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.

  • http://www.stealthmode.com hardaway

    Oh, I am so down with all your opinions, which is why I sold all my real estate (except my home in Half Moon Bay) in 2006! Having lost big once in the 80s, I was no mood to do it again.

    And having angel invested since the 80s, I know just how hard it is to win. One company I invested in ten years ago just got sold last year, and after all that time, I got $40k. Another from the same vintage has just begun to distribute profits (enough every month for a couple of dinner). Yes, some of them have been home runs, but the ones I just talked about are the norm when there's a good outcome. When there's a bad outcome, you have thrown $45k out the window, like I did on a bank in formation in 2008.

  • http://lmframework.com David Semeria

    As someone who worked for over 10 years on the markets – your fundamentals-driven approach is obviously music to mine shell-likes. Favourite quote: “The bull market dies when the last bear throws in his hand”.

    Judging by all the blog posts on the subject, the US market appears to have gone frothy over the last two weeks… I dunno, I don't live there.

    What I will say is that it's quite some time since I've seen a start-up that has made my willy go boing.

    It's a pity all this money isn't going into something at least a bit *interesting*

  • http://www.ryanborn.net ryanborn

    Care to opine on angels that continue to tout themselves as angels when in actuality they're not actually actively investing?

  • http://www.slackbrain.com sam schillace

    Totally agree. One comment – I don't think there will be as much m&a as people think, with these smaller companies. I was on the other side of this at Google. It's really hard to do small acquistion for anything other than talent, and even talent deals come with some emotional baggage. I feel like there are about 5k little companies out there that are going to be very sad.

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

    Mark, I agree with most of your points, a few things to add. Angel investments are not going to reduce in 2011. 2010 was the year of the angel investor and the folks who invested this year, will invest next year as well. In addition, many angels have raised new funds in 2010, so that provides at least 2 years of additional funding, examples include SV Angel, Floodgate, 500 Startups, OATV, K9 Ventures, Felicis, etc. If you look at AngelList, there are new angel investors being added on a daily basis, many of these people have only recently started investing and will likely to continue next year. I believe that VC funding will remain at a similar level in 2011 as it was in 2010 (tracking at ~$22B). There are many VC firms who have raised new funds in 2010, which will last them for the next three year, examples include Venrock, Menlo, DFJ, Trinity, Morgenthaler, CRV, First Round, Polaris, Redpoint, A/H, etc. Many of these funds, are co-investng with these angels. Lastly, M&A activity has been pretty good this year and many corporations continue to have a lot of cash and need to grow the bottom line, so M&A activity will likely to remain strong next year. For the three reasons I outlined above, I don't think there will be a tech market correction next year and fortunately/unfortuanely the forthy tech startup market will extend to next year.

  • http://twitter.com/carlostobin Carlos Tobin

    I too remember reading that article in the paper back in 2006. I referenced it often when talking to people about the rising prices.

    http://www.nytimes.com/2006/03/05/magazine/305tulips_shorto.1.html?_r=1&scp=1&sq=very%20very%20old%20house%20shorto&st=cse

  • dshen

    A big AMEN to this post – btw can i call you “buzz” for short? LOL

    This is why I'm starting to invest via a take-my-pro-rata strategy even as an angel which flies in the face of invest one round strategies by most early stagers. I hate conforming too…!

    And yeah, I still maintain there is a startup bubble forming in the internet-only space. Almost everyone I say it to disagrees with me…. isn't that a characteristic of bubbles too?

  • http://bothsidesofthetable.com msuster

    Yeah, us folks who have been around longer have that perspective. I guess others will have to learn the hardaway – sorry, couldn't resist ;-)

  • http://bothsidesofthetable.com msuster

    No. Those are called “posers,” not angels. But there are many VCs like that, too. They're called “zombies”

  • http://bothsidesofthetable.com msuster

    thank you, thank you, thank you. I wish more people would hear that. I keep telling people that they're judging m&a by what they read in the press due to things like the drop.io or hot potato acquisitions but these are the exceptions more than the rules

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

    Depending on what the SEC rules, the angel 'frenzy' you describe may come to an abrupt halt (http://bit.ly/cnure1). Concerned? Comment at SEC here: http://bit.ly/alrM6O

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

    I mentioned this a few days ago on another forum, and I'll say it again – every “frothy” market needs to understand that building something sustainable and repeatable is a marathon and not a sprint. There will always be quick-wins, but they are rare and there is no formula for success, only luck. The true winners put the time in, train, practice, learn from mistakes, readjust – the hard work that is required to build sustainable success.

    Truly sorry to have missed you Wednesday at Columbia – I was signed up, but fell ill and couldn't make it into the city. Hope you come back soon!

  • Richard Koffler

    As always, excellent post in both content and style. I'm a sap for good writing, and you make the top grade.

    There must be an evolutionary explanation for the common trait among humans of liking to breathe their own exhaust.

  • Jon Callaghan

    Excellent post, Mark. We've witnessed insanely short sighted behavior recently on the part of angel investors, VCs and even board members who should know better.

    Having lived through the rise and fall of the first internet bubble ('95-2000), i can tell you the other characteristic of today is a complete lack of humility and the belief that everyone's deal is so hot that it's OK to do irrational things 'just this once.' People are myopic right now. The short term ends justify often irresponsible means.

    As you point out, great companies take years of hard work, building, and integrity to build. The folks taking the short cuts today will reap what they sow.

    Successful entrepreneurship and investing is a five, ten, even 20 year pursuit. It doesn't happen on one deal, and reputation and ethics count.

    We agree with you and feel strongly that now (as ever), early stage innovation is a fantastic place to change the world. But we have lived through and realize that our market experiences cycles. We're in a peak now for sure.

    Thanks for the great post.
    Jon

  • http://dealkat.com Abir Bhattacharyya

    Mark, The last post you were like Larry David, this one=non-conformist, more like James Dean, Rebel but with a cause.

  • http://fudge.org Jay Cuthrell

    Buzz Kill As A Service – BKaaS (pronounced “because”)

  • http://www.stealthmode.com hardaway

    That pun is beneath you, my friend LOL

  • David Young

    I have had two investors (both super angel seed fund types) tell me in the past couple of months that they “don't care at all” about valuation. Clearly another sign of an overly frothy market. I get being founder-friendly, just wanting to be in the best deals and not being too hung up on an extra point or two, but to “not care at all”? Really?

  • Dan Munro

    Your real estate bubble assessment was timely/correct – but I think it had a lot more to do with an insanely artificial market in buying, slicing and then reselling mortgages. It really mirrored more of a ponzi scheme (also in vogue) than any historical analysis using rental rates and income. Pretty sure the quants weren't using those antiquated tools.

    Don't know if you saw it – but worth reviewing is Tableau Software's analysis of publicly traded software companies from last year. Oracle took 10yrs to get to $50M in annual sales – MSFT took 8. There are examples of 4-5 yrs – but the average among all 100 is over 8yrs. I think one company took 29. http://goo.gl/eSjde

  • http://www.canvera.com Dhiraj Kacker

    One difference: I've raised money from angels and one thing I realized is that a lot of them invest with no expectations of returns; they see their investment as a fee to get a peek into what the next gen of entrepreneurs are thinking. They learn a lot from being part of angel forums where there is robust deal discussions, company presentations etc. And possibly at times, it helps them get out of their daily routine to think about how future developments might impact the businesses they are presently running. It seems that their ROI has a non-monetary component as well.

    Of course this cannot be true for micro-VCs who have a fiduciary responsibility to their LPs and must generate returns.

  • http://bothsidesofthetable.com msuster

    First, the firms you mention are “micro VC's” not angels. Angels invest their own money.

    Regardless, the fundamentals of what drives investment is not the direction you're coming from. Angel investments are driven by how the broader economy is doing. If it does well in 2011 then angels will continue. If not, not. Same for VCs. That has at least always been my experience.

  • http://bothsidesofthetable.com msuster

    Ooooh. Great link! Thanks.

  • http://bothsidesofthetable.com msuster

    ha. the more I argue about it the more I'm convinced I'm right ;-)

  • http://bothsidesofthetable.com msuster

    well, having just watched the film “Inside Job” I can tell you that I'm cynical about whether the government will regulate anything in the financial services industry so we probably don't have too many worries there.

  • http://bothsidesofthetable.com msuster
  • http://bothsidesofthetable.com msuster

    thank you, good sir!

  • http://bothsidesofthetable.com msuster

    Nice!

  • http://bothsidesofthetable.com msuster

    Thanks, Jon. Funnily enough – Chemdex was the company that convinced me fundamentals had all changes in my young and more naive days. Or so Goldman Sachs (my investor) told me.

    Given how close you now are to the pulse of what is going on in early-stage investments in both Silicon Valley and New York this is very confirming.

    One thing I didn't cover was the silly things that I see some entrepreneurs doing in the name of temporary higher valuations. I'm going to cover that in my next post.

  • http://bothsidesofthetable.com msuster

    Oh, and I should have mentioned two other trends:
    1. Lawyers giving up fees for equity and piling more money into financing rounds
    2. Venture Debt providers loosing covenants (e.g. minimum cash) and not taking warrants!

    Plus ca change …

  • http://bothsidesofthetable.com msuster

    thanks for the great link! I'm going to edit my post to put it in the body.

    re: real estate – having read “The Big Short” I obviously agree. But I think some of the irrationality started even before CDO's and CDS's.

  • http://bothsidesofthetable.com msuster

    check back with my after the next major recession and let me know how they feel about non-performing investments

  • http://columbusholdinggroup.com Mark Birch

    The Angel crash of 2011 is coming. What everyone has seemingly ignored is the storm clouds coming in to rain on what been a non-existent recovery. When the economy once again tanks, a lot of those checkbooks are going to be shut tight for good.

  • dshen

    i wonder if some insurance company or bank would write me a CDO-like instrument so I can bet against the startup bubbles I think are out there…?

  • http://bothsidesofthetable.com msuster

    my gut says the same but hard to predict timing. Let's see …

  • Kylepearson

    Question: If every VC blogger is writing about the same thing, is it an example of how blogging VCs are “independent minded” and smarter than the majority of VCs out there, or how they just follow each others writing trends, similar to the trends they make fun of their peers for following in investing?

    While I'm being facetious, I've seriously read about 5 blog posts from VCs in the last 2 weeks about how the start up world is over priced and over heating. Whats up? It must be a serious case of bad market mojo coming or an even more serious case of VC blogger groupthink. Methinks its the former…

  • http://www.canvera.com Dhiraj Kacker

    Sure. My perceptions are also India-centric where things are definitely not as close to being as frothy as they seem to be in the US. And moreover the community in India itself is very small (only two angel networks of reasonable size) and investment pace with them is slow but steady. No one seems to be betting reasonable chunks of their net worth. Instead I find angels putting aside a small amount of money in order to stay active within the community and making 1-2 investments per year.

  • http://www.channelstack.com/mychannelstack/RVTV RamVaz

    Your comments about conformity and the real estate bubble really resonate with me. One of my personal favorites was George Carlin “Always question the perceived reality.” As a former South Florida resident during the real estate bubble, the perceived reality was that prices would continue to go up +30% because “it is sunny and everyone wants to have a place in Florida.” Needless to say my contrarian ways also made me a buzz kill.

    Regarding the angel/VC bubble, I am not privy to the deal activity and valuations like you are. But maybe the lack of attractive investment options might be a cause. For example:

    -Cash – no interest, currency risk

    -Stocks-slow economic growth, tax environment, mistrust (i.e. 2008 + flash crash)

    -Bonds- bubble like qualities on long-term rates

    -Real Estate – still a mess, unemployment rates

    -Private Equity – less leverage for LBO deals of the past

    Until these asset classes become more attractive the angel/VC bubble might continue to inflate. Just my 2 cents. Looking forward to upcoming blog posts on where the puck is going.

  • Russ Dollinger

    All of the comments that I see regarding crazy angel investments refer to individual angels or syndicates but not to groups such as TechCoast, Pasadena, Sand Hill,etc. Are they behaving similarly?

  • http://twitter.com/rodolfor Rodolfo Rosini

    What few people talk about is the dealflow disruption that Angel List provides to traditional VCs. One of the advantages of being a tier 1 investor was that you would get first picks and that your dealflow is of higher quality (which I'm sure it's one of the things sold to LPs). Taking to the extreme, dealflow is becoming a commodity and all VCs are panicking and sending principals to create accounts to check the AngelList firehose. I'm sure their LP will be thrilled to know that.

    Does it have an effect on VCs? Hell yeah. Last month got meetings scheduled in hours while 3-4 years ago would have taken me a week at least to arrange a meeting with partner at a VC firm.

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

    Mark,

    Great post as always! From the entrepreneurs POV, what are the pitfalls in market that is as frothy as this?
    I know you wrote about priced rounds and I think that is sound advice, but what are some other nuggets of wisdom founders should keep in mind?

    - Daniel

  • http://www.questvp.com Marcus Ogawa

    Shai, thanks for your comments. I think another interesting perspective to inject here is the macroeconomic impact of the quantitative easing(s) injecting an eventual hyper-inflation (18-?? months) but an immediate downward pressure on the real dollar purchasing power, making domestic companies both cheaper to be acquired by foreign investors and corporations over the next 6-?? months, until we see a Paul Volcker like tightening on monetary policy as in the 70's, or a collapse of our fiat system. I suppose the secret to not going down either path is succesfully stimulate a massive growth in the economy. Either way, rough times are ahead.

  • http://www.questvp.com Marcus Ogawa

    I agree that angel investing has gotten nuttier then squirrel shit, and I think a lot of it has to do with angel-list, lack of better performing alternatives, and as you called out, the glamor. That perfect storm of angel capital flooding in, along with VCs who didn't deploy capital in late 08/ through 2009 are desperately trying to keep IRR in line and aggressively investing now. Coupled with the gearing down in capital commitments required for startups to achieve a minimum viable product, the demand for startups has shot through the roof with the supply glut of money. And as you rightfully pointed out, it's led to a slippery, slippery slope where startups are able to command how and when the deal gets done, often without time for any kind of proper due diligence. I've found this to be true especially during the first half of '10, and everything still holds true today, with the exception that I've found valuation to have come down some as West coast investors attempting to flee poor deal terms have sought East coast startups, which in turn forced west coast valuations to compete with the traditionally lower east coast valuations putting overall downward pressure on pricing. Aside from valuation pressures easing up a little, shit is still FUBAR in the early stage investing world!

  • http://bothsidesofthetable.com msuster

    I understand the sentiment, but this isn't totally accurate. Sure, AngelList is creating a marketing frenzy and VCs are all signed up. Sure, their analysts are watching the firehose. But the best VCs are still out scouting for entrepreneurs through their own means and know that the high volume of deals through AngelList is better funded by angels these days. AngelList is a wonderful marketing tool for entrepreneurs. My only fear about it is that it is helping to drive some of the angel rapidity based on social proof alone and this is maddening.

  • http://bothsidesofthetable.com msuster

    oooh, love any comment that uses FUBAR! ;-)

  • http://bothsidesofthetable.com msuster

    We all agreed it at our last Bin38 meeting ;-)

    But seriously, many of us have been talking about how maddening the whole industry is becoming now and many of us have seen this before so our shocked at the amnesia. I don't think it's so much as “group think” (or you wouldn't see some VCs chasing deals like it's 1999) as it is a few of us vocally calling bullshit.

    I have been saying this all for a while and if you check back at my posts over the past 3-6 months you'll see some of the commentary coming through.

  • http://bothsidesofthetable.com msuster

    I could see how you would form that view but my sense of the angel frenzy is that it isn't that sophisticated. It's driven by marketing because:
    - everybody now envies Ycombinator
    - everybody is reading about all of the fundings on TechCrunch
    - a few big companies have been created and a few early exits have happened
    - AngelList is a new marketing channel that has taken “social proof” to a whole new level. It now has become synonymous with “no due diligence.”

  • http://bothsidesofthetable.com msuster

    I can only speak for the former two, but I'd say, “no, they aren't going crazy right now.”

  • http://bothsidesofthetable.com msuster

    Ha- great question. I already wrote about it a bit in my next post, but not publishing until tomorrow (Tues). The key is – the less sophisticated the investors (whether at a high price or not) the more the pain if / when things correct. I always tell people, “given an option between a higher price with a less sophisticated investor or a lower price with a very sophisticated one I would personally choose the latter unless the valuation were ridiculously low by historical standards.”

  • http://www.kevinkruse.com Kevin Kruse

    Dan, that data and link is gold. Once again, overnight successes aren't exactly overnight. Thanks.

  • http://www.kevinkruse.com Kevin Kruse

    This seems to be such a left coast phenomenon. In the nascent Philly Angel community due diligence takes months and valuations are tight.

    Agree it's tough to make money as an angel (especially amateur with short time frames). I've been amazed at how even successful companies can lose angels money!