Data On Seed Stage Investing

Here is something interesting that I found yesterday on early stage investing.  It’s a study from Harvard Business School.  The one conclusion I can make out of it is networks matter.  They matter a lot.

When I traded, people on the floor were my network.  They gave me ideas, told me when I was nuts, supported me, mentored me.  The collection of American trading floors ($CME, CBOT, $CBOE, NYSE) was possibly the greatest network ever assembled in human history.  You could get anything you wanted from it.  Capital, hotel rooms, business deals, information, jokes.  What a watering hole.

One of the problems with networks is they are squishy.  How do you know when you are in a good one?  I new I was in a good one on the floor.  There was plenty of evidence.  Professor Ron Burt at the University of Chicago did a lot of research on internal corporate networks that I think can be transferred to virtual networks we have today.  It’s extremely difficult to build a good network from the ground up.

This study looked at two angel groups and their investment from 2001-2006.  Common Angels out of Boston, and Tech Coast Angels out of Irvine, CA.  Neither are in Silicon Valley, and the time period includes the “nuclear winter” post tech crash.

The study shows the importance of network.  “we identify the threshold where a critical mass of angels emerges around a deal. Our approach compares firms that fall just above this threshold with the firms that fall just below.”    I wonder if this can be extrapolated to the networks Venture Capital firms set up.  Hence the question, “Who else is committed to this round and for how much?”

But, here is the interesting point.  Survival.

Several clear patterns emerge from our analysis: First—and not surprisingly—the interest levels expressed by angels in deals are a substantial factor in funding decisions. Second, when we compare, within a narrow quality range, firms that received funding to those that did not, the funded firms overall look more successful than those that pitched to the angel group but did not receive financing: They are 20%–25% more likely to survive for at least four years (or until December 2010, the last date of our data). They are also 9%–11% more likely to undergo a successful exit (IPO or acquisition) and 16%–19% more likely to have either reached a successful exit or grown to seventy-five employees by December 2010. Funded companies have 16– 20 more employees as of 2010, are 16%–18% more likely to have a granted patent, and are growing faster as measured through Web traffic performance between 2008 and 2010. In addition, funded companies are better financed. Overall, they have a 70% higher likelihood of obtaining entrepreneurial finance and on average have a little less than two additional financing rounds. These subsequent deals are often syndicated by the angel group with other venture financiers.

In this age of Angel List and raising virtual capital, this study says money is not a commodity.  It also says that even if you aren’t in a formal angel network, it helps to band together and hunt in a wolfpack.

Another interesting side stat that they found, “We find that the angel group performed as well as the venture capital industry overall during the period of study.”  Returns were similar to venture capital.  Of course, returns during this period weren’t great.

Additionally, from other studies I have seen, the data shows it pays investors to go early.  Smaller funds (less than $250M) do better than larger ones especially if they invest in seed rounds.

I think that a lot of entrepreneurs do not want to go through the drudgery and deal with the peccadillos of angel groups. Instead, they go the Angel List route.  There is no data on Angel List investing yet-and it will be interesting to use similar criteria and compare when the timing is similar.  But, this study shows it pays entrepreneurs to go through the trials and trepidation of getting a good angel group on their cap table early.

From the investor perspective, if you are a lone wolf, it’s harder to do well.  It happens.  But there is power in having a good network.