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Avoiding A Rocky Marriage - How VCs And Angels Can Work Together

This article is more than 8 years old.

Some might say angel investors and venture capitalists have had a rocky history. Not too long ago, it was common for VCs to look askance at angels—at best ignoring them, at worst disdaining them. Over the past decade, I've seen those perceptions change. Today, most VCs recognize the value angels can bring to a deal, giving birth to a whole new way to work together.

Geoff Entress, a seasoned VC and now a full-time angel investor who has 90 companies in his portfolio, agrees. "I'm seeing VCs make room for angels in their deals, which often wasn’t the case before."

Entress and William Bryant, a former angel who now works as a partner at DFJ Ventures, will elaborate on how VCs and top angels work together to achieve success for themselves and the companies they invest in at an upcoming Angel Capital Association webinar on August 12.

I spoke to Entress for some insight in building these investor relationships. He confirms the increase in strong connections between VCs and angels, noting that VCs increasingly are leaving room in their deals, sometimes even at later stages, for top angels. Participating later offers the chance for even larger absolute returns.  At least half of the VC deals he participates in include angels.

Finding Common Ground

As more angels seek ways to improve how they work with VCs, it's important to understand how VCs operate - especially given the differences in both timing and investment strategies. For example, VCs use a 10-year fund model. They make all of their first investments in the fund’s first five years of the fund, and reserve the last five years for follow-on investments and exits. Before communicating with VCs about a deal, angels should be aware of where the venture firm is in the 10-year cycle, as it is generally better to get VCs to co-invest or do the first A-round early in the VC fund’s first five years in order to maximize the time before they start itching for an exit.

Angels should understand that, by the end of the 10 years, VCs will want a liquidity event. Unlike angels, VCs are investing other people's money, and therefore are focused on the best way to generate a return (generally an IRR of 25% or more) for their limited partners. VCs need to see exits within a reasonable amount of time. Angels have more flexibility in their exit/return timing and often can be more patient.

Inside the Deal

Angels who want to invest with VCs or get them to make follow-on investments should bring expertise to the table, particularly in leading deals. VCs often have favorite lead angels that they have worked with before or seek angels who bring new needed expertise.  As an angel, being a lead investor helps because many receive a seat on the board next to  VCs who they may be interested in working with in the future. Entress has done many deals with VCs after building relationships with them while serving on the same portfolio company boards.

Both angels and VCs play a role in helping entrepreneurs bring their ideas to fruition and get the right team in place to make the business successful. Entress said he spends more than half his time meeting with and connecting qualified business leaders who are interested in working in startup companies. As both an angel and VC he also makes introductions to help startups obtain additional funding.

No surprise, there are sometimes conflicts between angels and VCs, especially when VCs want to sell earlier than angels would want. Angels need to remember that once they take venture money, they will be on a different time line. It's important to understand this and communicate to avoid surprises.

And, when another round of funding is needed, angels need to be careful to protect their share. "The challenge for angels is making sure we can participate later, after our early investment," Entress said. "Even with some type of pro rata participation rights in the later round, sometimes it's honored; sometimes it's negotiated away.  As an angel, my goal is to get more money into later rounds of companies doing well."

Angels can also play a role as confidant to the startup CEO, helping him or her work with and manage VCs, and introducing senior team members.

The relationship between angels and VCs is a constantly evolving partnership. Any angel investing in a company that is going places would be well served by developing VC relationships so their portfolio companies can continue attracting investment for growth.