The angel investment debate rages on. I don’t know if rages is quite the word, but it continues. Many people have written about it including Brad Feld, who cites a number of others. I have written about it. 

Mostly the debate revolves around who is and who is not a “good” angel investor. If the disputants are to be believed, a VC who just plopped $250K into your business to get an option on leading the next round is a “bad” seed investor but a VC who thinks like an angel investor and will give you some bandwidth is a “good” seed investor.

I am going to take the position that the later is just a “less bad” angel investor and that if you are looking for angel money, you should go to someone who does angel investing and has no pretenses to leading (or maybe even participating in) the next round. (I can hear the chorus now: But you want an investor who can support you as you grow etc….) My point of view is that if your business merits VC investment, you will get it on better terms if you started with an angel and then went to a VC than if you started with VC angel money. (Now, I may come to a different conclusion with respect to businesses that require really large amounts of capital, such as biotech and some cleantech companies.)

As I see it, the issue is that VCs who made angel investments are motivated to keep the first round valuation low whereas true angel investors are motivated to keep the first round valuation high.

The reasoning is simple. A VC who will be investing big dollars in the A round will get more for his or her money if the price is low than if the price is high. The dilution resulting from a low price will fall disproportionately on the founders, the holders of common stock and angel investors.

The exact opposite is true for an angel investor who is unlikely to participate in (or at least unlikely to participate in a big way) the first big round. A low price means more dilution to them than a high price.

Once you have a VC inside the tent, they will influence the next round price by their mere presence and because of the contractual rights you will have given them. Your VC investor will in all probability be involved (either as a BOD member or an advisor) in your efforts to find financing. In addition, their financing docs are likely to require that you get their consent to the issuance of new securities or any amendment to the certificate of incorporation (not to mention rights of first refusal and other things that might be in the docs). So, you are going to need their consent to any deal. All this of course assumes that your VC will participate in the new round. If they don’t you may have even bigger issues.

It is hard to imagine that in this context the VC’s presence won’t have a depressing effect on the price you can get from a “new” investor.

So, when you take on a VC angel investment, you are taking a significant risk that your next round valuation will not be as high as it would be if you went with a regular angel investor.