them around $88k income or $440k assets. I first noticed this when, as a mid-level law firm associate at the beginning of the tech bust, I started to get cold calls from investment banks, looking for suckers to bail them out of their private investments. They assumed that I was at or near the one or another of the thresholds, which was true, but crazy. Including the value of houses has, of course, lowered the bar even further. It's ironic that Congress finally acted on that just as house values plunged. Anyway, my test for whether the accredited investor definition is appropriate continues to be whether it includes me. If it does, it's probably too low.

    As noted, the cumulative affect of inflation has created a situation where there are probably too many people in the definition of accredited investor, since their assets and income don't necessarily indicate that they are (1) sophisticated investors, (2) capable of hiring sophisticated advisers, or (3) capable of sustaining a total loss of investment without noticing it. That hasn't accelerated over the last couple of years, since there hasn't been inflation. What has happened, however, is that the yield on safe and even mildly risky investments has gone down. I invest money for several relatives who need the income and I can tell you how frustrating it has been. I've held firm against the temptation to chase yield into the danger zone, but a lot of people don't understand risk or just need the income so badly that they forget what they know. That has driven craziness in the junk bond market, as the Wall Street Journal recently noted (http://online.wsj.com/article/SB10001424052748703957804575602913465227210.html?KEYWORDS=junk+bonds). I have a feeling it's also driving some craziness in angel investing.

  • philsugar

    What a great post.

    I completely agree with you. Especially on how long it takes to build a great company, how relatively few exits there are, and what happens when times get tough.

    I have no data but my gut tells me that right now a majority of these deals are getting done by first time (less than three years in the game) angels.

    Having been doing this for twenty years you watch people come and go. There are some kick ass guys that do it for ten or more years but they are by far and away the exceptions and that's why they stand out.

    When you're a first time angel everything is rosy (put in romantic analogy here) but when the bloom comes off the rose nobody likes losing money and the majority of the deals will do just that. People say, I only expect one of five to work out or something like that, but that is not how they act when they are faced with losing money.

    I personally have seen several companies blow up and go completely out of business when I made an offer to buy them for pennies on the dollar which is what they were worth, when pissed off angels wouldn't go along with the deal. The last thing you are going to do is have legal issues when looking at a distressed deal.

    Each time the angel wanted to talk to me and was outraged they could lose money….but looking at the end result my offers were totally fair. It will not end pretty. I was always amazed at how irrational they were.

  • http://stonebusinesslaw.com Ethan Stone

    I agree. When lawyers get excited, it's a clear sign of the apocalypse.

  • http://stonebusinesslaw.com Ethan Stone

    Agreed, but I tend to think that the extreme pressure to find yield is driving some of it, too.

  • http://www.kidmercuryblog.com kidmercury

    if you have any data on percent change in fund size, that would help. it's a bubble for sure, but fund size data can help us estimate how big the bubble is, how big the correction will be, who is likely to get most embarrassed, and who will be easiest to laugh at.

    also, +1 to those who have commented that this is in part a run from dollar and bonds. i'm now of the opinion that US stocks will hit new all time highs. in nominal terms, that is. IMHO the fed will minimize the downside, and QE2 will have sequels.

  • http://www.kidmercuryblog.com kidmercury

    IMHO govt has and will continue to use regulation to protect industry incumbents. all for the good of the people, of course. if you disagree you are probably an unpatriotic terrorist.

  • sbmiller5

    Jeff Bussgang wrote a good post on this recently. While we've definitely seen an uptick in M&A, it's been really only the top companies/deals and I personally have seen buyers being very tight with their cash and not offering crazy multiples.

    What I've said to a lot of prospective clients, you need to have a team or product that is absolutely considered the best in the space to get a high multiple.

  • http://www.piqqle.com/blog/ Daniel Kim

    Thanks for the reply and that is a good cost/benefit analysis in regards to dollar amount and investor sophistication. Looking forward to the post tomorrow!

    - Daniel

  • http://twitter.com/CoderDennis Dennis Palmer

    I wonder what that those houses are worth now? How much have they fallen?

  • http://markgslater.wordpress.com/ markslater

    I am not sure i get what you are trying to say.

    OK – too munch money chasing too few deals – i agree. I'll take your word for that.

    But there is no true distinction between a “VC” and an “Angel” really. After all both groups invest in the same asset class, and its most certainly not like a VC group possesses a “unique secret deal making sauce” that angels cant get at. Its a law-firm, a good financial engineer, and a thorough DD process that make a good investment in this class – and that not unique to anyone.

    I'll offer a different angle – VC's as they have come to be defined mostly as a result of the bubble in the late 90's, organize a bunch of MBA's around a large pool of capital against a set of pre-determined investing expectations (round size, investment frequency, areas of focus). A great deal of them seem to be posting on this very subject as if its their right to cast judgement on the not insignificant shifts in their market – those who do have not practiced what they preach. Deal dynamics have changed and the VC needs to “pivot”;)

    There seems to be a lot of whinging from VC's about angels competing for deals. But really to me is seems that the following has happened:

    The cost of innovating has fallen off a cliff – that is a well know fact. What that means to a VC is that he has lost his primary (i'd argue only) Barrier to entry advantage – amount of capital. Lets face it – to deply $4M in a series A, you need to be institutionalized and organized in the way a VC is. Most angels simply dont have that kind of capital and likely cant syndicate it.

    Now move the amount to $400K. That $400K will get you to 80% of the milestones that the $4M did 10 years ago. Now $400K opens up the potential investor universe exponentially. I dont need to tell you what that does at your dinner parties.

    The bottom line is – there is a whole new category of “professional angel” (i define this as some one or a collective that are doing this full time and have the best of breed processes that the VC's have) that is going after this market and weeing on your tree. But dont make the mistake of thinking that there is any special sauce because VC hangs on the door not Angel. Lets not forget that Angels are investing their own money.

    Ofcourse – there is also that slumlord angel category – that you may be referring to in your post. There is no constructive discourse for this bunch – Mugs comes to mind and you may want to talk to the wife about the dinner parties she's got you going to ;)

  • http://markgslater.wordpress.com/ markslater

    i have long wondered why someone has not done this. we could call it the fail whale fund and consolidate shorts on bad private investments.

  • http://markgslater.wordpress.com/ markslater

    this is a great post Ethan.

  • http://markgslater.wordpress.com/ markslater

    i am very interested to read that.

  • http://twitter.com/shaig Shai Goldman

    Agree, the weaking of the dollar has already allowed companies/investors to acquire/invest US companies. Look at one of the most recent large acquisitons, ngmoco, which was acquired by a DeNA, a Japanese firm, I think it was a 20%+ discount given the exchange rate. If it wasn't for foreign istitutions coming into the US, we would certainly be in a lot worse economic enviornment.

  • http://twitter.com/shaig Shai Goldman

    The angels that are actively investing in the seed rounds you are referring to are not those who financially tied to the broader economy and/or the stock market. These are angels who have had liquidity events, typicall from their previous startups. I know these angels, and rather than invest in the stock market, which is tied to the broader economy, their preference is to invest in startups, where they can add value and perhaps have some influence on the direction of the startup. These angels understand the long-term nature of their investments. The angels from previous cycles, most recently 2007-2008, were tied to the market and when it crashed, they stopped investing. The “new” angels that are currently investing, will continue next year, regardless of how the economy is doing. I think that 2012, could be a challenging year for these angels, as some of their investments they thought would have liquidy, won't receive it and some of their portfolio companies will fall in the funding gap you mentioned and might scare them away.

  • http://www.seekomega.com Mark Fidelman

    Ouch, wish I paid more attention to people like you in 2005. I bought an entire building in Florida only to see the value plummet over the next few years.

    The hard part is deciding when the timing to invest is right. Looking backward the decisions are easy, but one has to remember we need to make these decisions looking forward.

  • http://bothsidesofthetable.com msuster

    Nope. Happening in NYC, too. So maybe it's a coastal thing!

  • http://bothsidesofthetable.com msuster

    I'm with ya. And I wrote a long post on this exact topic.

  • http://bothsidesofthetable.com msuster

    1. if you invest your own money you're an angel. If you invest somebody else's money you're a VC. Maybe a “micro” VC, but a VC.
    2. I haven't argued that only angels are doing frothy deals – VCs are, too. But there is a big increase in angel volume.
    3. I agree a whole new market exists for micro VC investments. this is great. but huge companies will still need venture capital to go “fat” when they're on to a really big idea or they'll never get past the facebook, google, apple competitors that emerge. angel, micro vc and vc's all need to exist. It's just different market segments.
    4. VCs actually benefit from the huge increase in angel deals because they have more opportunities to look at funding the next round.

    I think the market correction, when it comes, will actually hurt the entrepreneurs, angels & VCs alike.

  • http://bothsidesofthetable.com msuster

    which is why I wrote this post. hoping that some angels and entrepreneurs would at least give more reflection to where we're at in this cycle and make decisions accordingly (based on your view of the world).

  • Russ Dollinger

    Thinking about it a bit more, since some angels specialize in particular areas (e.g. internet) while others are willing to look at a broad range of deals, I suspect that it may be more useful to split angels into different categories. I suspect that a great deal of the froth and craze is actually only happening with certain deal types.

  • http://irene-at-columbia.weebly.com e_irene

    Thanks for the perspective, Ethan!

    It always seems to boil down to the same question/choice: protection or freedom.

    I choose freedom + education + self-control. Buddhists on jihad, anyone? =)

  • http://irene-at-columbia.weebly.com e_irene

    lol! you may have a point.

  • http://twitter.com/ExecutivePlan Adam Hoeksema

    Even with all the angel investors getting in on the game the Angel Capital Education Foundation still suggests that only 1 to 4% of angel investor applicants successfully raise capital. For this reason I created my ExecutivePlan blog to help entrepreneurs create more powerful, effective, and memorable business plan executive summaries in order to raise capital.

    My blog, http://www.theexecutiveplan.com, offers a number of free guides, templates, examples, and articles to help entrepreneurs in the executive summary writing process.

  • Jerome

    “The four most dangerous words in investing are ‘This time it’s different.’”
    -John Templeton

  • http://www.betadvisor.com Jerome Camblain

    “The four most dangerous words in investing are ‘This time it’s different.’”
    -John Templeton

  • http://markgslater.wordpress.com/ markslater

    but not getting as much access at the lower valuations shifts your model no mark?

  • http://twitter.com/jscournoyer JS Cournoyer

    Hi Mark,

    Great post. I'm tempted to believe that the lack of talent supply, or excess demand for talent is likely to get worse over the coming years because of other non-traditional companies getting into the fray to remain competitive. Same for the excess capital situation. I've attempted to make sense of the implications in my last post, would welcome your feedback. http://www.jscournoyer.com.

    Cheers,

    JS

  • Inder

    Mark,

    I loved this blog post, and agree with you that there is too much money chasing tech ideas right now. At the same time, might I point out that it's easy to be a non-conformist, but it's very hard to predict correctly where the puck is going. I mean, anybody can choose to NOT go where the puck currently is (non-conformity), but it takes more wisdom to predict where it's headed.

    In the larger picture, I disagree with you that video will form the basis of the next internet. It's too resource-heavy to be the primary mode of distribution. Here's my attempt at being non-conformist here: http://thehumanintheloop.wordpress.com/2010/08/08/audio-revolution/

  • http://1000markets.com Matthew_Trifiro

    Awesomely concise and spot on, as usual

  • http://www.skollfoundation.org Phil

    You can't beat common sense … I just wish it was more common. Great post.

  • http://shanacarp.com/essays ShanaC

    This is what I hear- they are renting to the fresh out of college market, which generally is a market that doesn't make much (initially) Some buildings stand empty- but the jumbo loans used to build them have to be paid.

  • http://shanacarp.com/essays ShanaC

    I'm not surprised, when you are asked for advice about “what technology am I going to use next” by friends and family and you have too many of the similar web/software/something to choose from, you tend to think there is over investment. Plus, I don't think there is an understanding of the reality of burnout from the users pov. If they have all these choices, why choose any because it isn't clear which is going to make it.

  • http://www.repeatablesale.com/ Scott Barnett

    Thanks for the link, and great talk. I could not agree more regarding persistence – I made up mousepads about 10 years ago that have a quote from Calvin Coolidge that I still use today – “Nothing in the world can take the place of Persistence. Talent will not; Nothing is more common than unsuccessful people with Talent; Genius will not; Unrewarded genius is almost a proverb. Education alone will not; The world is full of educated derelicts. Persistence and Determination alone are omnipotent.” I keep reminding myself of this when I hear “no” 99.99% of the time from VC's :-)

  • http://www.CoopersPick.com Cooper

    Bookmarked new favorite blog for advice. Working on this idea for startups would love to get your feedback on the idea if your interested in hearing.

  • http://twitter.com/intercommassoc Inter Comm Assoc ICA

    This is a very big issue that is going to be even more dire in just a few days when thousands of condos that will fall off the FHA underwriting list. Because they, Condos, dont have a reserve fund which up intill 2009 FHA never said boo about (((((((if not covering it up.))))))))))

    Drum roll~ come Dec 23rd thosands of Condos will fall off Fannie Mae's underwriting list. Because Fannie asked every condo they back to refile their orginal applications for eligablitiy by end of this year.

    Both of these are being imposed from the top down with little or no regards to the actually ability of condos to do either of these things. BWT both of em <fannie, fha,=”” hud=””>dont pay their assessments when they own the units. This is why most banks are not taking possession of the units their clients had owned and stopped paying dues long before defaulting on the mortgage.

    It's also the reason why the actions they are asking condos to do are not possible. Talk about self inflicted wound. StateofCommunties.org is a blog we run about it and other issues that could effect the millions of Common Interest Community homeowners.</fannie,>

  • Anthony

    CALLER ID SCREENER- An easier way to decide which calls to take. New telephone accessory enables the user to block calls from certain numbers. Prevents a phone from ringing constantly; blocked numbers don't ring.

    Eliminates the need to constantly monitor caller identification services to determine whether or not the user wants to pick up the phone or not.

    Guides unwanted callers to a seperate answering machine/service, they'll never know their number has been blocked. Ensures that each time phone rings it's something of importance.

    Also can be used for advertisers to sell there services and products on mobile devices without disturbing an irritating the consumer's with unwanted calls and messages.