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Pay to Play October 10, 2009

Posted by mbdavenport in Uncategorized.
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There’s a lot of rage right now surrounding the decision of a group of angel investors – those that provide initial capital to potential start-ups – to begin charging potential investees to view pitches.

Fees can be as much as $2,000 for a 20 minutes slot in which the start-up shows their product, explains their business model and then offers a stake in the company for investment cash. If you’ve seen Dragon’s Den then you’ll already be familiar with the format.

This charging of poor by the extremely rich has certainly got the backs up of some very vocal individuals. Jason Calacanis wrote a scathing blog post about this relatively new practice in which he says:

“These pay-for-play scams remind me of the “modeling agencies” that charge people for representation, acting lessons and to have their headshots done. Trust me kids, Brad Pitt and Kate Moss did not pay to get representation… If you’re paying to get an agent, it’s because you’re being scammed.”

But it’s not as simple as that. There are two main reasons that angel investors are charging for their time:

1. The Recession

Yeah, that ol’ bugbear. As a result of all that credit-crunchiness it is now much, much harder to obtain money for investment in new businesses. Hell, most companies that went under in 2008/2009 went under because the banks withdrew previously agreed overdraft limits of a couple of thousand pounds, severely impacting on a company’s cash flow. Trying to get your hands on the large quantities of cash required to start a business or buy a house has become significantly more difficult.

So, angel investors will charge because they can. You need their money and you may be struggling to get it from somewhere else. If you need those funds bad enough then you’ll pay the investor’s fee. And they know it. Sure it sounds unfair but that’s capitalism. As the availability of a commodity (in this case cold, hard cash) diminishes, so its value and price increases.

2. Barriers to Entry

The barriers to entry in to the tech industry are relatively low. There’s no expensive machinery that needs to be purchased, no extensive premises that need renting and the technical knowledge required is not in shortage and so is not prohibitively expensive. This means that there are plenty of people able to consider entering the market, particularly as general media coverage increases as a result of Twitter, Spotify and the iPhone App Store.

Investment companies as a result are becoming inundated with requests for time from people who seek the investment that can start them off on their way. Some companies can see many hundreds in a month and end up with only 1-2 final companies that a worth taking a chance on. This is a very inefficient way to screen candidates. If you have a job vacancy do you interview expressing an interest? No, you have an application stage, and perhaps a telephone interview conducted by a member of your HR team/PA. I’m not suggesting that start-ups submit a written business plan first but what’s clear is that investors have had to increase the barriers to entry to clear away some of the dross.

Calacanis argues that a mature or better start-up would refuse to pay present their case to investors, instead relying on word-of-mouth buzz or industry connections. Instead the only people that would pay would be the less connected or the less good: those that had not invested the time to foster a network and/or those who did not have an inspiring product. Problem is, that’s the wrong way around. A bad start-up likely knows that they don’t have a very good idea and are not likely to want to risk their own funds if there’s a good chance they won’t receive funding. Whereas a good start-up will likely believe themselves to have a better chance of obtain a fistful of readies and so will be happy to pay (or at least, accepting of) the pay-to-play fee.

Paying that fee demonstrates self-belief, self-investment and overall a confidence in the future of your company. In a time when the the investment world is still firmly in the recovering stages that confidence can mean a lot. Who wants to invest in the future of your company when you won’t?

While I don’t disagree entirely with the practice I believe that some rules do need to be put in place in order to prevent abuse of the system. Angel Capital are calling for a cap on pitch fees at $500 and others believe that a fee should be charged as a percentage of the level of investment requested which sounds proportionate and fairer.

Those who believe that charging is altogether outrageous need to appreciate that start-ups are now more prevalent and far more risky than they were in earlier years – particularly while the question of monetising the web remains unanswered. Perhaps the trend will reverse as the global economy improves and the struggle to profitability lesson slightly. Somehow though, I feel that while the level of fees charged may rise and fall the modus operandi is here for good.

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