There is No Angel Bubble. There are Many Angel Bubbles.

A common meme floating around right now is that there is an Angel investing bubble.

In the sense that an enormous amount of capital is being placed at risk, and its popping will have grave macro-economic consequences, No.

The total amount of additional capital flowing through the Silicon Valley early-stage ecosystem, thanks to Super-Angels and newly minted millionaires, is on the order of half-a-billion dollars or so. It’s no more than a middling-sized VC fund. Would the emergence of a new VC fund be considered a bubble? Would the collapse of one signal disaster?

Furthermore, most of this capital is replacing traditional Series A deals. As we say around here, “Seed is the New Series A.” The same companies that needed $3M to launch now need $30K-$300K to launch. So, it’s not surprising that there are many more of them.

Ok, but could that mean that the amount of capital for funding startups in the old environment is too much for the new environment? That the total supply of early-stage funding dollars should come down by a factor of ten rather than the number of companies being funded go up by a factor of ten?

This one is harder to ascertain, but my sense is that if there’s too much capital, it’s not an overwhelming overhang. Most of the small companies being funded will fail, but the ones that hit will generate fantastic returns. And because of their small size and operating costs, a greater percentage will be able to get “ramen profitable” than was traditionally possible. Of course, actual exits might still be rare. The volume of small M&A deals hasn’t scaled with the volume of Angel investments in small companies. I think we’re all going to have to become even more comfortable with failures, re-starts, and the kind of team re-combination that one sees from one Y Combinator Demo Day to the next.

One thing that has been happening is that Angel investment valuations have been climbing very quickly – un-sustainably so. Twenty companies in an Investors’ portfolio carried at a valuation of X might now suddenly be twenty small bubbles at a valuation of 2x. They may not be able to clear their valuation in a micro-acquisition, or lead to a down-round in a VC financing, or just give a sub-par return for what might otherwise have been a hit. Prices on the margin *have* been rising, and that will hurt returns.

Prices have been rising not because of a huge influx of money (no big, macro bubble), but because of a modest influx of price-insensitive money. Prices get set on the margin. On Wall Street, it doesn’t take an influx of $5 Trillion into the stock market to move the total market capitalization of all of the companies from $15 Trillion to $20 Trillion. (In fact, money never moves into the stock market – it moves *through* the stock market, but that’s another post). Rather, a small series of secondary transactions at the margin, done by price-insensitive buyers at high prices, can move the quotational value of each stock considerably higher. Similarly, a small number of high-profile Angel investments, moving small amounts of capital but at very high valuations, can make the entire market look overvalued.

So what’s driving the new, price-insensitive bidders? It’s three things:

1) VC Funds – Every VC that announces a $20M seed fund is basically a price-insensitive Super-Angel. They’re buying first looks and options to finance companies in the future, so they’re not particularly price sensitive. When you have $1B under management, $20M is pocket change.

2) Entrepreneurs Set Pricing – Leaderless “party” rounds often end up with the entrepreneurs setting the valuation. And clever entrepreneurs are getting the less price sensitive investors to sign off on the initial terms, and then taking those terms, social proof in hand, to Investors who would have been traditionally more price sensitive.

3) New Angels – People who have had modest exits and are now angels are just building their portfolios. They don’t have enough exits under their belts to understand that price does matter. Not as much as in other businesses, because a Power Law distribution here means that one winner can dominate your whole portfolio. But it still matters because a lower price allows you to pick more startups in the hope of finding that one winner. New angels often hear that “If it’s the right company, price is irrelevant.” That’s true, but that gives too much credence in your own ability to pick the right company. If you’re informed just enough to know how un-informed you are, then you doubt your ability to consistently pick winners, and a low price will give you more attempts to figure it out.

So does this always end in tears?

For VCs, they will look back at these seed funds and find that (a) their seed efforts didn’t have the best returns and that (b) they didn’t always get the first look options that they always wanted. But it will probably still pay off. Seed is the new Series A, and if you don’t do Seed, you’re basically retreating to later stage.

For Angels who are price-disciplined, things will be fine – we are undergoing an incredible renaissance in technology, with smart phones taking computing to local arenas and social networks taking it into the mainstream populace. There’s a lot of opportunity and great companies will be built. For un-discplined Angels, there will be pain (unless they find their one big winner early), but it’s part of the learning curve inherent in the business.

Entrepreneurs win big, all-around. There has been some concern that all of these small companies are going to get orphaned – who will fund them downstream? I don’t necessarily view this as a negative, though. Even failed, these entrepreneurs are going to be much more employable than those who never tried or had the opportunity, and given that the minimum efficient scale of businesses is getting smaller and smaller, more of them will succeed than in any previous generation.

Entrepreneurs sticking to the old model of hiring are getting hurt. The old model used to be that after a Series A, you could hire an engineer and give him 0.25% of the company. Good luck hiring a great engineer for that in Silicon Valley now, for a freshly-minted startup with a small seed round in your pocket. The opportunity cost for that engineer is now to go join a Seed Combinator or raise some Angel funding. So, we’re going to see the equity gap narrow between the founders of raw startups and early key team members. Only the best startups with high valuations and tremendous traction can recruit under the old formulas anymore.

32 thoughts on “There is No Angel Bubble. There are Many Angel Bubbles.

  1. Wonderful essay Naval – thanks for doing this and laying out in all its pieces and glory what has been oversimplified. Indeed, your last graf (“Entrepreneurs sticking to the old model of hiring are getting hurt”) probably deserves a post of its own too.

  2. Great reading Naval.

    Nice points and I agree with most of them.


    Vengo Ventures

  3. Nicely stated but to be blunt, quite dated. There is a bubble in terms of the raw number of startups seeking seed rounds per day. That velocity has more than tripled in the past two years, which any seasoned SV angel investor would readily verify. That fact alone results in significant ecosystem disruptions and set point changes, some of which you note fairly, others which you are oblivious to, and others which you brush away nonchalantly. One has to question the validity of your views overall then and pay credence to your lack of extensive angel experience and lack of operational success as an entrepreneur. Do you rally know enough to know the impact of these trends or are you guessing as best you can?

  4. I’m really glad to hear you advocating price discipline on the part of angel investors. I’m shocked by the number of folks who don’t seem to care about pricing in deals. If you pay twice as much, you cut your returns in half.

    Of course, it’s important to bear in mind the converse–seed stage value investing is pretty much an oxymoron.

  5. As I noted, the increased money is being spread over many more startups so, yes, the velocity has increased. Maintaining AngelList, I see it first-hand. The ad-hominem attack is un-necessary, and my investors are quite happy with my track record as both an angel and entrepreneur, both of which you are welcome to Google at your leisure.

  6. Here I am holding out for as long as I can until I get more and more traction, and the market warms up again so I can get a better valuation and now we’re in another bubble. Now I need to rush to get funding before the bubble bursts and my company is bankrupt. Tough times for web entrepreneurs these days!

    Thanks for writing this post Naval, very eye opening!

  7. Extremely well said, Naval. Seed is the new series A, and we are witnessing a fantastic new renaissance in technology. Most significant, though, is that we all need to gain more comfort with failures, pivots, re-trys. We’re going to need to move faster, be more nimble, respond (with our Founders) to changes in markets and opportunities with more clarity and vision. Investors need to be 24/7. And thank you for calling out the fact that price, in fact, does matter. Both for Founders and for investors alike.

  8. Naval… you are obviously singing for your supper 🙂
    nothin wrong with that.

    all bubbles had someone reasoning them out before they burst…

    there could be rippling-collateral damage… like kpcb getting burned by loosing all their money in twitter 😉

    just another view…

  9. “Whose bread I eat, his song I sing”

    But check the post carefully, Ashok. I’m not saying that there is no froth. I’m saying that the problem is in the price of the companies getting funded, but that the higher volume is not unusual, given the underlying structural changes.

    As with any complex system, there are many subtleties. Thanks for reading.

  10. Not all VCs are price insensitive option buyers

    We approach seed like an angel would

    It’s the only way to do it

    And we haven’t done a seed in a year because we can’t find any that make sense

    The one caveat would be schachter’s tasty labs but that was really a traditional series a led by two vc firms at a seed stage

  11. Thanks Naval, this is enlightening and informative. We entrepreneurs have so very many things we must focus on, and in my opinion of the hardest to understand in the mindset of investors. Insights from folks like you are extremely helpful, and I appreciate it.

  12. “not all men are insensitive a-holes”

    perhaps true, but from an empirical perspective, they are… at least relative to women.

    the same is true for your denial above fred, relative to smaller [professional] investors.

  13. Fair enough Fred. I have seen some firms that are smaller and are experienced doing Seed deals are often even more price disciplined than individual angels. Perhaps having partnership dynamics keeps one more disciplined.

  14. This is a nice write up and picks up a focus often forgotten- this early stage abundance is good for entrepreneurs and engineers. Too much money in this early stage is froth on a very small scale. But with the benefit of teaching your leaders how to lead and build. We are all better off for the next companies that will come from the experienced entrepreneur who has benefited from being funding with an extra $500K.

  15. Nice post. Can we extend this idea by merging two different kind of bubbles (possibly) in the tech space? – I mean not just for early stage startups but for tech in its entirety: The bubble of good investments and another of bad investments. If the total size of bad bubbles (sum) is greater than the sum of good bubbles, the situation is precarious for all.

    N.B: I have come to your blog for the first time.


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