The Future of Startup Funding

Two years ago I [wrote](http://www.paulgraham.com/googles.html#next) about what I called "a huge, unexploited opportunity in startup funding:" the growing disconnect between VCs, whose current business model requires them to invest large amounts, and a large class of startups that need less than they used to. Increasingly, startups want a couple hundred thousand dollars, not a couple million. \[[1](#f1n)\]

The opportunity is a lot less unexploited now. Investors have poured into this territory from both directions. VCs are much more likely to make angel-sized investments than they were a year ago. And meanwhile the past year has seen a dramatic increase in a new type of investor: the super-angel, who operates like an angel, but using other people's money, like a VC.

Though a lot of investors are entering this territory, there is still room for more. The distribution of investors should mirror the distribution of startups, which has the usual power law dropoff. So there should be a lot more people investing tens or hundreds of thousands than millions. \[[2](#f2n)\]

In fact, it may be good for angels that there are more people doing angel-sized deals, because if angel rounds become more legitimate, then startups may start to opt for angel rounds even when they could, if they wanted, raise series A rounds from VCs. One reason startups prefer series A rounds is that they're more prestigious. But if angel investors become more active and better known, they'll increasingly be able to compete with VCs in brand.

Of course, prestige isn't the main reason to prefer a series A round. A startup will probably get more attention from investors in a series A round than an angel round. So if a startup is choosing between an angel round and an A round from a good VC fund, I usually advise them to take the A round. \[[3](#f3n)\]

But while series A rounds aren't going away, I think VCs should be more worried about super-angels than vice versa. Despite their name, the super-angels are really mini VC funds, and they clearly have existing VCs in their sights.

They would seem to have history on their side. The pattern here seems the same one we see when startups and established companies enter a new market. Online video becomes possible, and YouTube plunges right in, while existing media companies embrace it only half-willingly, driven more by fear than hope, and aiming more to protect their turf than to do great things for users. Ditto for PayPal. This pattern is repeated over and over, and it's usually the invaders who win. In this case the super-angels are the invaders. Angel rounds are their whole business, as online video was for YouTube. Whereas VCs who make angel investments mostly do it as a way to generate deal flow for series A rounds. \[[4](#f4n)\]

On the other hand, startup investing is a very strange business. Nearly all the returns are concentrated in a few big winners. If the super-angels merely fail to invest in (and to some extent produce) the big winners, they'll be out of business, even if they invest in all the others.

**VCs**

Why don't VCs start doing smaller series A rounds? The sticking point is board seats. In a traditional series A round, the partner whose deal it is takes a seat on the startup's board. If we assume the average startup runs for 6 years and a partner can bear to be on 12 boards at once, then a VC fund can do 2 series A deals per partner per year.

It has always seemed to me the solution is to take fewer board seats. You don't have to be on the board to help a startup. Maybe VCs feel they need the power that comes with board membership to ensure their money isn't wasted. But have they tested that theory? Unless they've tried not taking board seats and found their returns are lower, they're not bracketing the problem.

I'm not saying VCs don't help startups. The good ones help them a lot. What I'm saying is that the kind of help that matters, you may not have to be a board member to give. \[[5](#f5n)\]

How will this all play out? Some VCs will probably adapt, by doing more, smaller deals. I wouldn't be surprised if by streamlining their selection process and taking fewer board seats, VC funds could do 2 to 3 times as many series A rounds with no loss of quality.

But other VCs will make no more than superficial changes. VCs are conservative, and the threat to them isn't mortal. The VC funds that don't adapt won't be violently displaced. They'll edge gradually into a different business without realizing it. They'll still do what they will call series A rounds, but these will