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March 02, 2007

Should VCs buy out angels?

Interesting discussion at VentureWoods between Deepak Shenoy and Roshan D'Silva on this "perennial topic". Here are their first posts (in the comments section):

Deepak Shenoy said,

Alok, true - there is reason to think about why one wants to exit. As a stock market investor, I have made decisions to sell companies at (say) 400% profits, when the company went on towards 1000% of what I bought - yet, I wasn’t sulking in a corner. Because a) 400% is pretty nice and b) I’d reached that comfort level of profits.

Angels may not want to stay the distance, which could be much longer than their cash needs, and if the current valuation is attractive enough for them to exit. As individuals I would imagine that angel investors are the kinds that put in Rs. 10 lakhs to Rs. 50 lakhs in a business - and honestly, there are a number of such people who have this kind of cash lying idle in bank accounts (idle = they don’t need it right now). Such people can be angels, but they won’t be because VCs won’t let them book profits until the final exit, years away. Which again they have no control over because further rounds have diluted their stake too much.

The US has a huge background of such deal flow, but it’s absent in India. I was hoping a VC would take the lead and say that they would fund angel exits here (even partially so) and more angels would come out of the woodwork. We need those angels, if only to make more companies VC worthy…

Roshan D'Silva said,

Hi Deepak,

I think the angels you’re referring to are probably those that fall into one of the two categories:-
1. Purely financial a.k.a the family rich
2. People whose net worth does not afford them the luxury to ‘angel’ - (20k - 100k usd in the bank wanting to angel?? ;-) )

They typically make the usual mistakes - getting in at too low a valuation, adding no value, bickering, neglecting paperwork etc. etc. Category 2 usually in a few years realizes that they’re not in the ‘zone’ and go into other asset classes. For Category 1, it really does not matter.

The really good angels are very focussed on getting their portfolio companies funded and typically their angel rounds are done as debt convertible into equity at a discount to the subsequent round valuation. This also eliminates any negotiation between the angel and the founder and motivates them both to do ‘fair deals’.

For companies (trying to raise money) or VCs (wanting to invest in a company) who is stuck with angels of categories 1 &2 I would never suggest providing an exit to the angels. I would rather make the founder take on debt (which could come from the VC or a new ‘real’ angel) and let him/her negotiate to buy out these guys before the VC round. If the founder’s unwilling to do so, I would want to think along Alok’s lines.

Of course, I’m talking about ‘real’ VC’s investing in ‘real’ companies that can exit at 100mn+ numbers.

Arun Natarajan is the Founder & CEO of Venture Intelligence, the leading provider of information and networking services to the private equity and venture capital ecosystem in India. View free samples of Venture Intelligence newsletters and reports.