Sobering Realities About Crowdfunding Startups
Before you read this post, I will state up-front that I’m a big AngelList fan. Now, as the dust has settled a bit from the initial hoopla of syndicates, I thought I’d write out some brief thoughts of trouble spots I see coming down the road. I’m writing this because (1) I want to clearly articulate for myself what some of the potential land mines could be, (2) because other readers may add their own comments and enrich the dialog further, and (3) because in all the positive potential around AngelList — and there should be — I believe it pays to think through some of the potential potholes, as well, such as:
- Syndicate Lead Communications With Founders. Let’s say I’d like to invest in a company and ask the founder for a $250K allocation. The founder agrees. I then clarify that I will put in a certain amount of that $250K and then syndicate the rest on AngelList. The founder agrees. Theoretically, it doesn’t matter where the money is coming from to a point. Now, do I put this in writing at the time of the agreement, so that both Syndicator and Founder understand the arrangement? What if, for instance, the founder decides a year later that he/she doesn’t appreciate the syndication of the allocation and would have preferred to have added more individual angels to help out — would that sour a relationship if one party changed their mind or had a misunderstanding about the terms in the heat of a financing round? This is why I’ll be sure to have this conversation in writing, as well, if and when I syndicate my portion of a round. Again, I don’t think this will come up often, but it could, and there’s no sense in allowing for any room for confusion here.
- Syndicate Lead Communications With Backers. In the scenario above, I’m highlighting the agreement between a founder and syndicate lead. Now, if I’m able to syndicate my allocation to a set of “backers,” yes, they have to meet legal requirements and the rules set forth by AngelList to qualify. Let’s assume they all are in good standing. Now, assume that years after the deal just even one backer decides that a company he/she’s helped syndicate is a dog and/or should share revenue and gets upset, could that backer take legal action against me? Or, what if a backer doesn’t fully understand fully that some of their carry in a good outcome will be paid back to AngelList as a commission for brokering the deal? They likely could, so that would encourage me to be overly-communicative (in writing) with any of my potential backers to make sure they understood that investments in private companies are essentially illiquid unless there is an acquisition, public offering, or some type of secondary mechanism. The issue around illiquidity of investments in startups came up so much in my discussion about AngelList — even with “techies” who have been in the Valley for years — that I’m 100% convinced it will be the major source of confusion and dissatisfaction once people sober up to that reality.
- A Marketplace For Relevant Backers Erodes Old School Networks. Before AngelList’s moves this year, a lead in a deal would often “carve out” a portion for individuals to come into the round and add value (with buy-in from the founder, of course). I’m generalizing, but often this would be centered around a cabal or network of people who would coinvest as a result of their own relationships as opposed to adding specific value to the new enterprise. AngelList as a marketplace to find new pools of money to syndicate with. What this means is, over time, the people who live in and around the Valley and are able to put money to work without adding value may not have the luxury in a future AngelList world. For instance, let’s say I have a rocket imaging company that’s just raised a $10M series A from a big institution. We agree to carve out $500K of that for individuals that can add value to the team and business, but most of the execs in rocket technology and imaging reside in Los Angeles, Boston, Florida, and Dallas/Houston, and I don’t know them. Now with AngelList, instead of helping my VC’s buddies pile into my deal, AngelList creates the directory for me to search and find people with direct experience to help my company.
When you combine these three things together — the opportunities for the right Syndicate Leads are great, but must also be tempered by the reality that, at least in the beginning, there are so many different touchpoints for confusion, and they will happen. Communications, written and repeated often, will be key. But, for Syndicates who can anticipate both good and bad potential conditions and set the right expectations with founders and backers, and who either directly add unique value to the enterprise or can leverage networks to find those who do, AngelList is a platform that will eventually reward hard work, reputation, and the ability to lead. It may take a while to get there, but I believe it will.