Why Angel funding is killing innovation

I’m a fan of Max Levchin and his fellow Paypal alumni because this group has spent the past five years creating many of the more interesting Silicon Valley startups.

Levchin recently sold Slide to Google and he is an investor in Yelp and several other startups. And he is still young and has a lot more to add to his Wikipedia page before he is done.

Levchin writes on his blog, but only very occasionally. One such occasion was fairly recently, his first since mid-2008, a critique of Silicon Valley’s angel community.

Angels have done very well for themselves over the past few years and this includes many of his former Paypal colleagues.

In his latest post: On ambition « You’ve gotta be kidding me he writes that the Angel method of investing in startups is considered a better method, “an antidote” to traditional VC investing.

Silicon Valley Angels have done well by choosing companies that can exit (sell themselves) fairly quickly, at fairly low values, $10 million to $20 million. While this approach makes money for the angels and their investments, it tends to discourage building breakthrough companies.

Angels advise startups to take smaller and earlier exits, which minimises Angel risk but does little to develop startups with big dreams.

It’s an astute observation and it is something that I’ve been thinking about over the past couple of years. I meet with a lot of startups and I remember meeting with Levchin when I was at the Financial Times, and he was at Paypal; and hearing about Paypal’s ambitions. Similarly with the founders of Yahoo, Salesforce, Google, Facebook and other groundbreaking companies.

Today, it is rare to find startups that think beyond being lucky to survive two years and be sold.

Yet even a few years ago we did have startups with grand designs. For example, I was an early admirer of Ribbit, a plucky startup that had the potential to disrupt the Telco industry.

Yet in mid-2008 it agreed to be bought by BT, the British Telecom giant. I was very disappointed: Are we seeing a disturbing trend in “blackmail” innovation…? | ZDNet

Since that acquisition Ribbit has launched a cool iPhone app but not much else. It has been dead quiet under the ownership of BT — yet at one time this was an ambitious team taking on the world.

Levchin sees the rise of the Angel and “Super Angel” investors as the key factor in the lack of “significant innovation” today.

At the moment, what amounts to lack of visible significant innovation seems to correlate with abundance of angel-funded startups shooting to get picked up for a fistful of dollars.

We should aim higher.

I agree.

It’s easy to understand why Levchin takes this position. He and his team built Paypal into a formidable company that eBay was happy to acquire for $1.5 billion. That’s a hundred times more money than the $10 million to $20 million exit rounds of Angel investors.

Because Angel investors are investing smaller sums of money there is little incentive for them to take larger risks. However, traditional VC firms will invest at higher valuations and therefore will be less willing to sell for a “fistful of dollars”.

The VC firms require a larger exit, and that’s why they set a greater goal for their startups: to own markets of $1-billion and more — this creates startups with far higher expectations. And that’s what Silicon Valley needs if it is to produce the next Paypal, Google, Salesforce…

Levchin makes an important point in correlating the rise of the Angel investors, with the fall in innovative startups.