I’ve recently noticed an uptick in the number of “angels” that aren’t actually angels. These investors are institutional funds (read, LP dollars), the details of which aren’t generally disclosed until the founder sees a strange entity name on the signature lines in the docs.1

This is different than investing through a trust or fund that represents an investor for legal reasons. This is investors pretending to be individual angels when, in reality, they are fronts for groups of investors. That makes them VCs.

This seems to take a few forms. The first is an angel who represents a formal syndicate, such as on AngelList. Some investors announce “Hey – I run a syndicate” while others leave this information hidden until the docs are being signed, at which point attentive founders notice that the signature block refers to some mysterious entity. Some founders ask what’s going on, while others don’t.

Another form of this is the SPV, or special purpose vehicle. These are single purpose partnerships where a group of investors come together to fund a specific opportunity. These were designed primarily for large deals that went beyond an investor’s individual capacity for investment. Funds sometimes use these in large growth rounds to invest alongside their own LPs. The recent twist on this takes the form of individual angels forming SPVs around large seed checks, bridge rounds, and As or Bs.

Another form I’ve seen is the “scout.” This is a founder to whom a sleeve of funds is given by a larger VC fund. The thinking is that scouts expand the reach of a firm’s partnership, and allows that fund to discover founders who otherwise would have been hard to find. The scout usually gets carry on some portion of the investment, and the VC fund gets information from the scout about the company.

The final form I’ve seen is a full VC fund with a single person’s name on it. This is no different from starting with “Kleiner Perkins,” it’s just that the new VC isn’t yet as well known. What is different is when the investor pretends that there’s nothing behind the curtain, when, in reality, there is an entire LP base involved.

It is logical that angels would sometimes look to put more money into a deal than they can, themselves, do at a given time. More ownership translates to more profit since these deals generally provide the lead angel with carry on the investment of the rest of the group. It is also, unfortunately, logical that angels might try to hide this. Founders have been conditioned to equate angels with slightly eccentric, mostly benevolent investors who are investing as much for fun as profit. Angels are expected to be helpful and to conform to what is in the founder’s best interests more often than institutional investors.

VCs, on the other hand, are thought of as the Faustian partners of building a startup.2 Yes, you need their money, the thinking goes, but you shouldn’t trust them. They’ll fire you! They’ll try to get you to burn all your money so that they can take control! While these things rarely happen, they do sometimes happen, and it is true that investors have fiduciary responsibilities to protect their investments in a way that can put them at odds with the founders.3

What’s strange to me about this angel behavior is that it isn’t, in and of itself, bad. Anything that brings more money to startups is, on balance, good, because more things will get tried. The problem is disclosure. 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.

There is, however, one clearly negative impact of this new pattern, which I see playing out between seed and A rounds. I’ve recently noticed an uptick in investment offers from “angels” at terms that seem too good to be true. This usually takes the form of exceptionally high or uncapped safes into companies that are doing well. The angels say that this is great for companies because it lets them push off fundraising, or get great people involved. The angels are actually doing this because, as a fund, they now need significantly more ownership in companies to make the return they used to get from early checks.

The reality for founders is also trickier. In many cases this is a bad deal for companies because any money raised post seed takes up space in your eventual Series A. Your Series A lead will want ~20% of your company, no matter who your existing investors are. They won’t cut back because you raised an uncapped safe, which means you’ll have to break your pro-rata agreements or take dilution yourself. This can quickly turn what seems like a good deal into a bad one. It also turns the term “angel”into a misnomer.4

Founders should always ask investors where their funds come from. If an investor will not say, or needs to be asked many times, this is a red flag. Founders need this information to decide how to think about the investor and the funding offer or advice that investor may give. While it would be nice if all investors disclosed this publicly, the reality is that many do not. So, founders need to ask the questions or risk finding themselves in bad situations.

Notes
1. And only then if the founder asks.
2. The devil.
3. I wrote about this some time ago here: http://www.aaronkharris.com/investors-and-their-incentives and here: http://www.aaronkharris.com/why-vcs-sometimes-push-companies-to-burn
4. Which maps back to: http://www.aaronkharris.com/investors-and-their-incentives

Thanks to Jared Friedman and Nabeel Hyatt for helping me write this.