Capitalism and Angel Investors

“It is not from the benevolence of the angel investor that we expect our funding, but from their regard to their own interest.” (My apologies to Adam Smith.)

In 2005, Tourmaline Networks was acquired by Intellisync, ending one chapter of my career.

Prior to being a founder and the CEO of Tourmaline Networks, I was the VP of Engineering of Tiernan Communications, a San Diego based telecom firm that failed in 1999. It was a painful bankruptcy, and my recruitment pitch to my fellow ex-Tiernan soon to be Tourmaline co-founders was that “it cannot be any worse.” No doubt convinced by my inspiring words, we created Tourmaline Networks (named after a San Diego surf break), and with close to zero combined business or finance experience among us four engineers, off we went, the company literally starting in my garage.

Starting a company is technically not that difficult, the main challenge being that you will have to sacrifice much of your time & wealth. My primary guide was a book titled something like “How to Start a Corporation in California.” The Interwebs has made this process easier…

OK, things did get a little harder. After surviving a flood (leaking upstairs toilet), a fraudulent insurance company, the dot-com market crash and even a smash & grab of our computers, Tourmaline Networks somehow prevailed.

You cannot hit a home run if you are not in the batter’s box, and the act of creating an engineering consulting firm put us squarely in that box. A product eventually emerged, namely Soda-Pop Mail, one of the world’s first mobile apps! Revenue & profit spiked, and thus, the 2005 acquisition.

Which led to the next chapter of my career, one as an angel investor. I considered starting another company, but with three children at home and the growing success of my wife’s career, I opted for a “work at-home” option (a rarity before Days of Covid). Fifteen learning years later I am still an independent angel investor.

Angel investing is anything but an ordinary career, as your compensation can easily be negative. It requires passion for what you do, which is to provide the wealth so that others can be the hard-working founders of their own startups.

Anyone can lose money. The trick with making money as an angel investor is providing sufficient liquidity, on terms acceptable to all, that successfully allows for the formation of a team, and the creation of a high-growth, profit-generating product, or service.

Angel investors are literally engaged in the trenches of capitalism, deciding which startups receive funding, and thus, which products and services are created. Often competing with other angel investors in that potentially competing companies may be independently funded at the same time.

A core component of a decentralized economy is that individuals or small groups (i.e., not the government), decide how to allocate much of the excess wealth of our economy. In this case the individuals are the angel investors, and the excess wealth their own accumulated private wealth.

One possible step towards a more centralized economy would be to discourage angel investing. Perhaps repeating ad-nausea that millionaires and billionaires do not pay their “fair share” of taxes (a secret that someday my tax accountant will disclose to me…). Relieve them of this financial burden of excess wealth, and instead let someone else (I assume a political bureaucrat), decide where to “invest” it.

Are angel investors better stewards of this excess wealth than the government? Will they make better decisions, thus making more efficient use of this wealth, resulting in the creation of products and services that are in demand, that will eventually result in greater wealth creation for all?

I believe so.

Because we angel investors invest for one and only one reason, which is to make a profit. Not just a modest profit, but an investment that generates such a high ROI it will make up for the many prior startups we invested in that failed. Because we have “skin in the game”, we take this decision-making process very seriously.

It is much more painful to lose your own money then someone else’s money.

Almost all startups require initial outside funding. If you have read my book “What the Hell is an Economy”, then you will understand that a fundamental reason for the existence of corporations is to allow risky startups, with their enthusiastic founders, to efficiently raise this capital. The only question is where this wealth comes from.

There are only so many sources of “excess wealth”. Individuals, banks, venture funds, crowdfunding, and of course, the government.

Banks tend to issue low-risk loans only for which there is collateral, or an existing business track record. Venture funds tend to focus on just a handful of larger multi million-dollar investment opportunities. Crowdfunding may initially be a good alternative for some, but it is not a long-term funding strategy. Government’s role should be to fill the void for which the other entities will not transfer wealth to, often because a positive direct financial ROI will never be realized. Examples being NASA and large infrastructure projects.

Which is why many startups raise their seed round from angel investors.

Some have a problem with the wealthy angels (and VC’s) having such a disproportionate say in the direction of our economy, in terms of which products and services are created. That this is a “non-democratic” system by which the wealthy get wealthier.

The counter argument is that when one invests your own wealth, with no safety net in the event of a loss, you tend to make better financial decisions. Remember that it is the market, representing everyone, that ultimately decides which startups succeed, and which fail. This democratic system quickly filters out the products and services for which there is not enough demand, or the price is too high, leaving all of us with the best to choose from.

Only those angels and VC’s that consistently make good decisions stay in the business, improving the efficiency of the system, because for every failed company, precious excess wealth was consumed. It is imperative that the wealth created by the rare successes exceeds the wealth lost by those that failed.

Truly a Darwinian process, but one that has created tremendous wealth for our society, allowing for advances in science, healthcare, etc.

A warning sign that we are shifting towards centralization is when politicians start using the word “investment” regarding government spending. Government is best at allocating resources where others will not. A proper usage of public funds, but not a good financial investment, in that the taxpayers are not going to realize a positive ROI anytime soon.

If the government were to begin encroaching in the areas traditionally addressed by the banks, funds, and individuals, it implies that these experienced managers of wealth will be making less wealth-allocating decisions, as the government makes more. A shift towards centralization, and if history serves as a guide, expect a gradual decline in the quality and availability of products and services.

One of my most recent investments has been in the company producing the JackRabbit, an e-bike that Wired Magazine recently called the best “micro bike.” Prior to my financial boost JackRabbit was a Kickstarter campaign, with limited resources and growth prospects. Today it is quickly figuring out how to manufacturer and sell many thousands of these bikes.

In theory Jackrabbit could have applied for some sort of green government grant or found that very rare bank willing to make this risky loan. Either way, probably incurring delay in a very competitive market. No surprise that this was instead a good fit for an angel investor, someone who could provide the immediate infusion of cash in exchange for a reasonable ownership stake of the company.

Keep in mind that if the company succeeds, if it goes up in value, the founders come out ahead, the increase in stock price more than making up for the dilution of their percentage holding required to raise these funds.

Money is sometimes time. A delay in the introduction of a product to market can prove to be very costly in the long run.

This is capitalism. A decentralized decision as to the allocation of wealth, from the angel investor to a corporation.

This excess wealth could have been allocated elsewhere, as there is no shortage of individuals and organizations that need money, but I decided to invest it in Jackrabbit. Not because the company needed the money more than others, or is more deserving, or because I am benevolent, but because it is my belief that the given this funding, the founders would produce a product for which there is market demand, that it can be sold for a profit, to the benefit of all involved.

Which means for the benefit of me.

Capitalism is not a perfect system, and our economy is a mix of centralized and decentralized decisions when it comes to the allocation of excess wealth. But if you are involved in the production, sales and support of electric bikes, or if you happen to own one, then you should be thankful that our economy is partially decentralized, that capitalism is allowed to flourish where appropriate, because that is how affordable and desirable products and services will continue to be created.

And dare I say, with the creation of the Jackrabbit electric micro-bike, assuming there is sufficient demand, and we can sell it for a profit,

wealth will be created.

Want to learn more?

www.WTHisAnEconomy.com

Eric Johnson is a husband, father, engineer, pilot, surfer, investor and amateur astronomer who has read a lot of books on economics.