PART 3: Valuations and blurring of lines between angel and venture capital

Dollar Sign(EDITOR’S NOTE: For the third year in a row, we asked angel and venture investors who live in East Tennessee to share their thoughts on 2014 and their predictions for 2015. We were fortunate to have three individuals provide their insights. Today is the third article in the six-part series.)

TODAY’S QUESTION: There’s been a good deal of talk about two topics – valuations being too high and the lines between angel and venture monies getting more blurred. What are your thoughts on these topics and how they play out in 2015?

David Belitz, Managing Partner, Chattanooga Renaissance Fund:

I believe the market will take care of itself. We will always need angels and VC’s, the lines will blur overtime and then become crisp and sharp again as the normal cycle of investing waxes and wanes. I do believe valuations are becoming high and will become an issue. I’m not sure if it is 2015 or if it lasts several more years, but eventually I think we will see a natural shake out of companies that have real businesses that can generate a profit and those that were just really big marketing machines that never make a dime.

Eric Dobson, Chief Executive Officer, Angel Capital Group:

Nationally, early stage venture money is practically nonexistent. This state is aberrant due to the TNInvestco program. Rising valuations are not always a bad thing. The amount of equity a company can give upper round is fixed within reason.  The question is how much money can you get for the equity. At a certain point, companies can’t raise enough capital to execute their business plans (translation: “undercapitalized”). This was a key risk factor for company survival from 2008 to 2013.  However, if valuations become too inflated, it leads to negative consequences.

Valuations in Silicon Valley (SV) are again off the charts, and, if history is any indicator, that could be a bad signal. Valuations are rising around the nation, but not at the rate of SV. This year was dominated by convertible debt deals, but seems to be moving back to priced rounds heading into 2015.

M&A activity in 2014 finally regained its pre-crisis level. 2015 is expected to be a strong year for mergers and acquisitions, driven by corporations with large amounts of cash on their books seeking more productive use of capital and facing negative real interest rates. In short, cash is becoming a hot potato – corporations that have maintained large positions in cash against uncertainty are now selling cash and buying future revenue (companies). As angel investors, we are pretty far upstream from the M&A market – but not so far up that we can’t hear the sound of the waterfall down river. The noise of the water fall is definitely picking up.

Tony Lettich, Managing Director, The Angel Roundtable:

The Angel Roundtable has encountered increasing valuation expectations from entrepreneurs during the last 12 months. We do not perceive it to be to the point of being pervasive or “bubble-like.” However, as disciplined investors, we have stepped back from a couple of interesting opportunities as a result of the entrepreneur’s valuation expectations.

We do see a blurring of lines between angel and venture capital. From our perspective, it’s a good thing.  Opportunities to syndicate with VCs are presenting themselves and in doing so, our members obtain a better understanding of what is required for VCs to fund an opportunity in future rounds. The result is increased discipline within the angel network as they better understand the VC’s expectations, and higher probabilities of success as angels and VCs work together toward subsequent round financing for these fast growing start-ups.

Kristina Montague, Managing Partner, The JumpFund:

Valuation seems to always be the hot topic of conversation, both that investors expect much lower valuations in the Southeast for early stage, pre-revenue companies and that entrepreneurs are starting out with unrealistic and unfounded valuations. Convertible-debt is the other side of this topic that is much debated in angel investor circles.  Many entrepreneurs and some investors feel that since it is difficult to place a value on a very early stage company, thus it makes sense to use a convert until the company establishes revenue and can justify its value in an equity round. Others want to encourage founders to clearly define their company’s value early on for investors. Angels in the Southeast are also typically in later rounds (Series B+) than in SV and the East Coast which blurs the lines between angels and VCs (a Chattanooga Start-Up week speaker recently stated that “all angels are VCs and we shouldn’t kid ourselves otherwise”).

Geoff Robson, President, The Lighthouse Fund:

As noted in response to an earlier question, we have seen the general size of rounds getting larger and valuations growing with them. We look at these opportunities and try to decipher if the right milestones are being achieved and if they are being achieved in a capital efficient manner. It will not become too great of an issue, but I do think the investors will ask companies to rethink their approach to this and how they can improve execution to retain more value for the company and investors.

Grady Vanderhoofven, Co-Founder and Co-Manager, Meritus Ventures and Southern Appalachian Fund:

I believe the answer to the question about “valuations being too high” depends upon perspective. If you’re a founder and/or you’re running a company that’s raising money, you’re likely a fan of higher valuations. Investors generally are not fans of higher valuations, until it’s time to sell the business or raise more money from a new investor. The data available from the various sources that track statistics like valuation clearly indicate valuations are higher now than at any time in the past five years. I have interacted with companies that have what I believe to be unrealistic valuation expectations. The value of the stock market is at or near an all-time high right now. I think equity valuations are up across the board. I’m not an economist, but if I look back at the cycles that have occurred since I’ve been in this business, valuations appear somewhat “bubble-ish” at this time. Of course, there are regional variations with respect to valuation, so macroeconomic data may not accurately reflect local observation for everyone who might see these comments. Valuations tend to be lower when there is less capital chasing deals, and valuations tend to be higher when there is more capital chasing deals.

The angel investor community in this region has generally become more sophisticated over the course of the past 10 years, and I believe angels are more active when they feel like they have more capital to deploy, which is the case right now. I do believe there is more overlap in angel and VC investment activity today, and I believe one of the drivers of that overlap is the fact that we have relatively smaller VC funds in this region than is the case in more traditional VC hot spots.  Smaller funds tend to invest in smaller deals, which generally are more accessible to angels. Also, as some funds have migrated toward investing in more mature companies, some angels and angel funds have moved into the space that might historically have been seen as the domain of seed stage and early stage venture funds. I don’t think “angel” necessarily equates with “seed” in all cases, but seed stage deals tend to be a better fit for angel investors with respect to the amount of capital being raised.

Ken Woody, President, Innova Memphis:

The lines between angel and venture monies will continue to blur as we see VCs willing to coinvest with angels and angel investors becoming more sophisticated. Crowdfunding has definitely pushed up valuations nationally creating a bit of a problem for follow-on investing if the initial valuations were unreasonably high. This results in first investors and founders getting diluted more than they would desire.


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