Why It’s Preferable for Angel-backed Startups to Reject Venture Capital Funding

by admin

In a previous post, I talked about some of the reasons why it might make sense for an angel-backed startup to reject venture capital money, summarizing a great article by Darian Ibrahim.

Here, I want to summarize Prof. Ibrahim’s points about why it might actually be preferable for some angel-backed startups to reject venture capital funding.

Earlier exits

It’s long been thought that entrepreneurs wanted to continue running their startups so they enjoy the benefits of running their own ship.

However, many prominent angels, including Basil Peters, have stated that both entrepreneurs and angel investors would prefer to exit earlier because that results in a greater time-adjusted return on investment.

Also, as many are aware, many entrepreneurs suffer from founder’s syndrome. By selling their companies earlier, such entrepreneurs are able to go off and start their next big idea, instead of hanging around for years pushing a startup to some exit that would appeal to VCs.

Because VCs typically invest larger amounts than angels, they require much higher valuations on exits.  When you also consider that most performers in a VC firm’s portfolio are not that great, you begin to understand why VCs are so dependent on the homerun companies that return 1000x that keep the overall portfolio performance in the black.

Related costs & geographic flexibility

While angels typically invest in equity, VCs often take preferred stock. This adds not only complexity and costs to funding, but can even lead to different incentives for VCs and entrepreneurs/angels.

Finally, Prof. Ibrahim claims that angels have more flexibility in terms of where they live because they are not constrained to stay in Silicon Valley or Boston, as many VC firms are. In fact, some angels can even afford (because they are independently wealthy) to live in places with less dealflow.

Though these two reasons may be viable, in my opinion, I’m not entirely convinced. After all, how many angels actually choose to live someplace that doesn’t have great dealflow? In my opinion, the most compelling reason to reject VC funding is simple: you can get a greater return if you don’t dilute your ownership stake. Taking VC funding means you give up a large chunk of your company (usually anywhere between 30% and 40%) and a few board seats. If you early stage with little traction or cash flow, you might give up even more.

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