Angel Investors Are Going Where VCs Fear to Tread

From left, Five Founder Collective partners Micah Rosenbloom, Chris Dixon, David Frankel, Caterina Fake, and Zach Klein. Illustration by Gluekit

Chris Dixon is sitting in his lofty office in New York's Silicon Alley, trying to persuade an 18-year-old to take his money. The young man is in town from California, and the word on the street is he's poised to become one of Silicon Valley's hottest entrepreneurs. His name is Dan Gross, and he's developed a method for allowing people to easily search all the data they store in the "cloud"—music, bank statements, Twitter feeds, Facebook wall posts. All he needs now is the cash to get his fledgling company, Greplin, aloft. And Dixon, a 38-year-old millionaire who runs an investment firm called Founder Collective, is ready with his checkbook.

With his thick-rimmed square glasses, jeans, studded belt, and, of course, sneakers, Dixon is in many ways what Gross aspires to be: one of the successful few in the crapshoot world of Internet startups. Dixon—who sold his Internet-security firm, SiteAdvisor, for $75 million to antivirus software company McAfee, Inc. in 2005—is what's known as an "angel investor," descending from on high to bestow his largesse on comers like Gross. Unlike the big venture-capital funds such as Kleiner Perkins and Sequoia Capital, angel investors are mostly individual entrepreneurs who've hit it big and are looking to gamble their own money on the next generation of talent. And with VC funding harder to come by since the beginning of the Great Recession, angel investors have stepped in to fill the gap: the number of these funds has exploded in just the last year, from seven in 2009 to 26 in 2010, according to the Web site EarlyStager, which tracks startups.

Of course, the "angel" honorific is a bit of an exaggeration. These heavenly moneymen are as opportunistic as their venture-capital brethren, hoping to get in on the ground floor of the next Google. Instead of offering budding entrepreneurs millions of dollars in exchange for big equity stakes, as the venture-capital funds do, Founder Collective offers an average of less than $200,000. In exchange, it takes less equity. But it provides more in the way of personal support to the entrepreneurs than a VC would. The potential payoffs to angel and entrepreneur? In addition to the obvious, the young entrepreneurs get access to some of the top minds and most successful founders in the tech world. And the angels stand to win bragging rights if they pick the right horse. After all, who in the Valley doesn't know it was Sun Microsystems cofounder Andy Bechtolsheim who handed Larry Page and Sergey Brin a check for $100,000 in August 1998, before they'd even incorporated? Or that Peter Thiel was the first outside investor in a Harvard startup called Facebook?

The reason any of this is possible is because in the last 10 years the price of starting a technology company has fallen dramatically. No longer do startups have to pay $60,000 for an Oracle database or shell out tens of thousands of dollars for a content-management system: free open-source software has taken care of that. Bandwidth and hardware are also substantially cheaper. Plus, a company that might have needed dozens of programmers in the past can now get away with one or two. Add to that the fact that most people working for startups eschew large salaries in exchange for equity stakes, and the cost of getting a new tech company off the ground goes from several million dollars to a few hundred thousand. That has allowed smaller funds like Founder Collective to get into the game in a big way.

Dixon came up with the idea for Founder Collective in 2008. At the time, he was launching a new startup with Flickr founder Caterina Fake called, which offers users product and lifestyle recommendations based on their purchases and those of their friends. Fake had made millions selling her Flickr photo-sharing site to Yahoo in 2005 and was now dabbling in angel investing, pouring seed money into companies like Etsy, the hugely successful online crafts site. How many other ventures could Fake and Dixon launch if they pooled their resources? Instead of investing millions in a few companies that were already off the ground, they'd invest thousands in several companies that might not even be launched yet, including those that were nothing more than the proverbial idea on a cocktail napkin.

Their entrepreneur buddies included David Frankel, who started the largest Internet service provider in Africa; Zach Klein, one of the cofounders of CollegeHumor, which was acquired by Barry Diller's IAC in 2006; and Eric Paley, who sold Brontes Technologies, which makes dental imaging technology, to 3M in 2006 for $95 million. Together they were able to pool together $50 million to form Founder Collective. "We realize the word 'collective' sounds a bit radical, even socialist. This is deliberate," explains Dixon. "While we have an actual fund, we also have a unique structure where active entrepreneurs lead investments, work hard to help their investments succeed, and share in the profits when they do. Think of it as peer-to-peer venture capital." The partners, eight in all, are free to invest up to $100,000 on their own, but consult each other on larger investments. So far, Founder Collective has put money into about 50 startups.

You're probably not going to see VCs deciding to bankroll a company over coffee in a Greenwich Village café, as Dixon did with Chris Poole, the 22-year-old founder of the no-holds-barred online community 4chan, which he launched when he was 15 from his bedroom in Westchester County, N.Y. Now Poole is about to introduce a more mainstream version of 4chan called Canvas. Poole was attracted by the Founder Collective model precisely because of how involved it is in its investments. "They're partners in your business, and they help you attract good people to team up with, and they're there to support you," he says. So cozy is the Founder Collective relationship that "entrepreneurs have come and stayed at my house," says Fake, who lives in San Francisco. Venture capitalists "can show up to the board meeting, but they're not going to make you spaghetti and meatballs and play trains with my daughter. I'm happy to talk products well into the night. I love startups. I love the business. I love young entrepreneurs."

Rather than investing in individual companies, Founder Collective thinks of itself as investing in individuals, people who might wind up launching several companies. Which is why pitch meetings often involve Dixon asking a young prospect to tell his life story. "So you liked programming your whole life, that kind of thing?" Dixon asks Gross, who is from Israel and is just finishing up an eight-week startup boot camp in Palo Alto, Calif., run by the tech incubator Y Combinator. "Yeah," Gross says. "I hacked a prototype [for Greplin] in 72 hours."

Gross demonstrates what Greplin does, rattling off a dizzying mix of technical and financial terms that most entrepreneurs twice his age would stumble over. Gross is obsessed with the idea of "autocomplete based on your life"—so, whereas Google autocompletes your search by deriving it from what everyone else is looking for, Greplin will autocomplete based on other searches you've done. "You used to have to type in everything," Gross explains. "Now you have to type in 30 percent what you asked Greplin before because we can guess what it's going to be based on just the information."

Dixon grins; he likes what he hears. "It's one of these ideas like, 'Why hasn't someone done that?'?" Dixon says. "Once Google sees it, they'll probably want to buy you or something."

Bingo. The next week, Dixon cuts Gross a check for $100,000. That's 10 million pennies from heaven.