angel investors as hybrid unifiers

Investors thrive on social validation and follow trends. Innovators thrive on social invalidation and create trends. How can such completely different mindsets meet in the middle and cooperate for a common goal? Leaps of faith? Heaps of information asymmetry? Well, the real answer lies in the existence of a hybrid class of creatures called the angel investors, the most successful of whom are usually entrepreneur-turned-investor types.

Social Decoupling

Since angels manage their own money, they can more easily decouple themselves from the societal expectations, make independent decisions and stay away from consensus driven homogeneities.

Lastly, consensus frequently kills the outliers. Within venture firms, there are countless examples of firms passing on seed-stage deals because they were crazy ideas and consensus didn’t exist, only then to watch them grow into unicorns. Nearly a decade ago, Atlas changed its approach to seed investing in that any individual partner could back a “seed deal” (size delimited) without consensus support. This empowered partners to take some risk. As those investments mature, we generally move towards a team consensus as capital intensity increases. But at the earliest phases of the decision process, when uncertainties are high and getting to consensus could prevent leaning forward into a “risky” seed, we think this approach works.

Bruce Booth - Biotech Startups And The Hard Truth Of Innovation

Contrarian Spirit

Since angels are usually tech entrepreneurs themselves (or were so in the past), they can more easily resonate with the early stage ambiguities and challenges facing an entrepreneur, and be generally more accepting and tolerant. For the same reason, they also exhibit the most contrarian behavior among the investor folks. In fact, they like the cutting edge so much that they actually stay away from the existing trends. They like being right while others are wrong. In other words, they care for a particular kind of social validation. General public does not have the intellectual sensibility required for the epistemological jealousy they are after, but the other angels do. That is why angel investing thrives only in communities.

From the outside, angel investing may look like it’s motivated simply by money. But there’s more to it than that. To insiders, it’s more about your role and reputation within the community than it is about the money… No one can really predict what startups will succeed or fail, no one can really predict what trends are real or illusions, to any genuine degree of confidence. But everyone has to get up every morning and put on a bit of a show: that you are perceptive, you are brilliant, you are contrarian, and you are right.

Alex Danco - The Social Subsidy of Angel Investing

Note that this is not about being contrarian per se. You need to be both contrarian and correct. So angel investing is a stressful affair. It is one of those jobs that most people would not do just for money. That is why angels are given almost the same heroic treatment as entrepreneurs.

Domain Knowledge

Since angels are not restricted by any investment mandates, they can freely explore the edge cases. More importantly, due to their past entrepreneurial experience, they tend to have deep domain expertises that generalist investors by definition lack. Their backgrounds and their networks allow them to significantly de-risk their positions.

Remember, risk is in the eye of the beholder. As a company matures its risk profile becomes more quantifiable, but at the very early stages, its risk profile is very qualitative and resistant to the formulaic approaches thought in business schools. The ideal investor profile required for each early stage company is actually different. That is why (again) you need a whole ecosystem of angels who can handle different types of investment theses and entrepreneur teams. (Personality match is also important.)

I like to picture the dynamics in the tech investment world as follows. There are certain individuals, called entrepreneurs, who are far ahead of the general public. The first tenuous link these people establish with the society is through angels who collectively act like an umbilical cord. As the company matures and passes the test of time, increasingly bigger and increasingly more conservative investors step in to help with the actualization process. Finally, at the very end, the risk profile of the company becomes ready to merge with the general public via an IPO. (Tech companies used to IPO a lot earlier but this was primarily due to the immaturity of the private capital ecosystem. I believe that it is financially more natural and morally more appropriate for these companies to meet the public later in their life cycles.)