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“Angels” that aren’t actually angels, and the problems that poses (ycombinator.com)
96 points by akharris 70 days ago | hide | past | web | favorite | 34 comments

Don't underestimate the value of the angel investor being a person you can talk to. I've made several angel investments, and sometimes the company needed to restructure in a way that a strictly profit-focused institutional investor would not have allowed. Since I invest mainly because it's interesting and it helps people, I've never said no to what the founders wanted to do.

Of course, individual angels can be hard-asses. But an institutional fund is legally required to be a hard-ass. So I agree with Aaron's advice: you should know exactly whose money you're taking, and go for as long as possible only taking money from people you can reason with. If you don't have a good sense of the investor, ask a founder they invested in where the company ran into trouble.

"But an institutional fund is legally required to be a hard-ass."

This isn't true in the sense most people think it is. It's true that management must act in the best interests of the shareholders, but the legal requirement is more about acting in an ethically or financially defensible way, rather than dollars above all else. It is perfectly legal for management or an investment bank to allow the entity to act in ways that benefit in the long term but not the short term. The greatest example of this in modern business is Amazon. Bezos sees that getting a large, long-term-viable business means putting profits right back into the company, and sometimes even running debt. No where in any laws and regulations is any manager or investor required to sell tomorrow in order to maximize profit today. If a founder in a startup has a wacky idea, but the board/ownership/etc. feel that the plan can work, they CAN permit it with no legal repercussion. Fiduciary duty is about ethical action, not profit, they can't knowingly in a manner that is deleterious to investors/shareholders. And even that low bar is very hard to prove in court.

LPs aren't just shareholders. I wish. LP agreements are hundreds of pages long!

A complication with institutional funds is that they raise a new fund every couple years, with a changing set of LPs. So they can't make a deal like "we can write off the investment in your previous company, if you let us invest in your new company" because it's favoring one set of LPs over another. LPs get prickly about that.

So a company like Amazon can take lower profits now in return for bigger profits later, but institutional funds can't if they're into the next fund.

LPs themselves also have basically zero information to go on when evaluating a potential venture fund, other than exits they invested in with their previous fund. And the competition is pretty brutal among venture funds today. So a VC is going to have a very hard time raising money for their next fund if they can't show exits or at least follow-on rounds of funding at substantially higher valuations for some of their previous portfolio companies.

Not to pry, but I'd be curious to know how those investments did for you, if you don't mind sharing!

Institutional investors often succeed at nabbing seed-stage investments then holding onto them through 10,000%+ profit. In fact, I heard that in most cases, a few outsize successes are responsible for most of an institutional portfolio's returns.

Better not to count the chickens before they hatch. In general, with companies that are doing well, I'm doing as well as any investor would. With companies that failed, I walked away with $0 and no hard feelings. There are some in the middle that an aggressive investor could have gotten more money out of in return for some hard feelings. But as you say, most of the returns come from the big wins so it's best to spend your effort on finding more of them.

Thanks for this answer. I actually thought you might have to be aggressive not to be diluted, on your companies that are doing well. (Like they would just ask you to sign new paperwork since they're more valuable now, and an angel might cave and do so, since they're still getting a "fair" return. Actually I thought that was the point at which investors have to be hardest.)

> institutional fund is legally required to be a hard-ass

What do you mean by this?

There are laws/expectations that state a company must optimize for profits (Dodge v Ford). Perhaps this what is meant.

No, that’s a misconception.

While Dodge v. Ford does say that companies should be run for the benefit of the shareholders, it gives management a ton of latitude in deciding how to do so. Here’s a quote from the actual text: “[T]he ultimate results of the larger business cannot be certainly estimated. The judges are not business experts. It is recognized that plans must often be made for a long future, for expected competition, for a continuing as well as an immediately profitable venture...”

Shlensky v. Wrigley deals with the Chicago Cubs’ refusal to install lighting for nighttime games, due to concerns about how it would affect the game of baseball (which their president believed was “a daytime sport”) and the surrounding neighborhood. Although these are fairly nebulous concerns, the court held they were reasonable business judgements. The decision cites another case, Davis v Louisville Gas and Electric Co, which says “the directors are chosen to pass upon such questions and their judgment unless shown to be tainted with fraud is accepted as final. The judgment the directors of the corporation enjoys the benefit of a presumption that it was formed in good faith, and was designed to promote the best interests of the corporation they serve.”

The standard, from In Re Walt Disney, is that business decisions aren’t reviewable unless “the exchange was so one-sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration".

This comment is amazing. I feel like the phrase "companies must maximize shareholder value" is regurgitated dozens of times daily on HN without anyone stopping to think about how meaninglessly broad the statement is.

Pretty much the only time that fiduciary duty ever comes up (in the sense that it is constantly discussed online) is cases that run up against the Revlon Rule, where you actually have competing offers to buy a company. But there really aren't very many of those.

It's a common myth, and may be for certain states, but in general it doesn't appear to true in the US [1, 2].

1: https://www.nytimes.com/roomfordebate/2015/04/16/what-are-co... 2: https://www.nakedcapitalism.com/2014/05/guess-who-is-respons...

Is that for all companies, or just publicly traded companies?

Fiduciary duty.

Throwaway account for obvious reasons:

While the words of warning in this article may be true, they (sadly) sound like a thinly veiled complaint about competition increasing pressure on YC's investment turf.

Founders should be grateful for, not skeptical of, increased funding and competition in early rounds as it should help them raise on better terms!

To me, more capital is a good thing. If that creates competition which forces us to improve, that's even better.

My point is that investors who hide their incentives by obfuscating that they have outside sources of funding are exhibiting bad behavior. Founders should know about this pattern so that they can make decisions with as much information as possible.

There is, of course, a potential conflict of interest anytime an investor gives advice about other investors. But not as much as you'd think, when the investors specialize in different stages.

The rounds typically go:

  seed - angel - series A - series B - series C ...
YC only does seed and series B onwards, so it can give unbiased advice about angel and series A. By the time a startup is doing series B, they should have in-house experts.

I've never understood these terms. Is there a clear definition for those?

Seed is very little money, angel is more money, but still small enough that a wealthy individual can provide it?

Series A, B and C are pretty much the same, it just so happens that companies usually re-capitalize three times before going bust or IPO?

(The whole space is very perplexing, the idea of diluting earlier investors sounds outright fraud-like to me, but obviously it's well-accepted and probably priced in.)

Angels are often part of seed rounds. Differentiating between the two seems pointless.

Also dilution is part of equity. There is nothing fraudulent about it.

unwanted dilutions, share issuance dilution scams, controlling share dilution schemes, clawbacks... there's a lot of unpleasant things that can happen to minority stakeholders

Not sure I follow your reasoning. Even if YC only does seed and series B, investments in other stages have an impact their investment. YC has incentive to give advice that aligns with their interests.

I read the article differently. At the end, the warning seems to be less about lack of disclosure (i.e. funds masquerading as angels) and more about the consequences of taking large amounts of capital under a safe or convertible structure. That is very much a legitimate concern, and a mistake I have seen a number of startups make.

The complaint seems to be about the duplicity, not the raw interest in investing.

> Founders have a right to know where the money they are taking comes from, and they need to know how that source might influence the advice given them by their investors.

That's correct. However, a provocative question: does every YC company know where YC's funds come from? My purely anecdotal evidence is that at least half, possibly 2/3rds of them, don't. If that's the case, it might be useful for YC to disclose that to everybody.

Is it accurate to interpret from the article that if an angel investor is in fact backed by money from LPs, her fiduciary responsibility to her own investors is greater than the flexibility she might have toward the company if she were just running her own money, and therefore these incentives can put her interests at odds with founders?

Further, is there an implication that it's the SAFE itself that sets this up in the first place? The example I'm thinking of is an institutional LP who can't do risky deals like startup SAFEs, but they can buy into "established," funds where the risk is distributed over other partners who can, and this angel front gets them the startup portfolio exposure they need.

The downside is the SAFE explodes into giving up more equity than founders anticipated to their proxied angel, whose partners' risk appetite causes complexity and conflicts with potential A-round participants.

I've only read about this stuff, but what would you correct about these interpretations?

Does anyone else think that angel investing seems like an odd concept in that it implies a single person investing a large amount in a very early stage business.

Most people with sub 9 figure net worth should probably steer towards investing in larger derisked businesses as they are unlikely to back the 100+ startups required to get the 1 really big winner.

In contrast, large VCs who have the capacity to invest in several hundred startups are much better suited to this form of investing as they can derisk by having a large portfolio size?

Boston is guilty. New englanders are too practical to be angels.

Do you have any more details? There's dozens of angel groups in the Boston area.

One thing I don't understand - why would exceptionally high or uncapped safes be a bad deal for founders? The post mentions that this leads to dilution and other issues in the eventual series A, but doesn't an uncapped safe lead to less dilution in the series A than a safe with a lower cap? Why is it a bad thing that there are more "to good to be true" offers being made now?

Based on the title, I wanted Evangelion.

This is a bullshit article... ycominator is an “angel” who invests in “startups” like alpaca markets, a “free” trading platform.

This “free” trading platform, isn’t a startup, it’s a front for the front running side of the business alpaca.ai, yes the users in this YC backed front, are just the inputs to a more elaborate Japanese trading firm that front runs US markets.

You guys are Hippocrates.

Y Combinator is a seed accelerator, not an angel investor. They're quite distinct types of investors.

Your point about Alpaca is unclear to me. If you want to convince anyone, perhaps you should write a blog post, with sources and evidence, to explain why you think it's not a startup?

Open tab to alpaca.markets Then Open tab to alpaca.ai

Look around on both that they share founders, and that one startup is used to power the other.

It’s like Robin Hood but sneakier. P.s. I work in the regulated finance space, finra compliance is my life now.

Edit: “PFOF” as it’s called :-( https://files.alpaca.markets/disclosures/library/Alpaca+PFOF...

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