in Angel Investors

Early exits (without VC funding)

The National Angel Capital Organization had their annual summit last week in Toronto. The summit is a gathering of angel investors and angel group managers from across Canada to discuss best practices and current trends in angel investing. Two main themes in this year’s conference were co-investment and early exits. I’ll cover co-investment in another post. In this post I’ll talk about early exits as presented in talks by Dave McClure and Basil Peters.

The basic premise that both Dave and Basil spoke about was that for certain types of businesses, you no longer need (or want) to get traditional venture capital investment. For many software and Internet start-ups, you can get a product to market with minimal capital. This makes it possible for a company to realize an exit and provide payback to investors in a few years. This can start a cycle of wealth creation that will fund future companies/start-ups and contribute to a strong start-up ecosystem.

The following factors contribute to an environment that is supportive of early exits:

  1. Entrepreneurs in the Internet/software space can productize their ideas with minimal capital (i.e. several hundred thousand dollars) thanks to advances in development tools, cloud based computing, etc.
  2. Friends, family, founders and angel investor rounds can provide the necessary capital to get a company from start-up to market (i.e. Maple Leaf Angels typically does deals in the $200k-$400k range).
  3. Established companies in this space (i.e. Google, Yahoo, Microsoft, IBM, Oracle, etc) are very acquisitive. Innovation is harder to realize in a large corporation than a start-up. As such, large companies look to start-ups to prove out a new idea/technology and then acquire the start-up. Large companies are good at taking this start-up and applying their sales, marketing, operational expertise and growing it into a several hundred million dollar operating unit. In other words, large companies use M&A as a form of R&D investment to help find the products that will help fuel their top line revenue growth.

The model above works when M&A exits are in the sub $50 million dollar range because:

  1. Typical valuations for a first round of angel investment are in the $1m to $3m range. As such, a strong return can be realized assuming there are no more or only a couple of subsequent financing rounds with minimal dilution.
  2. Smaller value acquisitions are more frequent, easier for the acquiring company to do, and there are more acquiring companies that can be in the market for acquisitions. Large acquisitions in the hundreds of millions or billions of dollars may get the press, but they are infrequent and require higher levels of due diligence/approval by the acquiring corporation.
  3. Given this math, you can see how angels can realize exits of 3x-10x based on a sub $50 million dollar acquisition at an early stage in the company’s life.

Injecting Venture capital investment into this scenario is not conducive to early exits because:

  1. VC investments at the series A round are several million dollars in size and have post money valuations in the low 8 figure range.
  2. A VC fund of several hundred million dollars needs to have series A winners be 10x+ to meet their overall fund return objective of 20% per annum.
  3. Given this math, a return based on a sub $50m acquisition will not be enough. VCs need to have the company hold out to grow in its life to support a > $100m acquisition (or IPO) which as was stated does not happen as frequently and will take more time. Basil Peter’s states that an angel only backed venture will be likely to exit in 2-5 years whereas a VC backed venture will take 10-12 years.

So what does this all mean? Since most of the readership of this blog is in the software/web space, there is no better time to be an entrepreneur in this space to have the framework in place to start, build, fund, and exit a successful venture.

Even in the US, where you can argue it is easier for start-ups to get Venture Capital funding, angel investors fund more than 27 times more start-ups than VCs. As Basil’s blog states, it is erroneous for entrepreneurs to think VCs are the main source of funding. Successful companies can be started and profitably exited with just friends, family and angel rounds. Understanding your strategy for funding and exiting should be a key part of your business plan as angels are becoming more and more sophisticated and increasingly want earlier exits of their investments. Understanding the investment return expectations of any investor (be it angels or VCs) is critically important as it has a strong bearing size of exit they will be willing to accept and what this means in terms of timeframe to exit.

craig at

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