Are we selling angel investing wrong?

Last weekend, I had the opportunity to join AfricArena and several (mostly South African) venture capitalists at the second annual Venture Unconference. This, a few weeks after participating in the investor-early Africa Early Stage Investor Summit, organized by VC4A and ABAN. These events have been a nice opportunity for me – not a venture capitalist and barely an angel investor – to hear first-hand about the challenges and anxieties of those who write the checks. 

A perpetual question at these events is “how do we unlock more capital for the ecosystem?” 

And the sales pitch – depending on the target audience – often includes something about the opportunity to make outsize returns while investing in Africa’s future, improving the climate for entrepreneurs, supporting job creation, and so on. 

Conventional wisdom also says we need more exits. Not only are high profile exits a liquidity event for investors and founders to roll money back into the ecosystem, but it also opens the eyes of the less risk-averse, who may now feel more compelled to participate having watched others make real returns. 

Though, I am reminded of a short video I recently re-watched from Y Combinator’s Michael Seibel on “why fundraising is different in Silicon Valley”.

His argument, in summary, is that because of the volume of deals in Silicon Valley, virtually every early-stage investor will have said no to some deals for companies that go on to be very successful. This, in turn, creates a greater skepticism and diligence amongst Bay Area investors than anywhere else in the country or the world. He goes on to say, 

Silicon Valley investors are much more likely to give you the benefit of the doubt on your idea… whereas it’s far more common outside of strong startup communities for the investor to debate whether or not the idea is a good idea.

On one hand, there is a distance (literal and figurative) between Silicon Valley and Africa that has been tough to bridge, with especial difficulty in investors’ ability to relate to the dynamics on the ground. Nonetheless, we are empirically seeing increasing interest in African startups from the Bay Area. 

On the flip side (pun intended), we often hear of African HNIs and investors falling on the opposite side of this spectrum. They might better understand the market, but still lack a familiarity either with VC as an asset class or with tech as a sector. 

We in the tech ecosystem like to categorize investors who offer poor, take-it-or-leave-it terms as predatory. Perhaps it’s an unfamiliarity with this asset class. Perhaps they’re accurately pricing their risk-adjusted returns. But it’s not necessarily that it’s predatory for founders alone – it’s also self-inflicted in that it makes it much harder for startups to receive follow on funding. 

The above video was referenced in an article by Alex Danco, The Social Subsidy of Angel Investing. This piece argues that it’s not just that FOMO drives Silicon Valley angel investors because of the number of successful startups coming from there, it’s that whereas angel investing is (merely) a financial activity elsewhere, in Silicon Valley, it’s a social status exercise. 

Danco calls it a social “subsidy” because without it angel investing wouldn’t work. Investors in Silicon Valley are using a different calculus than others.

It’s also convenient that the investment return profile of angel investing for social status is way more attractive than angel investing for financial return. Angel investors’ money gets locked up for 5+ years (maybe even 10 years), so you face a significant illiquidity punishment relative to the S&P or even real estate. Second of all, your money gets massively diluted by follow-on capital. The more money a startup raises, the more you get washed out as a little guy who can’t defend pro rata.

But from a social returns perspective, you face neither of these problems. Not only are the social returns immediate, they also get reinforced by follow-on capital raises. That $50 million Series B for your favourite portfolio company might have washed you right off the cap table, but it’s an awesome achievement socially…

The end result is that the Bay Area has a critical density of people who are willing to offer founders a term sheet for enough investment, and at attractive enough valuations, that it makes sense for the founder to actually accept them. I honestly believe that without this social “subsidy”, a lot of angel investing stops working. If investors were being purely rational, they could only offer something like a $2 million valuation for founders’ first cheques. And if entrepreneurs are smart, they know they can’t accept it; it makes them un-fundable from that day forward.

…if you’re a founder looking for your first cheque, you need to find something that, economically speaking, shouldn’t be available. You need to find someone who’ll write you a cheque for a real amount of money, but that doesn’t take too high an ownership stake. The social element of angel investing is absolutely crucial here, because it contributes to both the speed and the valuations at which angels will make commitments to founders. It’s an innovation subsidy that works in the best possible way, but it only works in places where those social returns are actually valuable.

Now, I don’t mean to argue that this is the way forward for the African tech ecosystem. It’s not. But if Silicon Valley angels largely invest for the social returns, what is the equivalency for the African ecosystem?

During Season One of The Flip, we published an episode on blended finance and discussed the experience of entrepreneurs having to raise from a myriad of funding sources. Here’s what my b-mic Sayo Folawiyo had to say, 

And it’s also the nature of the problems. You’re building sustainable, profitable, impactful businesses – so it should be raised through profit seekers, impact seekers & sustainability seekers.

At the time I thought this was a good thing. Now I’m not sure. 

Whereas startup building elsewhere in the world is a purely commercial endeavor, in the African tech ecosystem it’s “blended”. To what end? 

Development agencies or DFIs or grantors are undoubtedly well-intentioned, but inherently and inevitably driven by their own agendas. Corporates or HNIs being pitched to “support the development of the ecosystem” can’t necessarily be faulted for misunderstanding the relationship between their investees and them. 

So how do we reconcile? Perhaps it starts with clarity – on both sides of the table – and with empathy. Maybe it’s as much a timing thing as anything else. I suspect a culture of angel investing is an inevitable manifestation of an ecosystem that has gone through a few cycles. 

Danco writes of the natural exportation of the Silicon Valley approach to angel investing,

The good news is that this export of “angel investing as social status subsidy” is happening naturally, as people move way from the Bay Area and seed their local tech communities with that particularly useful kind of FOMO and status anxiety. 

Maybe it’s investment communities like Rally Cap and Future Africa, with an ethos inspired by Silicon Valley, pulling the African tech ecosystem along. Or, maybe it’s something entirely new or different altogether.