Angel: VC or PE? Posted 2024-12-26

Is angel investing just “very early VC”? I certainly thought so when I began to invest actively as an angel.  I was realistic: instead of 1 success in 10 companies, I figured it would be 1 in 20. And instead of 5-7 years, I assumed 7-10. But, yeah, same model: buy equity, re-invest in winners, hope they grow explosively and exit mightily, and expect most won’t.  Somehow, a couple will make the whole fund. My fund. With some experience, I have changed my view quite a bit, but to understand why, I need to set the stage a little first.

The common wisdom is that Venture Capital portfolios are assumed to have one winner that creates all the returns.  That is, of ten companies in the portfolio, one will skyrocket, one or two will do "OK" (50-250% of capital returned), and the rest – 70% or more -- will “underperform”. That's not how a VC makes investment decisions - no one wants to invest intentionally in a zero! - but that's the outcome.[1] Fingers crossed, the total of all that will be on the plus side. This is Power Law investing.

I started out thinking the same way about my angel investing. Inspired by the heavy activity on AngelList and the Syndicate (and the “spray and pray” strategy for angel investing advocated by its founder), I made a number of investments based more on the “idea” than a detailed analysis. Surely, one of these would pay out.

And maybe they will. Some have died; at least one has returned 92% of capital. Will I get that 1 in 10… er… 20? It’s too soon to tell but, so far, I don’t see which it will be. That’s not a good sign.

But as my personal allocation to angel started to reach its limits, I got a bit choosier. And, as luck would have it, I invested in a couple of companies with a story that generically is like this:

We’ll be a good business: growing OK, profitable in a reasonable amount of time, etc. But there’s this thing… currently sort of a side hustle... that might fit something that we see in the market out of the corner of our eye. If it everything goes right – and that’s not in our control -- this is a great business.

This is a more grounded vision than your average disrupt-the-industry unicorn-hopeful startup. Investing in that sort of company is different. The upside is still there, but the downside is a lot more limited. The focus isn’t on taking huge risks for a big win, but on building a stable business with the option for significant upside should the stars align. If they execute at all, it’s a single or maybe a double. If the market makes the thing happen, it’s a home run. But in no case do they have to take wild swings to try for a grand slam. For an investor, it’s equity in an OK business and a free option on a big win.

This is much more the style of Private Equity rather than VC. Rather than optimize the upside, PE will limit the downside. And I am much happier speaking with the CEO’s of my invested companies under such terms. In a VC model, I need to berate them to take more risk, grow faster, exit (or die) sooner. Instead, I can encourage the entrepreneurs, and help them to execute… to build at least something… secure in the fact that the option for great returns is there if we get lucky, rather than needing luck to get any returns at all. It’s a lot nicer model.

[1] See https://medium.com/@guillemsague/understanding-the-nature-of-venture-capital-returns-95846c65c049

Also... please enjoy a congruent view from a VC co-investor.