Saturday, March 3, 2018

Why Software Startups Shouldn't Aim to Sell to German Mittelstand Companies


There Are Buyers of Products, And There Are Buyers of Companies And They Are Different.

A recent article detailed two well-known Berlin startups which had just been acquired by Mittelstand companies.

This begs the question why there aren’t more of these types of exits. Can the German Mittelstand companies be startup acquirers at a larger scale?

The majority of startups are building Software as a Service (SaaS) companies with high gross margins. In a SaaS world where growth is directly correlated with enterprise value a founder’s is to grow as quickly as possible to build an important and material software company and to maximize the company value. The highest valued SaaS companies have annual growth rates in excess of 75 per cent.

As a reminder, Mittelstand companies are "highly focused medium sized companies, achieving unprecedented efficiencies by designing a business model with a razor-thin focus and learning to do the one thing really well. They are typically privately, family owned". Many of them are in the automotive and mechanical engineering sectors and are focused on hardware and systems integration. Medium size Mittelstand companies have revenues on the order of a hundred million Euros with relatively narrow margins. They tend to grow with the GDP of their major export markets. In the past years of low interest rates they have been significantly credit financed.

Will these companies be able to pay the expected acquisition prices? Does their balance sheet provide enough room to pay cash? Do they understand the mechanics of a software business? Does their ownership structure allow them to agree on a deal ? Are they willing to take significant risk?

The answer to these questions is obvious and seems like bad news: The majority of Mittelstand companies are unlikely to be potential acquirers.

The good news is that the Mittelstand companies can be great customers and fantastic early adopters: They have fewer hierarchy levels and can make decisions quickly. They want to co- develop the Minimum Viable Product to get results. They tend to be very international and they will want to deploy products globally right from the start. In contrast, big industrials and automotive OEMs are much slower moving, and their many hierarchies and lack of true urgency will likely kill a startup. Many of their innovation outposts and labs are clueless and powerless.

For successful exits, SaaS startups need to understand the software ecosystem. The same companies that are competitors can be potential buyers. In the manufacturing and Industrial Internet of Things (IIoT) spaces, CAD and PLM companies like Dassault, Autodesk, Siemens, PTC, SAP, Oracle, Infor, and Ansys are some of the key  players. These companies make acquisitions routinely using their cash and stock, and their investors understand the need for growth.

The German Mittelstand companies can be great customers, but they are an unlikely buyer of startups. In fact, they are not really an exit option unless a startup is willing to sell very early or has essentially failed.

Angel Investing in 2017 - Looking For Value in New Places

I did not make any predictions for 2017, following Winston Churchill’s quip about the politician ‘who needs the ability to foretell what is going to happen tomorrow, next week, next month, and next year. And to have the ability afterwards to explain why it didn't happen.’ Here is what was noteworthy in my eyes.

Picture credit: Nasdaq

Public markets and private tech startups

Who could have imagined that the value of the DJII would increase a whopping 25% and go from 19762.60 to 24719.22, and that the Bessemer Venture Partner Cloud index would increase by 49.9% in the same period?

There were only 14 Tech IPOs, and the majority were in the consumer/retail space. The Stitch Fix IPO was noteworthy for delivering massive returns to investors. Meal kit providers Blue Apron and Hello Fresh both managed to go public but then followed two very separate trajectories, illustrating the importance of understanding the unit economics and LTV, but also the difference between the investors in their respective markets.

In the venture capital space, 109 mega rounds of $100+ million were evidence of the massive amounts of capital wanting to be invested. 22 new unicorns were minted while this was more than in 2016, it was only about half of 2014 and 2015 numbers.The pipeline of unicorns was still growing, yet many of the unicorn valuations took significant hits. The most prominent and public example was Softbank’s investment in Uber.

Seed investing activity in the U.S. declined to reach a two year low, and yet a median seed stage deal size of $2.0 million remained astonishingly high. International investments were strong: In Germany alone, €4.3 billion were invested in 507 deals with Berlin leading the way by a wide margin. The number of deals and the investment volume in Germany could be best compared to New England, but was significantly smaller than in San Francisco, Silicon Valley, or New York.  

It would have been easy to speculate about how technology trends like Blockchain, the Internet of Things and Artificial Intelligence will to disrupt everything. And yet, as Peter Thiel reminded us a few years ago, the biggest secrets are about people and not about nature. Susan Fowler’s courageous reflections in February about her very, very strange year at Uber surfaced biases of the worst kind. And subsequent revelations forced us to examine our daily interactions and whether we treat others like we wanted to be treated ourselves, with dignity and respect. A few years back I had penned a somewhat admiring post about Harvey Weinstein, and in hindsight it became clear his professional and personal behavior were inseparably intertwined.

At the same time, I met Tammy and Grace from BetterBrave, and they deserve a big shoutout for tackling a topic that defies easy answers and yet is so crucial for society.

My existing portfolio

I entered 2017 with thirteen active angel investments. Compared to 2016, the value of my portfolio stayed flat: Four companies raised additional funding, and I participated in two of these. There was one significant markup, one down round to half the value, and one recap that effectively wiped out the existing investors. There were no exits and no final death notices.

Special shout out to for getting the first large telco PoC, and to 3DprinterOS on closing the first OEM deal with Dremel.

New investments

It turned out to be the year of investing in Industrial IoT (IIoT) and in German startups; the result of 18 months of research in and search for enterprise software startups in Germany. Much of it was self sourced by attending pitch events all over the country, founder networking and mentoring, and outreach to VCs.

  • I met Simon of Kreatize and invested in the first round together with Atlantic Labs and with other angel investors. Simon and Daniel are building a SaaS network to order custom manufactured parts and allow for seamless collaboration between manufacturers and suppliers. They are headquartered in Berlin with strong roots in the industrial southwest of Germany.
  • I mentored Akshat and the Amper team through the Alchemist Accelerator program. Amper is helping manufacturers increase efficiency and productivity through real-time machine and factory monitoring, and they are based in Chicago. My initial investment was followed by Slow Ventures.
  • Kemal, the CEO of Relimetrics, was referred to me in December 2016. Kemal and Juergen have developed a low-cost imaging technology to inspect and monitor material shape, deformation and reliability across different phases of the engineering lifecycle. Relimetrics went on to raise a seed round from Silicon Valley, German and French investors in December 2017, and they are based in Berlin and in Silicon Valley.
  • Atlantic Labs graciously referred me to Wandelbots. Christian and the team have built software and hardware to teach industrial robots with wearables, making programming robots available for everyone. They are based in Dresden.

There also were five startups that I spent significant time working with but did not invest in. The number of blog posts collapsed from 11 to 2 as deal sourcing and founder mentoring took precedence.
2018 resolutions

Organizations and experts ostensibly more qualified than I regularly fail at making predictions, Instead, I will rather focus on a few key resolutions: Continue to look for differentiated opportunities in enterprise SW in Europe - and in Germany in particular- , bet on contrarian outliers in Silicon Valley, and dive deeper into Blockchain and tokens.

Saturday, June 10, 2017

The Three Types Of Seed Investing Strategies

In early seed stage investing, there are thousands of startups, few early breakout performers, and little data that can be analyzed. But early stage investing can be highly profitable, and three distinct strategies have evolved: boutique firms, index funds, and hedge funds.

A boutique seed approach best describes the typical angel investors. They make few investments, and try to leverage some special insight to increase the probability of success. The underlying assumption of a small fund is that the investor can pick the top of the seed stage startups. In private markets, that seems like a very tall task. In fact, the vast majority of angels lose money using that approach, just like most VCs don’t make money for their investors.

Superangels, seed investors and small incubators fall between the boutique seed approach and an index fund. They invest in about 10-20 startups every year and over time create a portfolio that is large enough to increase the likelihood of having one or more outsize winners.  

The seed investing index funds are represented by accelerators and incubators such as Y Combinator, 500 Startups, Alchemist Accelerator and others. By investing in a large and broad number of early stage startups, they are increasing the likelihood of having outsize winners in their portfolio. If the number of startups is large enough and the investor is a decent picker of talent, there will likely be some outsized returns in the portfolio. Y Combinator is a perfect example for that approach.

Dave McClure of 500Startups and others postulate that a portfolio of 100 companies is required to capture the outliers that generate 50X returns. The good news is that unicorns are not even required to generate returns for a seed stage fund: Exits on the order of  $100 million are enough. An exceptionally well connected angel investor such as SV Angel has 16 unicorns among their 628 investments.

Traditional angel investors make an initial investment only. Some are putting money aside for follow-on rounds, but the increased capital requirements limit the ability to participate.

An alternate approach has been pioneered by Chris Sacca: The hedge fund. After making an initial investment in Twitter, Sacca realized that the company was a rocketship on the way to unicorn status. Initially he took the typical super angel path of raising a small fund, but when we had the opportunity to buy $400 million worth of Twitter shares in a secondary sale he realized he wanted to play in the bigger leagues. Within 30 days we was able to raise commitments from institutional investors and put in place vehicles for successive investments . By the time Twitter filed for its IPO, entities affiliated with Sacca held the largest positions in the company. As Jim Collins wrote in From Good to Great: “The most effective investment strategy is a highly un-diversified portfolio when you are right.”

All three seed investment strategies assume that an investor gets into the right deals. Even the index fund investment strategy requires 1 out of 50 investments to end up in a $100+ million exit. But an investor will not ‘see’ all startups with that exit potential in their deal flow, and may not recognize them. Attractive deals may be oversubscribed and the investor may not be able to participate. So regardless of the strategy, an investor needs to attract the ‘best deal’.

Picture credits: Time Inc, Money Q&A, Forbes

Sunday, April 9, 2017

Angel Investing in 2016 - It's Only Halfway Through a 12 Round Boxing Match

'Cause I was thinkin', it really don't matter if I lose this fight... 'Cause all I wanna do is go the distance... if I can go that distance, you see, and that bell rings and I'm still standin', I'm gonna know for the first time in my life, see, that I weren't just another bum from the neighborhood.
- Rocky

Six years into my angel investing activities feel like round 6 of a boxing match. Somewhat banged up, and you know you will have to go the distance. Let’s look at what happened in this last round.

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Public markets and private tech startups
2015 had ended with late stage companies reducing headcount by 10-25% to focus on revenue growth and profitability. But within the first week of February, valuations of SaaS companies were ravished and fell by more than 50%. The DJII had a low point on February 11, but by late spring valuations had recovered before U.S. election fever started setting in. the public market took a sharp upturn after the U.S. election and the DJII ended with at 19762.60, close to historical highs.

Market uncertainties resulted in ‘only’ 14 tech companies going public in 2016, with Talend, Twilio, Nutanix, Coupa some of the more notable names. There is an almost unbelievable pipeline of 182 unicorn companies, the majority of which could go public within the next 18-24 months.

In line with prior years, the median size of the seed round in the first half of 2016 continued to increase to $625 thousand. Areas where seed investments were concentrated: Automotive, AR/VR,M machine learning, food and beverage, and agriculture.

My startup portfolio

It was a year where my portfolio companies honed operational procedures, fine tuned product, hustled to get contracts. Investment highlights:

  • Readypulse merged with Experticity In January
  • RetailNext raised additional funding in Q2
  • I made follow on investments in DecisionNext and 3ten8.

Net-net, the value of my portfolio stayed relatively flat: One significant markup versus one investment entering the deadpool. No exits and no liquidity.

My dealflow was the usual mix of proprietary deal flow including the Band of Angels and from notable accelerators such as Y Combinator, Angelpad and Alchemist. I plied the startup scene in Germany and started to some interesting prospects in enterprise related software. The Silicon Valley based accelerators continued to graduate interesting startups, but there was nothing to move me over the line, and for the longest time it seemed the year might pass without new investments. But in November I put down money twice

  • I made an early stage investment in Shopinbox. ShopInbox helps consumers claim refunds from their credit card companies when prices drop, take advantage of extended warranties, and more.
  • I also made an investment Practice Fusion. The Band of Angels was the earliest investor in the company, and Practice Fusion has gone on to dominate the EHR space for small medical practices and continues to grow by leaps and bounds.

Unfortunately, Evergive entered the deadpool. James and Mary made the tough decision to sell the technology and close the company. Evergive had set out to simplify the way Americans donate $270 Billion annually and quickly focused on faith based organizations. However, the team had to realize that the TAM of engaged members is but a small subset of the market. This divide appears to be intrinsic to the broader faith sector and poses an insurmountable hurdle in achieving venture scale adoption metrics.

Things that kept me engaged and interested

I spent time with 3DPrinterOS, 3ten8 and Savvy on operational topics and fund raising related activities. I wrote 11 blog posts on founders, the Internet of Things (IoT), and other topics relevant to my investing theses and activities.

And I came to realize that just like a boxing match, these were just the early rounds. The contest will continue for many years to come, and some rounds will be better than others.

To become a champion, fight one more round.

– ‘Gentleman Jim’ Corbett

Friday, November 11, 2016

Always be Closing - How to be a Lead Investor For Other Angels

Angel investors provide startups with their expert counsel and own capital but lack the financial fire power of larger institutional funds. They can overcome this frustrating situation and increase their level of involvement and influence by becoming lead investors and inviting other angels to pool money and add complementary expertise. This larger brain trust and combined rolodex of a team of experienced angels can be a significant help to a startup CEO. In fact, the right ‘dream team’ of advisors can deliver unique expert counsel that small VC firms are unable to supply. This approach also allows other angel investors to invest in areas outside of their comfort zone.
Attracting additional angel investors can be a daunting task. The opportunity needs to be marketed and sold to other investors all the way from getting their attention to closing the deal and defining an ongoing engagement model.
These syndicated deals provide the entrepreneur with efficient access not only to funding, but also to a set of angel investors with a broad set of skills and a willingness to help the venture post funding.

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To start, the lead investor should be familiar with the industry and work with the startup to understand the basics of the business. The lead should also conduct a thorough background, and potentially criminal, check of the founder. Pre-existing term sheets need to be well understood. If there are issues with the terms, they need to be made transparent before the process commences. The lead investor should come into the deal in a clean way, and not as an advisor who has been compensated with cash or stock. Conflicts are not uncommon and should be disclosed.

The founding team and the lead investor need to work hand in hand during the critical stages in selling a deal to other angel investors: Getting attention, creating interest and due diligence, and closing.


The lead investor’s first task is to attract the attention of the other investors. Angel groups are ready made vehicles to expose opportunities to like minded investors. These investors in turn may have additional, ‘secondary’, ecosystems they are interacting with. The communication with angel group investors largely follows a two step approach starting with an executive summary,  followed by a group presentation. The lead works with the startup on their summary and presentation and uses it as a mechanism to refine the strategy.

Interest and Due Diligence

Angels are interested in new investing opportunities for many different reasons - some believe in certain markets, others in great founders, and others are looking just for good investment opportunities. Ideally, all three come together.

This due diligence phase is also one of discovery for the new angel investors, even if the lead and other angel groups have already done own due diligence. Spending more hours on due diligence correlates with greater returns. Angels want to learn from the entrepreneur, and they also want to learn from each other. They prefer to learn by directly interacting with the founders and with each other in in-person meetings. In this phase, the lead should reach out potential investors who can add significant value but who may not have been interested initially. As the due diligence team attracts other investors, the lead should recruit investors with complementary skills and experience, e.g. in IP law, relevant technology, target market etc. Lead investor and founder should have identified these skills prior to closing, and make the introduction between the startup and these angel investors.

Ideally, the lead investor crafts a short 2-4 page due diligence memo to summarize investment thesis, market size, customer needs, uniqueness and competition, financial projections and funding strategy, exit strategy, deal terms, risks and what needs to be believed, and a leadership assessment - the memo doesn’t have to have the extent of Roelof Botha’s now classic Youtube investment thesis. Expected valuation, existing terms, traction, and team background influence investor interest. The founders should set up a due diligence web site, and the lead investor can organize a  feedback site for the interested investors only. Negative information that is obtained during the process needs to be disclosed.
The number of interested investors is likely to drop significantly during this phase, often as much as 75%. The number of potential investors may matter less than their qualities and contributions: Some angels have great expertise, some are great connectors, and have large funds.

Decision and Action

The due diligence phase has been completed. The lead investor negotiates the terms and changes to the terms on behalf of the other investors and may be negotiating directly with the company's attorney. Preferably, one of the investors groups has their own independent attorney to do the investor negotiations.

Interested investors have said ‘yes’ to the opportunity, but they haven’t written the check yet. The angel investors are seeking affirmation that this is a good deal, and the lead needs to convince the investors that they really want to invest in this opportunity. Simple distractions created by other competing deals and vacation absences can be reasons for potential investors to drop off. In fact, in syndicated deals it is not uncommon for the number of potential investors to drop off by more than 50% from the previous phase. One helpful tactic is to to keep up the sense of urgency by tightly managing the time between the due diligence and deal term completion. Lowering the valuation can also help to get a deal done. Enthusiastic support from other members of the due diligence team can be helpful in attracting a broader interest from other angels.

The lead investor takes the deal all the way to closing, making sure the legal paperwork is correct, signed, and the funds come in from all who committed. After the close, the lead investor typically stays involved with the company either as an advisor or board member.
In closing: Convincing additional angel investors to come in on a deal is difficult. Success for the lead investor should be defined by the process, and not the outcome.

Thanks to Karen Riley, Ken Arnold, Don Lee, and Bob Kyle for their insights and comments.

Tuesday, November 1, 2016

Startup Investing in Germany: The Investor Who Comes Too Late is Punished For Life

A stereotypical Silicon Valley startup raises multiple rounds of venture funding. Many of these funding rounds are well publicized, and hence there are few secrets about new startups and the problems they are intending to solve. Contrast that with Europe, and Germany in particular, where limited information about startups is available, particularly in the enterprise software space: Founders have a culture of self financing, there are few venture capitalists who invest in the space, and hence these startups are not written about nor do they seek attention.

Two recent funding news from the enterprise software space support these observations: Berlin based Signavio raised31 million from Summit Partners in December 2015, and Munich based Celonis raised $27.5 million Series A from Accel Partners and 83North in June 2016.

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Both Signavio and Celonis have demonstrated that an enterprise software startup can bootstrap its way to fast and profitable growth. Their journey also illustrates some important points for investors  

  • The founding teams developed their ideas during their university projects. They were first time founders without a track record in running a business. Public funding from the EXIST program financed both startups for the first year after founder graduation from university. Neither team took on any money from angel investors.
  • Signavio and Celonis were profitable and therefore able to self finance from the beginning. Both companies signed up hundreds of customers in just a few years. Signavio and Celonis did not raise a series A or B until the first funding event about six years after founding. According to CBInsights, startups from the 2009/10 vintage raised an aggregate of $18 million in three rounds during the same time period.
    The focus on business customers and the absence of external funding made Signavio and Celonis largely hidden from the general public.

  • This type of horizontal business process applications are fairly country and even language agnostic and travel easily. Both startups were visible within the international VC community and investors approached the startups multiple times. These funding rounds were contested and in both cases the founders chose international investors with expertise in international expansion, although better term sheets were provided by German investors. Given the inherent profitability of the business, these funding rounds may be the only opportunity for growth stage investors to participate.
Just providing capital to bootstrapped startups is not enough for investors to be invited to participate. Instead, investors need to differentiate by providing additional expertise and value. For angels, domain knowledge and expertise in getting a company started are differentiators. For growth stage investors, experience in scaling startups internationally will be a key advantage.

Investors at every stage need to become proactive and step up their game to be invited to the party. To quote Mikhail Gorbachev: Dangers await only those who do not react to life.

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