Sunday, July 8, 2018

Angels Choice: Direct Invest or Accelerator Fund

Angels: Direct Invest vs. Accelerator Fund
Angels that take a position in a pre-seed, seed, or emerging company are now often looking at accelerator funds as an alternative to direct investment. Investments into start-ups as part of an angel group is becoming passe' in favor investing in accelerator funds. 

Angel groups (investor collectives) that pool funds and management have been an important organizational innovation which started in the early 1990s.  The theory went, that by pooling their efforts, investors were able to get access to better deal flow, evaluate and monitor companies better, and strike better deals than they would on their own.  Now, business accelerators (organizations that provide capital and mentoring to early-stage companies) are in vogue and angels have been allocating their capital from angel groups to accelerator funds. Why?

First, and most important, investing in accelerator funds dramatically reduces the price that angels pay for their investments. Currently, the median valuation for a start-up by an angel group is $3.6m. A typical accelerator invested, on average, $25,000 into these start-ups in return for a 6% piece of the equity of the companies - that's a valuation of about $417,000. So, even after a 20% carried interest, the valuation of the typical angel group would be 7.3x that of the typical accelerator.

How Start-ups Turn Out
Therefore, an angel who invests through a typical angel group vs. an accelerator fund would have to believe that the start-up will have a 7x greater likelihood of a positive exit or a 7x better exit.  This is very unlikely.

Second, investing in accelerator funds increases the amount of diversification for the angel. The average portfolio of a typical angel is 7 companies - that is too small!   Seven investments does not ensure that the investor will generate an acceptable financial return. Running the numbers through mathematical simulators indicates that investors need to build a portfolio of 50 investments to have a greater than 90% probability of a 2x return on investment.

The typical accelerator fund makes approx.12 investments per year (about 5x the rate of the typical angel investor). Therefore, by investing in an accelerator fund, the angel has a much higher likelihood of achieving the diversification necessary to generate a worthwhile return.


Third, is time. Investing in accelerator funds significantly reduces the amount of time an angel must spend on analyzing each of her/his investments.  Typically, an investing angel must spend time attending pitch presentations, participating in the due diligence process, renegotiating term sheets, and so on. As an accelerator investor, the angel does none of this. The managing director of the accelerator undertakes these, very time consuming, tasks.

In summary, angels spend less time, invest at a lower price point, and get more diversification by investing in accelerator funds vs. joining an angel group. So, by default, the accelerator is a much better investment vehicle for the angle vs. direct participation.

Best and stay in touch,

Jim Lavorato, Principal
Fund-House Ventures, LLC

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