In Seed Funding Race, AngelList Sorts the “Junk” from the “Maybes”

8/20/10Follow @wroush

You don’t have to search far on Twitter for glowing testimonials about AngelList, a matchmaking service for startups and angel investors launched in February by San Francisco investor/entrepreneurs Babak Nivi and Naval Ravikant:

“Wow, just a few days and I’m pretty impressed by the quality of the opportunities”—Hunter Walk

“An entrepreneur’s best friend. Two companies just became over-subscribed thanks to the list.”—Keith Rabois

“If there was a Nobel Prize for helping the startup/angel ecosystem it would go to @angellist. :)”—Christoph Janz

“Love what Nivi and Naval are doing”—Satish Dharmaraj

“Angel List is killing it”—Mark Suster

Let’s leave aside the fact that tweeting about AngelList is a great way to butter up “Nivi and Naval,” as the two influential founders are invariably known. It’s still clear from comments like these that their operation is addressing a perceived gap in the ecosystem of tech entrepreneurship.

After all, the Great Recession of 2008-2009 appears over (at least in the Bay Area), and it’s become respectable once again to be a chaser of startup glory. That means there are many, many more entrepreneurs running around with business plans than there were a few years ago. At the same time, there’s a growing clan of successful serial entrepreneurs who have more cash than they really need (again, at least in the Bay Area, thanks in large part to the diaspora of Google, Facebook, and Yahoo alums) and who want to support the next generation of world-changing companies. To top it all off, it’s actually possible these days to start a software or Internet company for a few hundred thousand dollars in seed money—the kind of financing that an entrepreneur can assemble from a relatively small syndicate of angel investors, without ever having to set foot on Sand Hill Road.

But it’s a chaotic marketplace. It’s hard for entrepreneurs to know who has money to invest or how to contact them. And it’s hard for angels to sift through all of the proposals for the truly golden opportunities. That’s what AngelList is for: Nivi and Ravikant and solicit written pitches from entrepreneurs, winnow out the losers, and send the best ideas on to their hand-picked pool of angels.

Naval Ravikant“We’re helping startups raise money more efficiently from the people they want to raise money from,” says Ravikant. “And we’re helping angels by sending them high-quality deal flow. A lot of angels get hammered with deal flow, and a lot of it is junk. If we can screen out all the obvious nos and just leave the maybes and investment-grade deals, in one blow we have made the angel’s job much more efficient.”

Ravikant makes it sound easy, but there’s a real art to what he and Nivi are doing, and a few land mines that have to be sidestepped as well. These days, there’s automatically some skepticism toward organizations that try to insert themselves between investors and entrepreneurs. A case in point: When Boston-based Revolutionary Angels tried to set up a contest last year where startups paid $5,000 each for a chance to share their business plans with angel investors and perhaps win a $300,000 investment, critics attacked it as a “pay to pitch” scheme, and the negative PR eventually contributed to the contest’s shutdown.

But AngelList doesn’t take money from entrepreneurs or angels. The funds to run the SoMa-based operation come out of Ravikant’s pocket, together with a grant from the Kauffman Foundation. All Nivi and Ravikant ask—and it’s a suggestion, not a requirement, Ravikant says—is that startup founders give them a place in the seed round, if their matchmaking is consummated.

“We have no real ‘business model’ that I care about, and I’m happy not to have one,” says Ravikant. “I’m happy to do it, because as an active angel investor myself, I want to build a brand and get the best deals. This brand allows us to get into a class of deals that we would not be able to access otherwise. That alone will pay us back.”

The AngelList “brand” is itself a spinoff of another brand, VentureHacks, a blog that Nivi and Ravikant launched in early 2007 to give new entrepreneurs a better understanding of the venture capital industry’s inner workings. That’s a topic the 36-year-old Ravikant knows well, having made his name around Silicon Valley as the founder and CEO of the consumer review site Epinions.com (funded by Benchmark Capital and acquired by Shopping.com in 2003) and as a former venture partner at August Capital. Most recently, Ravikant founded and now chairs Vast.com, a pay-for-performance online advertising network for the auto, travel, and real estate industries. Nivi, meanwhile, was the president of Songbird, an online music startup backed by Sequoia Capital and Atlas Venture. He’s done entrepreneur-in-residence stints at Atlas and Bessemer Venture Partners and is now an advisor to multiple startups.

Babak NiviThe very first post at VentureHacks, back on April 1, 2007, was called “Term Sheet Hacks” and was full of tips for entrepreneurs preparing to go up against steely-eyed venture capitalists in deal negotiations. The blog has won a large and fervent following, with 40,000 RSS subscribers. But Ravikant says that as the angel investing culture gained momentum, the pair came to realize there was a group of entrepreneurs whose fundraising challenges start long before they get to the stage of approaching venture capital firms.

“Problem Number 2 for startups is how to negotiate a good term sheet,” says Ravikant. “Problem Number 1 is how to get a term sheet in the first place. That’s what Nivi and I set out to do with AngelList.”

Ravikant says that if he were starting over with AngelList now, he’d probably pick a different name, because it’s not really a “list” or a directory in the sense of Angie’s List or Craigslist. Angel investors can’t automatically sign up, and entrepreneurs’ pitches don’t automatically get their pitches sent to every AngelList angel.

“We reject probably more than half of the angels who apply, because they are not serious,” says Ravikant. “We try not to reject real angels who have been out there making real investments, but the guy sitting in Dubai who just read a TechCrunch piece and decides he might angel invest someday, we don’t want to corrupt the list with that.” At the time of my meeting with Ravikant in early August, there were 95 angels on AngelList, plus another 60 venture partners looking for seed-stage deals, as well as nine incubator programs, according to Ravikant.

On the startup side, the competition is even stiffer: Ravikant says he and Nivi receive anywhere from 15 to 200 pitches per week, and pick 2 to 3 percent of them to send on to investors. There’s a lot of pre-screening, based on what Ravikant and Nivi already know about their angels’ interests and specialties. “There’s just a lot of stuff that is wrong for our group of angels—it might be a hotel or a restaurant or a biotech company in Geneva,” he says. “And there are a lot of judgment calls. I ask, could I see myself investing in this company?”

Since February, AngelList has helped “dozens” of companies raise money, according to Ravikant. But only 12 or so have gone public with their funding details, including Thumbtack.com, an online marketplace for local services, and LearnBoost, a maker of software for teachers and schools that I profiled a couple of weeks ago. “The non-obvious value Nivi and Naval provide is that they are like sherpas helping startups scale the Mt. Everest that is fundraising,” says Rafael Corrales, LearnBoost’s co-founder and CEO. “The fact that they’re helping founders out for free just makes AngelList that much more valuable.”

In a June post on VentureHacks, Nivi described how one AngelList-mediated deal came together. The startup in this case was BlockChalk, a service in San Francisco that helps users communicate with other people in their neighborhoods by leaving place-based virtual notes or classifieds. AngelList was introduced to BlockChalk by Joshua Schachter, the Del.icio.us inventor and former Yahoo employee who’s now an active Silicon Valley angel. After word went out to AngelList investors, the company won seed funding from Mitch Kapor (founder of Lotus), Thomas McInerney (creator of the Usenet search engine Guba), and Josh Stylman (co-founder of Rotomedia and Reprise Media). Through Stylman, BlockChalk connected with Chris Dixon and Eric Paley of Cambridge, MA-based Founder Collective, who also invested. Then Battery Ventures’ Satya Patel, Harrison Metal’s Michael Dearing, and former AOL exec David Liu piled on (though not through AngelList referrals).

“What this shows is that the old model of angel deals is alive and well,” writes Fred Wilson, the Union Square Ventures principal whose site A VC is probably the world’s most widely read venture capital blog. Wilson is one of the venture capitalists on AngelList, and he lavished praise on the organization in a July 24 post. “Angels love to share deals with each other. It is how angel rounds come together,” Wilson wrote. “But AngelList adds at least two things to the mix. First, it adds a place where the deals can come together online. And second it adds people to the mix that would not be part of the offline deal sharing networks that already exist.”

Ravikant says running AngelList is pretty much his full-time job these days—but that’s partly because he sees it as an extension of his own angel investing. Nivi also works full-time on AngelList, using VentureHacks as its “marketing arm,” in Ravikant’s words.

But while AngelList may fill a gap by connecting the most promising startup founders with the most appropriate investors, Ravikant cautions that this is only the final step in the angel investing process. “I think the way to get into angel investing is, first, you obviously have to have money; you have to have a brand, otherwise you are not going to be differentiated and you are not going to see good deals; and you have to have a network of angels to work with, so you can move in packs and find other people to help you with due diligence,” he says.

It’s only then that AngelList can help. “The final thing is that you need to have good deal flow, so that you can see when the good things come along,” Ravikant says. “We will bring you deal flow, make it easy to syndicate deals, and we’ll show you deals that hopefully over time match up to your interests.”

[Update, 10:50 a.m. PT, August 20, 2010: Investors and startup entrepreneurs are generating an extensive discussion thread today about AngelList at the question-and-answer site Quora.]

Wade Roush is a contributing editor at Xconomy. Follow @wroush

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