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Divine intervention

‘Super angels’ formalize their investments in startups

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Print this page by Richard Foster

In 1997, Frank Batten Jr. took a $2 million gamble on a little-known emerging software development company called Red Hat, based in Raleigh, N.C. His investment famously paid off to the tune of more than $1 billion, according to some media reports.

“I just did not have the vision that it was going to become as successful as it became,” says Batten, the chairman of Norfolk-based Landmark Media Enterprises. “I’m delighted it has become as successful. It was a great experience.”

Initially Red Hat’s founders were seeking investment capital from Landmark, which in 1997 was being run by Batten’s father, Frank Batten Sr. The younger Batten heard Red Hat’s pitch and, being a fan of the Japanese quality and process improvement, he thought Red Hat’s business model and processes made sense. It also helped that Red Hat’s founders were able to easily explain their story in layman’s language to Batten Jr., who was not a technology expert.

However, Batten Sr. didn’t think the investment fit in with Landmark’s profile as a media corporation, and he passed on it. That’s when Batten Jr. decided to invest his personal funds in the venture. His father would later be quoted as saying that “Frank has a Red Hat, and I have a red face.”

In traditional business lingo, Frank Batten Jr. was an “angel investor” in Red Hat, an affluent individual investor who privately provided a startup company with the venture capital and mentoring it needed to get to the next level.

Deals such as these, in which a startup approaches a wealthy private investor for capital, are “old as the hills. It’s been going on for years,” says James B. Murray Jr., founder and managing partner of Charlottesville-based Court Square Ventures, a venture capital firm.

What is new is the emergence of “super angel investors,” largely in Silicon Valley. “You have people who came out of the technology business and who made a great deal of money at Google or Cisco, and they consider themselves very sharp on technology, and they’re only 45 years old, and they’re worth $100 million, and they don’t want to retire,” Murray says, so they make small but significant startup capital investments in emerging technology ventures. “They’ll make 20 or 30 bets and the dollar costs average out.”

Because of the low cost and fast pace of the technology market, one wealthy investor can make a relatively small personal investment to help a new technology business get started and see a significant return on investment within a couple years, Murray says. “All it takes is $200,000 or $300,000 to demonstrate whether or not you have a product people want to buy, and that’s an ideal climate for angel investing,” he says.

It’s much less expensive to start a technology venture now than when Batten invested in Red Hat, he says: “Nowadays with the web technology, it doesn’t take very much to start a company. A lot of people don’t need much capital to start a [technology] company because you can outsource so much. You can rent your servers from Amazon … [and] open-source software has made it cheaper.”

Technology companies today don’t require a lot of overhead such as expensive hardware or office or factory space, says Murray, and new software composition tools now enable one person to write software that would have been a 10-person job for coders 15 years ago. “It’s a huge productivity gain,” he says. “It’s possible to have the code written for an iPhone app and have it all done by one person.”

Lower costs also reduce risks for angel investors: “If they’ve only got $200,000 or $300,000 invested, it’s such a small piece of their net worth,” Murray says. And “after 24 months, it’s either going to be a roaring success, or you’ve written it off.”

Most such deals are too small for venture capital firms like his, Murray says, making them perfect for individual investors.

In Virginia, however, major super angel investors have been increasingly formalizing their investments, creating more traditional venture capital firms. (This is also happening in California; Ron Conway, perhaps the best known of the Silicon Valley super angels, created the SV Angel fund in recent years, forming partnerships to make investments in early and middle-stage companies.)

Nigel Morris formed boutique venture capital firm QED, which has invested in Northern Virginia and Washington, D.C.-region technology companies such as daily deals site LivingSocial and web tech firm Clearspring. Operating as a venture capital firm, Morris says, he is able to apply “a level of governance process [and] rigor in screening investment opportunities.” As a firm, QED can seek out additional investment capital beyond what he can provide alone. And it is able to provide more service, attention and advice to a startup firm than he could as an individual.

“We seek out entrepreneurs who envision their own companies as intensely data-driven and perhaps want counsel from their investor on how to reinforce the culture and capabilities to support that vision,” Morris says. “It’s a bit harder for angel investors who write smaller checks (for example, $50,000) to do this, as that check size usually doesn’t give them enough skin in the game” to make financial sense for them to spend significant time helping a startup company.

AOL founder Steve Case makes his major technology investments through two venture capital firms, Revolution Ventures and Revolution Growth. Revolution Ventures, which is overseen by former Time Warner Ventures vice president Tige Savage, acts like a super angel, providing startup capital and advice and support to new technology companies. (Its investment portfolio includes LivingSocial and Clearspring.) The Revolution Growth fund, which is led by former AOL executive Donn Davis, is a more typical venture capital firm, investing in existing companies that have already shown a measure of success. The key partners in Revolution Growth are Case, Davis and the vice chairman emeritus of AOL, Ted Leonsis, who joined Revolution in 2011.

“We’re trying to be business builders, not just investors,” says Davis. There are a lot of small emerging technology companies that need relatively small amounts of startup capital, he says, and that need “has mostly been filled by angel investors. But that trend had certain limits to it, because it wasn’t set up for additional rounds of investing” and individual angel investors typically don’t have time to devote to being mentors and supporters of a business the way a firm like Revolution can. Revolution can help see a company through from startup to maturity, providing funds and support, due to the unique expertise and combined capital of its partners.

Typically, angels may not have had access to large pools of capital for each investment they made, and they had to limit their individual participation in firms because they often were already managing their own businesses. Hence, many angel investors are creating or aligning themselves with investment funds like QED and Revolution.

Says Savage: “What we’ve been seeing in the last 24 to 36 months is the institutionalization of the angels. The angels are starting to raise funds on their own. It’s a little bit of back to the future in that regards.”

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