Fabrice,

Paul as usual has great insights on start-up funding, which are then retweeted and re-used by entrepreneurs out of context. As a VC, let me give a slightly different perspective on Paul’s article.

If you are a super-angel investor, such as y-Combinator, you do provide lots of value to a young company, not least of which is that you are willing to take the leap of faith when there is essentially no traction. For most entrepreneurs, this is one of the most significant milestones in their young companies – the first external bet that they can succeed, plus the first firepower to allow them to succeed.

However, one of the principal differences between the super-angels and the VCs is the expectation of follow-on capital.

A VC firm with $100 million under management will make roughly 15 to 20 investments, with the up-front investment amount being $500,000-$5,000,000 and the total capital per company being $2,000,000-$10,000,000. Almost every company will get at least one follow-on round of investment. A super-angel with a $15 million fund will make 40-50 investments, with $100,000-$500,000 up front but little or no follow-on investments. A firm like y-Combinator, for example, will generally put $0 into follow-on investment rounds.

You can see where this is going. If a company is gets Angel funding and is able to be profitable, it will survive. If a company gets Angel funding and is able to attract other investors (whether with the help of the Angels or not) it will survive. But if the company cannot get profitable on its initial capital and cannot find new investors, it is dead.

This is the heart of the Super-Angel fund model – invest in 50 companies, 20-30 will go bust, 10-20 will survive but with the future investors’ waterfall there will be little chance of getting any money back for the angels, 5-7 will get decent returns, and 3-5 will get huge returns. For the VC, 4-6 will go bust, 6-8 will get money back, 4-6 will get a decent return, and 2-4 will be big hits (although not as big as the Angels get). Note that quantum of companies that do not get further funding is 4-5x that of a VC.

And a SuperAngel fund cannot change its model to allow for material follow-on investments, because unless it follows on for substantially all of its investments, it will signal to the market that for every investment it does not follow on, that company should be shut down (there are several VCs who have tried to enter the SuperAngel market only to find this signaling problem is very real). If a SuperAngel ends up investing in most of its follow-on rounds, it will not create the level of diversity needed to support its returns model, and so will transform itself from SuperAngel to VC and by definition have to invest in fewer companies or raise substantially larger funds with the higher exit thresholds these require.

When I invest in a company as a VC, three things can happen. Management can outperform plan significantly, it can perform close to plan, or it can under-perform plan significantly. In each case, there comes a moment when the company wants a commitment for more capital (unless it is already cash positive). When the company outperforms plan, two things happen – one, they get more money from me and almost always from others, at increasing valuations. Two, they get little of what Paul refers to as novice pilots over-controlling the aircraft. In fact, they get lots of support and praise for the job well done, free p/r, introductions, references, etc.

When a company is close to plan, and they ask for money, I am pretty much always there, but if there is no external capital the best they can generally hope for is a flat round valuation. “Why when we are so much further along than at the last investment round do we not get an valuation uplift?” they ask. Well, if they were doing really well, there would be an external lead. And if this was an Angel funded investment and no external lead came along, they would be dead. So having the VC involved gives the entrepreneur comfort of not shutting down if no external party recognizes your value creation, but at the cost that you will see no pricing uplift. HOWEVER, you still do get very little of the pilot overcompensation – you are close to plan, so you are not questioned. You may get a little less of the free p/r, but not a lot less, and you will still get the introductions, references, etc that any investor (angel or VC) should provide.

Then there is the case of the under-performing company. Of course, if management is really really bad and the market is simply not there or the product has been designed really poorly, then we may choose to not fund. But often, we will still invest. However, at this point we do look to have major adjustments to the economics and we will want to either change the plots or have a significantly larger say in the business. “But Paul Graham says founders having more power is a good thing, and Paul Graham says investors should leave the piloting to the management, and Paul Graham says if I don’t have to deal with investors I will have less stress, and Paul Graham says if you act hard on me you will hurt 10 other entrepreneurs who will never raise money.” Yes, and if Paul Graham invested in your company you would be shut down. Out of business. Gonzo. Nada. Dead.

You want a chance to survive, having a VC gives you a lifeline, so that (as long as you are not completely incompetent) when things go awry, you may not end up with as much control or as much economics but you will have the chance of success rather than the certainty of failure out of your entre into entrepreneurship.

There is a story of a company called NexTag, backed by Morgenthaler Ventures. The business went through tons of capital, and almost went backrupt. Morgenthaler wrote one last check, and several years later the Company ended up selling a controlling stake at a $1.2 billion valuation. Had Nextag been angel invested by y-Combinator and Super-Angels and not brought in VC capital, it almost certainly would have gone bust. But that one last VC check, combined with cutting out almost all of the staff that management had built up, and changing the business model, generated $1.2 billion worth of value. Every VC can go through dozens of similar (though not quite as extreme) examples.

In summary, in its context Paul makes excellent points, and the technology marketplace is much better off for the existence of SuperAngels. But do not write off tradition VCs yet, nor discount the role they will play in the technology landscape going forward.