Angels shine halos, competitors swoop in

It’s good to be an angel these days.

They’re investing more often, VCs are trying to emulate them more frequently and their startups are getting acquired for more lucrative returns.

Few people may appreciate this as well as Bill Tai, a general partner at Charles River Ventures. Before Tai joined CRV, he invested in the music file sharing company Slim Devices as an angel in 2001. Logitech International bought the startup this month for $20 million in cash plus possible earn-outs, giving Tai a 10x return on a deal that would have been too small for CRV or most any other venture firm to consider.

“I know that a lot of investor’s numbers, and our track record is superior to many VCs,” says Ian Sobieski, a managing director of The Band of Angels, an angel investment network in Menlo Park, Calif. “And we do it all without spending millions of dollars, or tens of millions, on management fees.”

Sobieski says that the Band of Angels has had a 50% internal rate of return on nine IPOs and 40 acquisitions since it was founded in 1997. Those are enviable results, especially when the mean return for venture investment during the same period is close to zero. “The angels couldn’t be more well positioned than they are today,” Sobieski says. “Selling to a Google is easy.”

Overall angel investing increased 15% to $12.7 billion in the first half of 2006 over the same period in 2005, according to the Center for Venture Research at the University of New Hampshire. Meanwhile, the effect is that VCs are going earlier, too: they invested $540 million in seed companies during the third quarter, up more than 80% from the $295 million invested during the same period, according to Thomson Financial (publisher of PE Week).

“Everything we’re seeing now makes me think Q4 will be really strong,” says Laura Roden, managing director of The Angels’ Forum, a Palo Alto, Calif.-based group of angel investors. “We’re seeing more good deals than we can do due diligence for.”

Among the VCs who have taken notice is Eric Di Benedetto, formerly a general partner at Convergence Partners. He has launched a venture fund targeted at the early, early stage startups that venture investors with bigger funds typically ignore. “There’s a need to bridge the gap between startup and institutional VC,” he says.

Di Benedetto’s firm, Active Starts, targets startups within a year of their launch. He’s already backed 11 fledgling companies, including reputation management system RapLeaf and sales software company Before the Call Inc. RapLeaf, based in San Francisco, has also raised financing from The Founders Fund, an early stage venture firm launched by the co-founders of PayPal. Sunnyvale, Calif.-based Before the Call is partnered with and has raised about $2 million in financing from investors, according to Thomson Financial.

Meanwhile, many big strategic acquirers have made buying startups an art and they’re looking earlier in the company’s formation before buying. Take Cisco Systems Inc., a stalwart strategic buyer for years, spending billions of dollars each year to acquire startups. The company, which is one of the few that makes its acquisition prices public, has made four buys of venture-backed startups this year, not one of which is greater than $100 million. Just last week, Cisco announced it bought telephony software developer Orative Corp. for $31 million in cash.

But it’s not just hardware companies that are buying younger. Google has followed a similar model, the YouTube deal not withstanding. It is proactively looking for early stage companies before they bulk up with sales and marketing people. “Right now there are a lot of inefficiencies in the M&A market,” Roden says. “Most of the deals that are getting done are happening through the company’s own deal sourcing.”

But those sort of returns don’t scale, Sobieski says. He’s skeptical of funds such as Di Benedetto’s. “If he does well, presumably he’ll go out and raise a $80 million second fund and a $200 million fund for the next round after that and then he’ll be competing with Mohr Davidow Ventures,” Sobieski says.