Amid the crunch, VCs subtly remind entrepreneurs what angels can't do

By Sarah Lacy , written on January 8, 2013

From The News Desk

There's some subtle gamesmanship going on in the venture world right now.

Several years ago -- when super angels were the rage, people were building funds off of flip-economics, large distribution platforms like Facebook and iOS, and the low cost of creating a product -- there was a lot of rhetoric about how some companies just wouldn't need VCs anymore. Most VCs, like any market incumbent, were wise enough not to justify this with public sparring. But they remembered who was going around saying it.

And several I've spoken to are watching with no small delight the dramatic change in tone now that angels are struggling to get their companies a spot in the Series A game of musical chairs. "Oh, I guess VCs aren't so bad after all?" I've heard more than a few remark since my Series A Crunch post a few months ago. They're too professional to take this out on the startups, of course. But it's leading to some interesting angel-VC tête-à-têtes.

Less than a year ago, we were writing about the somewhat extreme lengths to which VCs were going to get more early stage deal flow and compete with seed investors. Suddenly, they find themselves as sought after buyers in a sellers market.

Everyone admits the great companies will be fine. But there's an awful lot in that "good" category that is far more subjective.

There are still concerns out there about the potential negative signaling risk if a VC does your seed deal and doesn't invest in the Series A. But as seed extensions become a necessary tool to figure out what members of the "good company" category get their next round and which don't, the narrative is starting to shift to "wouldn't it be nice to have a seed investor with deeper pockets?"

Despite so many people who advise against it, a recent report by CB Insights noted that seed deals with VC participation actually had a higher rate of getting follow-on funding historically.

This is an effective time for VCs to remind the entrepreneurial world why early investors at big institutional funds can have some advantages after all. Witness Fred Wilson's blog post today called "In Between: The Tough Place to Be." He notes -- correctly -- that a lot of VCs fund hopes and dreams and a lot fund big success. The place in between is where it gets hard; and that's where the most competition for deals is this year.

Bryan Goldberg talked about this in a recent post as well. He writes, "The engineer who just closed an angel round has no idea what kind of trap he is walking into for a real Series A." That is so true, it should be cross stitched, framed, and handed out by someone as a warning when entrepreneurs close seed fundings.

Goldberg continues:

An engineer is used to getting a $150,000 commitment from SV Angel, based on one meeting, only to see a bunch of rich people pile onto the round once it has the blessing of an expert like David Lee.

What no person, engineer or otherwise, can anticipate is the deep — no, insane — level of diligence that an institutional VC will put them through a year later. He cannot anticipate the horribleness of having one VC call him back to Menlo Park five different times before passing…or being constantly manipulated because he’s 23 years old. He’s not used to VCs prying to find out who else might invest, and using that information against him. He is not used to getting only one “yes,” only to find it bundled with an impossibly messy term sheet that he probably shouldn’t sign. If Goldberg were a VC, he might have added, something like: "Having someone already on your side who understands this process is a plus."

Wilson adds just such a cautionary note to his post:

The truth is early stage investors are often asked to be the funders of last resort for the "in between" stage. We do that all the time at USV. We will lead or do an inside round for the Series B and Series C rounds if we have to. So choose your early stage investors well. Make sure they are willing to see you through the in between phase if need be. Because they will probably need to.
Another VC and frequent co-investor with Wilson, Spark's Bijan Sabet added from his blog:
It’s never easy to do the inside round that nobody else wants to do. Especially for a non-mega sized fund. We love working with USV in so many Series A rounds because we think alike with the follow on investment decisions (in good times and tough times).
To me, these statements are more interesting because of the mark a cultural defense of the early stage VC, after a few years of bashing. (Few entrepreneurs really need to be sold on taking Fred Wilson's cash.) It takes a while in the slow-moving venture business, but the pendulum always swings back.

[Image from this movie]