Navigating Angel Groups

A seed round is often times a good idea either after a ‘friends and family’ raise or in place of it.  A seed round tends to have less strings attached.  People always say the clock is ticking once you have taken a Series A from a VC.  A seed round is serious, but typically you haven’t proven you idea can work – you are still kind of testing it. So often times it is just more appropriate.

One of the reasons Angel groups are a good source of seed funding is not because of their skill or professionalism but simply because of the concentrated access to self-identified investors that they provide. Finding 10 to 20 angels willing to write a check of, for example $25,000, from an entrepreneurs own network would probably take quite a bit of time, even if the ‘hit rate’ on a percentage basis might be higher. So the odds of raising a seed round of between $250,000 and $500,000 seem higher and additionally the time commitment of the entrepreneur is likely lower than in a 1:1 meeting scenario.

Conversely, the value of an Angel group to its members is that they get deal flow. More sources of deals means more investment choices and ought to mean better investments and better returns.  It actually doesn’t, but that’s a different blog post.  The point is that for an entrepreneur pitching to an Angel group is a competition.  Entrepreneurs may not be thinking about it this way but they should.

As an insider here are some hints that can help improve your odds of winning this competition:

1) Market to your audience.  That means know your audience and don’t try to use a one-size-fits-all pitch.  Simple right?  Apparently not always.  Check out the individual bios.  Ask what the groups other investments have been.  Meet with a member of the group 1:1 before hand to understand some of the quirky do’s and don’ts.  Chances are you’ll find out that the group is old and white and male.  That’s changing slowly, but it’s still true today.  That means keep the initial interface with the group at a high level. Don’t go diving into the intellectual property as some entrepreneurs are prone to doing.  Use analogies.  I’m not saying this crowd is simple – they are not!  They are not all that tech savvy especially across lots of categories.  Finally, plan for less presentation and more Q&A. Let the investor be in the driver seat.

2) Keep the message simple. If the presentation has a bunch of ‘eye charts’ or lot’s of builds, or even too many slides, that is a sign the message hasn’t been boiled down to its essence.  Ben Franklin once wrote a letter to a friend concluding it with something along the lines of  “I’m sorry this correspondence is so long, it would have been short if I had more time to consider it.”  Essentially this means don’t brain dump!  Think about what is most important and how it is best said.

3) Find a champion within the group.  Let’s say you are one of 20 companies getting screened, one of 10 presenting to the Angel group and 1 of 3 that gets brought back for final investment consideration.  Think about how terrible those odds are.  Three opportunities to get nixed, lost in the shuffle, fallen through the crack or not properly remembered and considered.  I estimate that a good idea gets unknowingly screened out monthly.  So find a champion within the group. Get someone to help you keep your pitch alive by reminding the group about your business and why it is different and good.

4) Help find a lead investor. This one seems weird but it can be really helpful.  A bunch of times an Angel won’t be as good at valuing a startup or deciding on a term sheet.  If there is someone out there willing to set the terms and the valuation that accomplishes  two things: lets the group know that there is conventional wisdom that this is a good idea, and also helps make the investment decision easier for the rest of the investors by providing some guidelines about what the investment will look like.  Of course, finding a lead is the hard part, but Angel groups tend to be better at filling out the round than being in the driver seat.

I’ve seen a lot  of blogs that talk about how the deck should look and what the presentation style should be.  I think you should take that advice as well.  But, if you truly have a good idea for a business and you work the system I think your odds go way up.

D3 (DUMBO Demo Day)

I went to my first Demo Day in Brooklyn. It was a source of pride for me. It was sponsored by NYU-Poly Incubator (who else).

What I liked about it was probably what others in the audience liked. It had a less formal feel to it. These companies weren’t pitching to raise money. They were pitching to let people know what they are creating, and that they are hiring, and that anybody that wanted to be involved should get involved.

The companies that pitched were all Brooklyn companies (nice right?). They included:

Knodes – a social data analysis company. The CEO, Ron Williams, killed it as he laid out the company’s plans to build an infrastructure of users and developers around what the company is doing. As an ‘analytics guy’ I can see plenty to business models and I can’t wait to see which one is optimum.

Docracy – a crowd sourced document availability and management company. I first saw the co-founders John and Matt at Techcrunch Disrupt last summer when they were still fleshing out the idea and getting ready to take the leap away from project based work. It was nice to see the progress made as well as the roadmap for new services.

HowAboutWe – a venture backed dating and relationship site. The management presenters were just the right amount of quirky as they talked about the sign up process and challenges of national expansion.

I did miss one presentation, as I had to leave early.

All these three have successfully raised funds – Knodes has support from Quotidian Ventures, Docracy also has support from Quotidian Ventures as well as RRE and HowAboutWe has raised two sizable rounds from RRE and Khosla Ventures.

I though all the companies did a good job. The venture capitalist in me wanted to hear more about the business model and the challenges and opportunities for growth. But, at least so far, that is not the Brookyn way.  These guys seem to know that if they make something cool they will be able to take it to market.  And I’m sure I’ll get to ask my questions at some point.

I’m already looking forward to the next one!

More About Silicon Valley

 

I spent the week in the Valley last week.  I hadn’t really been there with a VC hat on. I’ve spent most of my career thinking about public companies as a Sell Side analyst and as a strategist running corporate development for a public company.

 

Anybody who knows me, knows that I’ve been really excited about the large steps forward that the New York venture scene has taken over the past 18 months or so. However my view has tempered recently by both the recent data on the deal environment and by my trip.

 

The recent data points

  1. The National Venture Capital Association put out data that showed that NY did fewer deals and at lesser volume in Q4 than in Q3 and that Boston really is the number two locale for venture in terms of deals and volume in 2011.  This is clearly a step back for NY or, more likely an inflated sense of the steps forward.
  2. The return on venture investment declined for the fourth consecutive year (see below).  This is probably cyclical, but there is undoubtedly damage to be done to the number of VCs and the amount of investments to be made. In fact, a plurality of U.S. venture capitalists believe venture investment and fundraising will decline in 2012.

This is probably bad news for the 54% of U.S. 18-34 year olds who want to start a business as per a recent Kauffman Foundation survey because it means funding will be harder to get.

What this means to me if you are an entrepreneur is ‘get funded while you can’.  Prioritize your company’s future existence over the value of the business.  Or as Mark Suster would say, “when they are passing the hors d’oeuvre try, take two and save one for later”.

The trip

I went for a predictive analytics conference, but also to reconnect with folks I have done business with in the past.  So I went to the conference.  It was fine.  While I was there, I learned about another conference called Launch. I was able to get into that conference with the help of a company I know here in NY.  BTW thanks guys for saving me a grand.  There were 40 brand news companies there at least. It was cool to say the least.

On my way there, I past the venue that Apple was introducing the latest iPad.  There were a gaggle of tech journalists there covering the event.

And then the next morning, in the convention center next to my hotel, there was a Game Developers Conference with thousands in attendance.  All this in a 3 block radius of San Francisco over 18 hours.  And that’s just what I knew about.

The point is the shear size and scale of what is going on in Silicon Valley is so vast that it will be a long time before NY deserves to be thought of in the same way.  I’m not saying I was diluted into thinking there wasn’t a big gap, I’m just saying once you see it up close you realize how much work and effort needs to be done to build a ecosystem of funders and fundees that is truly self-sufficient and provides built-to-last value.

My point here is do what you can to make hay while the sun still shines!

 

Speed Dating – The Entrepreneurs Side

Back on February 7, 2012 I had just come from a pitch event where I was listening to entrepreneurs speed pitch their companies and I tried to provide advice to make life easier for an entrepreneur in the event she/he wants to attend an event like this.

The advice essentially boiled down to be concise and be conversant in both your company and your industry.  One of the entrepreneurs who attended that Funding Post event read my post and offered to provide his opinion of the process.  I suggested the following parameters for discussion…

  • Talk about what you were hoping to accomplish.
  • Talk about what you think you did accomplish?
  • Compare this, if possible, to other events you tried before.
  • Assess if this event was a good use of your time?
  • Discuss whether the Angels and VCs gave you actionable feedback?
  • Did you learn anything for next time?

The following guest post addressing the ‘Speed Dating’ topic from the perspective of the entrepreneur is from Ken Kiarash, Co-Founder MiiWee:

I am the co-founder of a start-up in NYC and wanted to share my experience of recently attending the NYC Venture Capital and Angel Showcase, sponsored by the FundingPost. I attended with a friend who was also looking to meet some VCs and Angel investors, to make connections with not only potential investors, but also other entrepreneurs as well. I have attended many such events in NYC and Silicon Valley, some smaller in size and more ‘intimate’ while others have been larger ‘social‘ events.

The event was generally well organized and easy to navigate, but there are a few things that both organizers and participants can do to meaningfully improve it. Let’s start with the registration and post-registration issues: The event’s site is very confusing and poorly organized/written. There were two types of tickets: 6-9PM cocktail reception for $135 or for $425, you would get a ticket to the reception plus an optional pitching workshop. Not only the information on Fundingpost’s site was confusing to decipher, but also my subsequent to communicate with them was just as confusing. I attended the evening reception, but found out that the afternoon ‘workshop’ session was well worth the additional cost due to ability to get a lot more face time with the VCs.

Regardless of which session you attended, from an entrepreneur’s perspective, there needs to be more clarity and transparency of what a particular VC fund and or Angel investor is interested in and what they won’t invest in. I spoke to a VC fund, that although I thought we would have a good connection through our alumni network, it ended up being a super-brief pitch, followed by ‘we don’t invest in consumer-oriented companies’, something that could have easily been avoided had they mentioned that in their bio or even on their site (I am not going to go into a tangential discussion of reviewing VC sites, but let’s just say most can do a lot better than the generic pages they have created from boilerplate templates!).

The fact that there were two reps from each fund made the line of eager entrepreneurs move a lot quicker, but there were a few tables with reps that were simply not ready for the crowd, including some who were too young and too inexperienced to handle the deluge of various ideas being thrown at them in the rapid-fire format. One firm had even decided to send two extremely junior reps who jointly listened to each and every individual, letting them pitch for 10 minutes or more, making it almost worthless to wait in line for your turn.

As frustrating as the fund-raising process may be, those seeking capital need to do a better job themselves. First and foremost, be prepared! You must do your homework before you get to these meetings. There were 37 funds represented at this event and we spent nearly two days researching each and every one of them. You should get to know who these VCs or Angel investors are, types of companies they invest in and see whether it is even worth your time to stand in line and pitch your idea. Some invest in very early stage ventures, some only do so after you have an established product and even generate some revenue, and others may only invest if you are in a particular city/state, etc. If you’re looking for small seed money, you may be better off spending your time and resources elsewhere.

Next, you must have a pitch deck ready for these events. If you don’t have one, Google is your friend: search, find, read many, and finally write one. The deck is not only something to give to the VCs/Angels but, just as importantly, should be used as a tool for you to crystalize your idea and be able to pitch it more efficiently. You only get a limited amount of time and if your deck is done properly (short and concise), you will be able to pitch your idea to any investor in under 2 minutes.

Finally, prepare to answer key questions, and if you have spent enough time preparing a good deck, you should have most of the generic topics that come up in a short ‘elevator’ pitch covered: What is your product? What is the problem you are trying to solve? Your solution, market size, competition, who is in your team, how do you make money, what do you need the money for, and lastly, how much do you need (hopefully you can answer this with a pre/post valuation as well, as it is a sensitive subject for many Angels)

If you need to, have a drink to calm your nerves, but keep it moderate and leave the hangover-inducing version to later at night when you need to deal with all the rejections. And generally, don’t forget to have a good time. Talk to as many people as you can. Introduce yourself to strangers and exchange cards, even if you don’t get to talk to them about your idea in detail. These events are probably as important for their networking opportunities as they are for meeting potential investors. Lastly, be prepared for lots of rejections, as they are extremely normal in the industry. If you TRULY believe in your idea, such dismissals should give you a sense of where you need to tweak your plan, whether it lacks management depth, execution issues, or the idea itself needs to be refined. Having said that, even you should recognize if an idea is a really bad one and cut your losses short.

Wishing you all a successful fundraising year… Ken Kiarash Co-Founder MiiWee

Thank you, Ken, for your perspective.  I think this is a sound perspective and good advice.

Work To Do

Before I begin, let me tell you that I just read back through this post and realized that there are a bunch of anonymous companies, people, etc.  The reason is I don’t want to out anyone or make anyone uncomfortable.  I just want to point out where there are opportunities for the community to improve.

So as one with a vested interest in the community I try to come into contact with as many entrepreneurs in the Brooklyn area as I can.  It’s always interesting to hear about their businesses.  I try to ask what they like and dislike about Brooklyn and what could help out their situation.  More often than not I am told how great the environment is and how most employees prefer it to Manhattan because they live in Brooklyn anyway.

This week I heard a couple anecdotes that let me know that things are not all beer and skittles particularly here in DUMBO.

No Damn Space – I was talking to a CEO of a company that recently moved from Brooklyn to Manhattan.  I figured the story would be that this company had graduated to the ‘big leagues’ and wanted the prestige of a Manhattan address.  Couldn’t have been further from the truth.  He told me that as his company had grown he needed more space.  He was looking around for nearly six months and couldn’t find a good deal.  He felt forced into Manhattan.  And this particular entrepreneur is plugged in.  He knows many of community leaders and landlords.  He suggested that not only was there not enough space zoned for commercial, but there was also some brinksmanship around which properties in the neighborhood would be developed and when.

I’ve heard conflicting stories about the amount of space that is currently available for startups and what is planned to be zoned for commercial and when.  What I do know is that this is not the first time that I have heard this issue come up so there is either some truth to it or some confusion that needs to be clarified.  What I’m going to do is try to figure what is available and post something about it.

Plugged In – The other morning I had breakfast with the CEO of a startup who’s company is just ready to lift off.  He’s got a great product, good technology and many happy customers that are of decent size.  Plus, he is just closing his seed round to expand his business.  This is exactly the type of entrepreneur that Brooklyn could use.  I have no doubt that this company is going to be a job creator over the next couple years.  When I asked when he was moving in he was hesitant.  I knew he had been looking at a couple options here.  What he told me was that he was drawn to Brooklyn because of the reputation for being a tech hotspot, but he wasn’t sure because he couldn’t figure out how to plug into the community easily.  Without that, there wasn’t as much value.  In truth, the only thing I could offer him was to introduce him around.  I heard this same issue raised the other night at the Brooklyn Bridge Ventures event Making Brooklyn: A Community Roundtable on Brooklyn as an Innovation Center and the point is a good one: the community as a whole could benefit from making it easier for new companies to plug in.

Let The Right Ones In – I was reading this guys blog the other day and it reminded me of a similar story from a Brooklyn networking event over the holidays.  Let me start by saying if you are interested in the startup community you probably have heard of Frank Denbow.  He curates The Startup Digest.  He is a regular at General Assembly.  This is his twitter. He’s awesome, not to mention a good person to have involved in your startup community.  I had the privilege of meeting him for office hours a couple weeks ago.  I told him about my blog and what I was hoping accomplish.  He said, “yeah I came out for a Brooklyn event last night.  I was waiting in this crazy long line. When I got to the front they wouldn’t let me in.  I ended up just leaving.”

This is a tragedy and a blunder.  This is the equivalent of not letting Pete Rose into a baseball memorabilia convention.  He’s the guy you want to be there.  He’s the guy that can help move things forward.  I’m not saying that anyone who throws an event has to do it in any particular way, especially one so successful that people can’t get in (that’s a nice problem to have).  I’m just saying, let’s not leave any money on the table.  If people want to be involved let them.

Self-reflection is always valuable.  Even more so when it is acted on.  I’m going to do what I can.

Angel Valuation & Return

How can an angel value a company that has no revenue or customers?  There are a couple ways that have been devised but none is very good.  Still, angel investors want to make investments so they have to work with what they’ve got.

In truth an angel doesn’t have to do a valuation calculation.  Most angel rounds these days are notes that convert into preferred shares when a VC comes along and provides a “professional” valuation.  This works because the angel gets some interest (which is nominal but better than nothing) and then gets to convert into preferred at typically a higher valuation at a time not too far into the future. Also, the preferred might be at some discount (say 20%) to the price the next investors are paying.

However, angels should want to do a couple high level valuation calculations so that they can get a ballpark estimation of expected return.

First things first… the practical determinant of valuation is always the market.  If the market is hot the valuation will certainly be a little higher.  But beware, markets are cyclical.

Median – the median pre-money valuation of venture capital seed-stage enterprises has varied annually over a narrow range between $1.7 million and $2.5 million since 2002.  Experienced investors will compare the calculation of other methods to the median as a check for reasonableness.

Berkus Method – this method starts with a valuation of $0 and adds $500,000 for each of the following items:

  • Good idea
  • Prototype built
  • Good management team
  • Strategic relationships in place
  • Product at rollout or early revenue stage

That means the top valuation should be $2.5 million.  Sound familiar?

Scorecard Method – choose factors (team,  TAM, technology, etc) and assign a weight so the factors add up to 100%.  Then rate the startup on each factor with 100% being the norm (ex. a strong team might get 125% of the norm).  Multiply each weight by the factor value and add them up.  This sum is a multiple that gets applied to market rate for pre-money.  For the NYC area the recent median has been $2.0 million. As the example below shows, the pre-money valuation is $2.25 million.

Discounted Cash Flow (DCF) – DCF utilizes cash flow projections plus a terminal value for the business in future years, discounting them to the present as Net Present Value – the higher the risk, the higher the discount rate.  If you really want to use this method go here.  But I wouldn’t for two reasons: first projecting 5 years of cash flows of a startup is ridiculous and second, I recently did this for a company that has been in business for several years (going for a series C) that had great projections and the partner I was doing this for said,”we don’t really use that in venture. the P/E guys do and the public equities guys do, but we don’t.”  That’s good enough for me.

So that is a good place to start on valuation.  What about angel return?  Here’s a couple things to keep in mind.  The basic rule of thumb is angel investors are targeting 5 to 10 times return on their money in 4 to 8 years.  See the table below.

 

So what does this mean?  It means angels are seeking investments that can grow revenues to at least $50 million within four to eight years on a median valuation.  It means they are expecting a market value of the company in excess of $100 million.  And that building companies with revenues sufficient to create $100 million in market value in four to eight years typically requires much more capital than is normally invested in seed/startup rounds, or in other words, the angel investor is going to get diluted. Dilution sucks, but it is a necessary evil.  That is why angels need to be disciplined and frank when dealing with entrepreneurs they are going to back.

It gets harder… angel investing follows the 80/20 rule.  80% of the return of an angels investment portfolio are going to come from 20% of the investments (sometimes even less).  So the really do have to be home runs to make up for the ones that didn’t work out.

Plus, there is an early negative return bias.  The other day one of RTPs partners mentioned the old adage “lemons sour quickly”.  That means early on (about 2 years) in an angel investment portfolio, the angel investor will probably know what investments won’t work out, but it might take 8 years for the really great companies to develop. So an angel is losing money for a long time until all of a sudden there is a nice return.  Or not.

Here’s some more resources to help you think through valuation:

Angel Capital Association
Angel Resource Institute
Bill Payne Angel Valuation Analysis
Dave Berkus Method
Common IRR’s and their multiples
The VC Method

Startup Product Mantra: Laid, Paid, Made

This week I referred to something I read in a post by Dave McClure back in December on two separate occasions when discussing the importance of building a product that can have an impact in the marketplace.

The first time was at a coffee with a respected marketing consultant.  She expressed frustration that one of her startup clients really just wanted to build ‘cool stuff’ and figured the sheer coolness of it would be enough to eventually figure out the business model.  She seethed that this team had “a solution searching for a problem.” She wondered how to snap them out of this ‘build it and they will come’ mentality.

The second time was in a discussion about Pinterest.  A successful CTO I spoke to said, “you know I like Pinterest, but I don’t really understand the valuation”.  For those who don’t follow these things, Pintrest recently raised a $27 million Series B (total of $37.5 million raised) at a rumored $200 million pre-money valuation.

In both cases I simply repeated what Dave said, ‘great products and do 1 of 3 things: get you laid, get you paid, get you made’.  Consciously or not this was reference to Maslow’s Hierarchy of needs – first physiological (food, water, etc.), then safety, then love and belonging, the esteem and finally self actualization.  It boils down to: Laid, Paid, Made.

To me the context of both of the above discussions is driven by the understanding of how a product taps into the psychological and emotional needs of humans.  About a new product, an entrepreneurs should ask his or herself: which of the following does my product do?

  1. help drive commerce by solving a problem
  2. increase the quality or quantity interpersonal relationships
  3. build a persons self-esteem or self-confidence
  4. spark creativity
  5. spark desire
  6. keeps people safe

This might seem obvious, but if the answer isn’t one or more of the above, this is not a product to start a business around.

So if I’m the marketing consultant I ask my ‘cool stuff’ entrepreneurs to have a conversation about the needs that the product fulfills.  I make them tell me how the product gets me laid, made or paid.

And to the CTO I say that Pinterest does 5 of the above 6 things.  Whether the users own the products, movies, books they have pinned they are telling people what they think is cool and what they aspire to have.  Whether they have been to the places or eaten that food they have pinned, they are defining beauty in their own eyes.  Pinterest sparks personal creativity and desire.  In addition it can act as a sales tool for vendors, creatives and designers.  and of course there is a social aspect to it.  So I don’t know if $200 million pre-money is right or wrong, but I can at least understand it.

The point is make sure your product is going to have an impact in the marketplace.

Steps On The Path To Community

Dictionary.com defines community as a social group of any size whose members reside in a specific locality and often have a common cultural and historical heritage.

I’m particularly excited to write this post because the group I’m interested in fostering, those focused on developing Brooklyn Startups, took what I think are some great steps on path toward community.

Charlie O’Donnell of Brooklyn Bridge Ventures sponsored a gathering of entrepreneurs, community leaders, city government folks, techies, creatives and a host of other people for a discussion entitled Making Brooklyn: A Community Roundtable on Brooklyn as an Innovation Center. The number of people in attendance spoke volumes about the passion of those involved.

To me the key steps were 1) being able to look around the room and see who makes up the community and 2) being able to have a valuable exchange about the goals and the path forward.

What I heard were ideas about protecting the creative class, building cool technology, taking pride in Brooklyn as a brand and defining the inputs for success. Anyone making notes would surely have realized that the discussion for building the Brooklyn into an innovation center was advanced.

What I also heard was a willingness to continue to foster community.  That means more meetups, more communication, more help from community leaders in making certain Brooklyn neighborhoods startup friendly.  Issues from transportation and real estate to good infrastructure and good takeout where on the table.

How could one not come away from this distinct confirmation of common culture with a sense of excitement and optimism.

From my perspective, the inputs required for building an innovation center that fosters startups are the following:

  • Intellectual Capital – a source of creativity, a source of academia, a source of ideas
  • Technological input – access to engineers, data scientists, business development skills
  • Financial Capital – Angels and Venture Capitalists willing to put money to work on good ideas (also continuous flow of funds into the the community on infrastructure)
  • A base of industries/customers that can provide revenue and mentoring to startups
  • An ecosystem of successful companies to support new entrants and be a big brother to newcomers.

There is a lot that can be done to make the lives of entrepreneurs easier.  And to the extent that the community continues to do these types of things it will enable the competitive advantages that Brooklyn already has to really shine.

I can’t wait until the next discussion.  Thank you Charlie!

Test Drive

If a picture is worth a thousand words than a demo is worth a thousand slides.

If you want an investor to know how great your product is let her/him take a test drive. Trying something out is way better than hearing a pitch about how it is supposed to work.  Here’s an example:

Entrepreneurs Roundtable Accelerator (ERA) has a company in its newest class called Let’s Wombat.  I have no idea what Let’s Wombat means, but their service is pretty cool.  They create a sponsorship marketplace for what I call micro-events.

What’s a micro-event… let’s say you are planing a family reunion, or a Super Bowl party or an Office Team Building exercise.  Guess what… your group likely represents a demographic.  And there are companies trying to reach your demographic.

Let’s Wombat matches sponsoring companies with micro-events.  Put another way, they help you get free stuff or money for your Super Bowl party if it is a desirable demographic.

I wanted to see how this would work to provide feedback and commentary to the Let’s Wombat team.  So I went on their website and I registered an event.  In this case it was my son’s third birthday party.  The target audience wasn’t bunch of three year olds, but their upper-middle class, hipster parents.  I put in a few high level pieces of information about who was attending and that was it.  A couple days later I was contacted and told that Izze (a Sparkling Juice Company) wanted to sponsor the event.

In this case the sponsorship entailed a couple cases of free sparkling juice.  We had the sparkling pomegranate which was more popular than the sparkling peach.  Going into the event we were a little nervous – we wondered what our friends would think of us pimping out our son for some free stuff.  That was an unfounded concern.  There were no signs or banners or any obligations to do anything other than put out the product for people to drink.  Beyond that, a really interesting thing happened.  I started telling the story of how we got the sparkling juice.  It became a topic of conversation.  People said, “Hey, I like this stuff.”  And, “Will you send us the website?”  The sponsorship took on a little life of it’s own.  People started taking pictures with the product (see below).  I’m pretty sure Izze got it’s money’s worth from the two cases of soda it sent over.

The outcome was that I saw this service work and, in my opinion, it worked well.  At this point I don’t know if sponsors will flock to this company or if it will catch on with event planners, but I do know that Let’s Wombat has created an interesting marketplace where none existed before.  I have seen it with my own eyes.

If you want to make an impression with an investor let them take a test drive!

Underfunded

Ask me if there is an Angel investment bubble and I will say no.  On the other hand, I will also say that there are a bunch of angel investors out there that are going to get slaughtered in the next two years and may never Angel invest again.

Why no bubble? Because there is natural supply and natural demand.  These are genuinely good companies that deserve to be backed by investors who have the means to do so.  There are not too many catfood.com companies getting funded.  Valuations have gotten a little rich, but not too bad and that is coming from the top down much more than the bottom up.

The financial crisis in 2008 caused economic contraction.  A bunch of good, smart people lost their jobs and couldn’t find new ones.  They did what people of ingenuity might do… they created their own job by starting a company.  Lots of smart, skilled people yielded lots of  interesting, viable companies.  There’s your supply.

In October of 2007 the Dow Jones was at 14,066.  By March of 2009 (18 months later) it was at 6,626.  That’s a decline of about 53%.  Since that time it has recovered slowly to about 13,000.  That means there are investors that after 5 years who could still be under water.  The Dow is supposed to be safe, or at least safer.  Over the past decade it hasn’t been.  Investors are saying, forget it.  The risk return is out of whack.  Let’s find something else.  They look at alternative investments.  Angel is an interesting asset class.  There’s your demand.

Natural supply.  Natural demand.  No bubble.

Then why are many Angels going to give up and walk away?  There’s a number of reasons including:

  1. Not enough follow on capital from VCs to keep these investments alive.
  2. Higher barriers to investment exit including high costs of startups going public.
  3. Angel investing is harder than it looks with high failure rates. Lots of first time angels will simply bail out.

A less obvious reason and the one I want to focus on is ‘under funding’.

Here’s a common case study: a company comes into the office.  They show me their technology.  It is top-notch, high-end, built-to-last, datacenter class technology that has real value.  I love it! It is obvious why the idea deserved to get a seed round of funding.  The product is just completed, or close to it.  The team is still just the founders and some technical people or contractors.  The product is about to go into beta testing and has no customers.  There isn’t much of a marketing or a go-to-market plan yet.  They have been heads down building a good product.  The founders say “we either need another $500,000 in convertible debt, to take this product to market, or we need to raise a proper Series A (call it $1.5 million on a $5 million pre). And oh, by the way we gave away 20% of the company to the first round seed investors.”

Guess what? As a VC I cannot invest in this company.  The company did not make enough progress with the seed round to stay on the natural funding progression track.  They were almost there, but ran out of gas before completing the last mile.  They needed to gain a strong expression of interest from the customer for me to invest.

I could blame this on the entrepreneur, but I won’t because it is their job is to know about the technology, and they did a good job with that.  No, this is the fault of the seed stage investor.  They are supposed to know about the capital side of a startup and this company has been left underfunded.  The seed stage investor didn’t tell the entrepreneur what she/he needed to accomplish with the funding proceeds.  Common or not, that is a mistake on the part of the investor.  The result is that the company has been left in funding no-mans-land.

Most likely the current angels aren’t going to step up for a follow on.  They are not geared for that.  New angels will want some percent of the company, meaning 30% or more could be gone before the Series A.  That would mean at least 50% would be in the hands of investors by the time a Series A is done.  The entrepreneur would have taken all this risk for very little return in the end.  On the other hand, a VC is unlikely to want to do this deal.  He/she has no proof that market wants this product.  He/she is unlikely to give the company a valuation that would be palatable to the founders with no customers and no revenue.  If the entrepreneur does except a bad deal to keep the company alive, the personal incentive, again, will be too little.

What are the outcomes:

  • Some of these companies might get saved because the technology is just so awesome that someone will take a flyer on it.
  • A lot of these companies, awesome technology or not, will fall through the cracks. Certainly the ones with average technology won’t make it.
  • Angels, who are sure they backed a winner, will become disillusioned with this process and stop angel investing.
  • Entrepreneurs will take it as a lesson learned and hopefully go on to create something even more awesome, or be flushed out of the system.

So my premise is, it’s not a bubble, but there will still be a lot of Angels forced out of the game.  There are a lot of reasons.  But at least one of them will be their own fault. Underfunding.

If you are an entrepreneur view this as another cautionary tale and beware of who your seed investors are, what they are giving you, what they expect, and what you need to deliver to continue to be funded and successful.