Funding Markets Develop in Reverse

I co-founded AngelList because I was tired of saying no to entrepreneurs. I wanted to say instead, “yes, we can help you get funded.”

So, it’s especially disappointing when we get promising startups pitching on AngelList from remote locations. Some we’ve managed to get funded – including ones in Canada and Europe. Others are harder – especially in Russia, Latin America, and Asia.

The problem, as I’ve come to realize, is that funding markets develop in reverse.

In any given geographic region, the first companies that get funded are the ones that least need funding. They have strong operating histories, auditable financials, predictable cash flows, etc.. Funding these companies is less risky, and so a secondary, and then a primary, market forms around them. Call these the public markets.

After the public markets come the mezzanine investors, investing just before a company goes public. And because the mezzanines now exist to pick up risk, late stage private investors start forming behind them. And so on and so forth until you end up with Seed incubators and Angel investors.

Essentially, the single biggest risk that you have as an investor is “downstream financing risk.” The risk that the company won’t be able to raise more money once it has spent all of your cash.

This explains the apparent paradox that in less mature innovation cities, you’ll have an easier time finding VCs who will invest $10M in a mature business, than Angels who’ll invest $100K in a raw startup.

It’s a measure of the incredible strength of the Silicon Valley ecosystem that Y Combinator has chosen it as its hometown. YC and its brethren can only exist because of the rich Angel ecosystem. Paul Graham was smart enough to realize that his graduates couldn’t function without a rich Angel ecosystem, and went to great pains (such as AngelConf) to foster it.

Similarly, the true evidence that the NY Angel market has finally blossomed is that TechStars and a number of other seed combinators are choosing to do business there.

As an entrepreneur choosing your base of operations, take a careful look around. If you don’t see many VCs, you’re not likely to find many Angels either. Even though the VCs invest more money, they actually take less risk.

Similarly, Angels should realize how this whole pyramid functions. Investing in companies that won’t have access to Venture is incredibly risky. Investing at Venture valuations in Angel-stage companies means that your portfolio will likely generate negative returns.

Finally, if you are one of these talented entrepreneurs in a “frontier” location where there aren’t enough angels around, you have two choices. You’re either going to have to bootstrap to the point that you can show real financial returns, which will attract local and foreign investors. Or, you should consider relocating your headquarters (although not necessarily the whole company) to a funding hub.

9 thoughts on “Funding Markets Develop in Reverse

  1. Are there many success stories of your implied last proposal? (Relocating the headquarters, but not the entire company?) My former employer’s HQ was in a venture-friendly city while the engineers were 2500 miles away where the progenitor company had been founded, and the long-distance management was an impossible burden; the assets are up for auction next week.

    1. I think Skype had the founders in London a fair bit, and there are plenty of companies with front-ends in SF and back-ends elsewhere. There are anecdotes on both sides. However, you’re right in that it’s certainly not easy. The far and away best solution is to have the entire company in a funding hub.

  2. You mention Canada and Europe. What about inside the US, but outside of Silicon Valley, NY, Austin, or Boston? For example, is is possible to get a company in Ohio or Indiana angel-funded?

  3. What about 2 guys sitting in the middle of nowhere, to be precise in Serbia ( Europe ) with a brilliant idea, however lack of resources…money. Imagine a system which can track more than 100.000 users real time and make software changes. How about thought that we build a factory which is producing software…

  4. I live in Malaysia because it is the centre of where all my work is. I work in Disaster Recovery and Development which in Asia is a $270 billion dollar a year industry.

    Singapore along with New Zealand has the highest level of business transparency in the world, the US unfortunately has now dropped out of the top 20 in the world. Asia now has more High Net Worth Individual wealth than Europe according to Merrill Lynch, what it doesn’t have is a easily accessible platform like where you can quickly put your pitch to interested investors. (not that it has so far worked for me but that is beside the point).

    My argument is perhaps investors in the US need to look outside their own backyard for some great opportunities that the world has to offer.