Angel Investors Lend Expertise as well as Cash

Angel Investors 042415 XNYT35-Joshua+Reeves,+chiefQUENTIN HARDY The New York Times News Service

Like many tech entrepreneurs, Joshua Reeves says he thinks his company can change the world. It may do it, too – with the way it was financed, as much as by the product itself.

Reeves’ company, ZenPayroll, has raised several million dollars through a network of technology executives.

His cadre numbers 56 such “angel” investors, almost all of whom are busy running their own companies. That is more than half the number of employees at ZenPayroll, which has 95 workers and opened for business in late 2012. Among ZenPayroll’s investors are people who helped found and run companies like Dropbox, Evernote, Instagram, Yelp, Yahoo and Twitter. Many are worth hundreds of millions of dollars, even a billion dollars, either on paper or actually, depending on whether their companies have entered the public market.

Reeves, who sought $25,000 to $200,000 from each angel investor, is after more than their money. Each month, he sends investors requests for things he wants them to work on for him and his company, which offers online software that takes care of payroll for midsize and small businesses. It might be sales contacts, or information about how to create a corporate culture, or thoughts on new types of software.

“They pay us, and they work for us,” said Reeves, 30, who has grouped his angels into skill areas, like marketing or technology. “They are working entrepreneurs who like to think of themselves as company-builders and attack problems.”

Traditionally, angel investors were just those early people who believed in someone’s dream. Sometimes they were mentors, relatives or friends of friends who would descend with money and walk away, expecting only periodic contacts or updates. But now, Reeves sees a way to exploit his angels’ innate talents.

Jeremy Stoppelman, the co-founder of Yelp, says Reeves talks to him mostly about building a strong company culture. He was introduced to the company through Aaron Levie, the co-founder of Box, whom Reeves has used for other introductions. Elad Gil, who sold one company, Mixer Labs, to Twitter and is now working on a biotech startup, says he gets questions about issues like mobile application technology and business operations.

“We’re operator angels, giving firsthand experience,” Gil said. “We give advice and learn things that will go stale very quickly, on things like acquiring users or using mobile. Money managers can’t do that for a company; their services are more generic.”

Besides, ZenPayroll “is working on a real problem I had in my first startup,” he said. “I wish it had been around then.”

Evoking passion for solving corporate payroll issues seems unlikely, but these are unlikely times in financing technology startups. Just as Tom Sawyer got other boys to whitewash a fence for him, people like Reeves may be onto a way to create an entire company: Draw on the industry’s experience, evoke previous entrepreneurs’ interests and continually expand a network of like-minded investors.

That he can get these human resources says much about the state of values in technology, where money is cheap, compared with time and experience.

Angel investors have been an increasingly important part of how Silicon Valley works for several years, as people have become wealthy earlier in life and corporate tools like free open-source software and cheap cloud-computing resources have lowered the cost of a startup.

AngelList, which offers to match startups with early-stage investors, says it has raised $104-million from 2,673 investors to help finance 243 startups. Investors on AngelList are expected to certify that they have more than $200,000 in income for each of the last two years, or over $1-million in net worth over and above the value of their homes. In some cases, AngelList may require proof.

People can invest by themselves or follow the investments of various tech executives who participate. Reeves is one of the featured investors on AngelList, and he has given money (and, he says, time) to startups like Clever, which makes online software for education, and Patreon, a service like Kickstarter to support artists.

Reeves is giving the companies he finances the same operator angel treatment he gets from his angels. “Fundraising should be like hiring,” he said. “Either way, you are putting people in your company.”

Thanks to two long tech booms in just two decades, there are lots of relatively young executives with lots of money. Many invest close to what they know, throwing millions at familiar human and technology networks.

Some older investors see helping people like Reeves as a way to follow what is happening today and give back in hard-won experience.

“I’m 37. I’m the old guy in the room,” said Stoppelman, the co-founder of Yelp. “It’s kind of fun to leverage your knowledge, build someone else’s success and see your suggestions put to use. Most startups underutilize the people they bring on board.”

Many of the ZenPayroll angels, who have built businesses using the same technologies of cloud computing, mobility and open-source software, see themselves as part of a movement. This technology is changing society, they argue, and they like being part of as much of that as possible.

“This is a transcendent moment,” said Tien Tzuo, the chief executive and co-founder of Zuora, which makes software for companies to run online subscription businesses. “Fifteen or 20 years ago it was about the money or for geek status. There’s now a visceral feeling that we’re changing the world together.”

All of this early-stage money can create a level of implied valuation that may be contributing to what many now say is the overvaluation of technology companies. When, after the early investing rounds, startup companies need the larger sums and corporate connections available through venture capital, they already have a valuation well above what was typical before angel investing became common.

After the venture round, it has become common for some institutional investors, including private equity funds and even mutual funds, to come in before the company goes public, creating an even higher valuation. The institutional investors are betting that the initial public offering will eventually surpass even that valuation. Thus, the angel investors, some argue, are making for a disaster.

“There is a lot of capital in this market with no tech-funding market experience – angels at the bottom, private equity on top,” said Dave McClure, whose 500 Startups has financed many early-stage companies. “Josh deserves a lot of credit, managing an investor group of that size and pushing the investing rounds up.”

Reeves said he was not concerned about a market collapse changing his methods. “This is entrepreneurs helping other entrepreneurs, and that has always been part of the secret sauce of the valley,” he said. “I am looking for mission-driven entrepreneurs. They derive joy from hearing about problems.”

In Silicon Valley Frenzy, VCs Create New Inside Track

Wall ST J BN-HS055_CLUB04_M_20150402101507Pinterest board observer raised $200 million in three days to buy more shares—with startup’s blessing

Silicon Valley insiders are taking advantage of soaring values for technology startups by creating a potentially lucrative side business.

Venture-capital firms such as Andreessen Horowitz and FirstMark Capital, along with a cast of prominent entrepreneurs and executives, have each raised tens of millions of dollars for impromptu funds that take a direct stake in a single startup.

These funds, which often come together in a matter of days, give institutional investors, friends and business associates exclusive access to highflying companies. The funds also let the venture capitalists invest far more money in a company than they otherwise could. In many cases, the funds are blessed by the startups, which see them as a way to raise big sums quickly.

While the investments are usually billed as exclusive, can’t-miss opportunities, the funds aren’t without risk. Their investors—which include fund of funds, family offices and pension funds—are usually offered limited financial information about the companies. They are also charged a performance fee that is typically about 20% of any investment profits on top of already rich prices.

When image-bookmarking site Pinterest Inc. set out to raise more than $500 million in February, one of its earliest investors, FirstMark Capital, wanted to take part in the round.

But the venture firm couldn’t invest a big enough sum from its $225 million fund to keep pace with Pinterest’s steep proposed valuation of $11 billion, more than double the price from May. Venture firms typically spread out their bets and avoid allocating too much capital in one company.

So Rick Heitzmann, FirstMark’s managing director and a Pinterest board observer, struck a deal with the San Francisco company to create a special fund that would pool capital from other investors and take a direct stake.

In just three days, Mr. Heitzmann rounded up $200 million from seven of FirstMark’s investors and included a small of amount of capital from its main fund, according to a person familiar with the deal.

He sweetened the deal by waiving fees typically charged to manage a fund, usually about 2%. FirstMark will get the same “carry,” or a cut of the investment profits, as its main fund should Pinterest hold an initial public offering or get acquired at a price higher than $11 billion.

In the eyes of some investors, the wager is easy money: Pinterest has the potential to follow a similar trajectory as Facebook Inc., FB -0.12 % which became a social destination for hundreds of millions of people and a top place for advertisers. But Pinterest is no surefire bet as it only officially began selling advertising on its site in January.

A Pinterest spokesman declined to comment.


The deal illustrates how startup investors are increasingly using an emerging funding structure that helps them defend their most promising bets. They are employing a type of fund called a special purpose vehicle, or SPV. Unlike venture funds that invest in dozens of startups over several years, an SPV represents a bet on a single company at a specific point in time.

These funds let investors write bigger checks to compete with the billions of dollars pouring into later-stage startups from mutual funds, hedge funds and banks. Venture firms are finding they don’t always have enough funds reserved to retain percentage stakes in startups as valuations rise quickly.

In the past 12 months, at least 70 private companies world-wide raised capital at a valuation of $1 billion or more, according to Dow Jones VentureSource. Many companies, including Pinterest, have been valued at more than double their previous valuation in that time span.

Further down the chain, a small but prominent group of entrepreneurs and executives are capitalizing on their access to fast-growing startups by raising SPVs for companies such as grocery delivery service Instacart Inc. and bitcoin processor Coinbase Inc., people familiar with the matter said.

Elad Gil, a former executive at Twitter TWTR -1.13 % and Google, GOOGL -0.27 % raised tens of millions of dollars from current or former employees of Google, Facebook and Twitter for Instacart’s $220 million January round that valued the company at $2 billion, said a person familiar with the matter. Mr. Gil couldn’t be reached for comment.

A spokesman for Coinbase confirmed the presence of an SPV in its January round, saying it represented less than 3% of the total $75 million investment. Instacart didn’t respond to a request for comment.

With the connections already in place, these deals happen quickly and further narrow the exclusive club that gets access to prime startups. But these funds pose financial risks. A venture capitalist gets a detailed look into a startup’s revenue, costs and financial projections before they make a decision to invest. Buyers of SPVs are usually only offered a high-level view into the potential performance, not detailed financial metrics, according to both investors who have arranged these funds and firms and individuals who have considered investing in them.

“There are going to be some bad outcomes,” said Brad Garlinghouse, a former executive at Yahoo Inc. YHOO -1.10 % and AOL Inc., AOL -0.08 % who has invested in some SPVs and passed on others. “When you’re the last money in coming at the top, you’re going to be disappointed with the financial returns.”

There are going to be some bad outcomes. When you’re the last money in coming at the top, you’re going to be disappointed with the financial returns.

—Brad Garlinghouse, former Yahoo and AOL executive

As more startups go this funding route, some investors question whether the companies are losing out on a chance to bring aboard more strategically valuable investors.

“Entrepreneurs should focus on investors that deliver value to them,” said Jeff Clavier, managing partner of venture firm SoftTech VC. “When you crowd out experience just to get an SPV going, then that’s a problem.”

SPVs gained popularity around Facebook Inc. and Twitter Inc. as those companies headed toward mega-IPOs. Chris Sacca, a former Google Inc. executive, helped popularize this trend when he bought up hundreds of millions of dollars in private shares of Twitter from executives and early investors over several years preceding the company’s 2013 public offering. Those shares, bought on behalf of J.P. Morgan JPM -0.02 % and investment firm Rizvi Traverse Management, would be valued at about $4.2 billion at today’s Twitter stock price.

Investment banks have also given their wealthiest clients special access to hot deals, such as Goldman Sachs GS -0.15 % ’ creation of an SPV in 2011 to market shares of Facebook to its clients at a $50 billion valuation, a year before the social network went public at about $100 billion.

Rick Heitzmann, a venture capitalist and Pinterest board observer, raised $200 million in just three days from investors to buy more Pinterest shares.
Rick Heitzmann, a venture capitalist and Pinterest board observer, raised $200 million in just three days from investors to buy more Pinterest shares. Photo: VICTOR J. BLUE/BLOOMBERG NEWS

But many of the earlier SPVs bought shares from employees or early investors. Startups such as Uber Technologies Inc. have attempted to prevent the trading of so-called secondary shares, and regulators have tried to crack down on a market of middlemen trying to buy such stock and reap big fees.

The newer breed of SPVs involves primary shares issued by the companies, which are giving express permission to invest.

Since its site launched in 2010, Pinterest has raised more than $1 billion, much of that through SPVs. Besides FirstMark, another earlier Pinterest backer, Andreessen Horowitz, recently arranged its own special fund, people familiar with the matter said.

The firm shopped the fund to its limited partners and “friends and family,” said one of these people, and waved its management fee and charged a 15% carry, smaller than what it normally takes from its main funds. A regulatory filing from Andreessen Horowitz for a fund called PinAH LP disclosed it raised $37 million in mid-March.

A spokeswoman for Andreessen Horowitz declined to comment on the funding round.

Last year, SV Angel, the seed-stage fund headed by San Francisco financier Ron Conway, led a $200 million round in Pinterest at a $5 billion valuation.

Other companies have turned to SPVs for large sums of capital in recent months.

Data analytics provider Palantir Technologies Inc., which was valued at $15 billion last September, turned to an SPV arranged by Founders Fund, a San Francisco firm headed by billionaire investors Peter Thiel, according to people familiar with the deal. In March, ride-sharing service Lyft Inc. included an SPV of more than $10 million from GSV Capital for its $530 million round that valued it at $2.5 billion, a person familiar with the matter said.

By Douglas MacMillan

The Wall Street Journal

—Evelyn M. Rusli, Telis Demos and Yoree Koh contributed to this article.