It sounds funny but there are many circumstances where angel investors aren’t interested in investing in startups with clearly defined monetization models. Here’s why…
Following the Money:
To understand this strange phenomenon we must hark back to dotcom-era-vernacular when companies were always defined as either B2B (selling business to business) or B2C (business to consumer). In particular, B2B was the business model that sparked much of dotcom boom (and ensuing bust) with examples including Salesforce and Oracle. B2B startups are relatively straightforward to monetize; in general businesses will pay for products and services where they can either save or make money. So come up with an idea, charge a subscription and sell like crazy, right? Unfortunately, angels aren’t nearly as keen on B2B models as you might think — and with good reason.
As has been well chronicled, IPO’s of venture-backed companies have virtually disappeared. IPO exits have been replaced by acquisitions coming from the likes of Microsoft, Google and Yahoo. Since angels seek returns on personal money invested, it makes sense that their investments skew toward companies perceived as likely to reach a liquidity event quickly. Because the majority of liquidity events are now acquisitions and since those acquisitions are being made by B2C firms (Google, Yahoo, etc), it’s easy to see why angels prefer investing in B2C.
B2C acquisitions are also interesting since many B2C startups are forgoing clearly defined monetization models. Instead, these companies focus on building eyeballs, not revenues. Two things are at play here. First, the underlying assumption that eyeballs, i.e. traffic, will ultimately be monetized through advertising. Second, companies like Google seem to put more stock in users than in technology. In many instances, Google wants the community, the founder’s engineering talent, and then the product or technology in that order.
Fear of Follow-On:
The second reason angels shy away from B2B models (and even B2C models that require some type of sale or subscription) is that they worry about follow-on rounds resulting in significant dilution. My friend Rob suggested that angels get diluted 30% or more per follow-on venture round. It’s widely accepted that B2B companies require more capital and thus are much more likely to need follow-on rounds.
Thus while it might not make sense on the surface why angels aren’t jumping to back an awesome product you plan to sell into small business, it might now.