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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Sunday, October 16, 2016

Everyone in Business is a Technology Buyer Now

Investor Peter Thiel has stated that ‘limited technological development has mostly been confined to IT’. Historically, technology decisions were made by the IT departments of large companies and by their 3rd party technology partners, starting with IT mainframes in the 1950s. The advent of IBM’s /36 spread computing power to medium sized companies. The advent of the personal computer spread technology within large companies and smaller enterprises.

Technology now has evolved to a point where end users can get their hands on applications almost instantly. Smart mobile devices and Software as a Service (‘SaaS’) are the two major disruptive trends which have accelerated the speed at which technology is adopted. The off the charts usage of mobile phones by consumers has put the traditional technology adoption curves to shame. This accelerated adoption has spilled over into enterprises at every level. SaaS applications have democratized application deployment and usage in every business.


These two developments have allowed for new buyers to emerge in large companies. Departments and groups who have had to compete for capital budgets before can now use their operating budgets to pay for SaaS applications. Marketing and sales are among the first movers and are the fastest growing SaaS segments.

The invasion of mobile and SaaS in enterprises have also democratized the buying decisions and have allowed individuals to buy. In mobile, Bring Your Own Device (‘BYOD’) has become the norm. In SaaS, Box, Yammer are some of the examples of first selling to individuals and managers before IT departments. An armada of startups is targeting every level of buyer in every organization at the right price level.

The easy deployability of SaaS and the simplicity of mobile have also lead to an accelerated technology adoption by Small and Medium sized Enterprises (‘SME’). SaaS is an efficient way to deliver applications for the more commoditized business processes in SMEs. New go-to-market approaches for these smaller solutions have further accelerated the sales cycles and have led to much faster technology adoption.

How Y Combinator Turned Around Their Demo Day Pitches

The Y Combinator program for startups has been a prototype for other accelerators and incubators. The efforts of these programs culminate in the so- called demo days where the startups are pitching their ideas and progress to potential investors. 

Over the past years the content of the pitches seemed to decline with each demo day and the number of buzzwords and assertions reached new highs. Investor frustration culminated and listening to these pitches became a waste of time.

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The latest summer 2016 Y Combinator demo day was a welcome return to fundamentals. The presentations were consistent and conveyed important information:
  • the space the startup is addressing
  • the problem and how the job is done today
  • the number and type of paying customers and how much they pay
  • the growth in monthly recurring revenue (MRR)
  • the size of the opportunity (the total addressable market - TAM)
  • how much bigger the opportunity could be
  • the duration of the sales cycle
  • summary - the name of the startup, the customers, and the growth
Clearly, this is not rocket science, but demonstrated customer validation. 

If all the demo days got back to these fundamentals it might actually be worth listening to the startup pitches again.

Sunday, March 27, 2016

The iPhone revolutionized mobile in 2007. What's going on in IoT?

In the telco world, the owner of the network from the device to the backbone was king. The network operators controlled the transport, and traditionally decided which devices were permitted as end point devices. But starting with the introduction of the iPhone in 2007, the value has migrated to the end user devices and the applications. At the time of writing in early 2016, Apple, Google and Facebook are three of the top five companies by market capitalization.

When will 2007 be repeated for the Internet of Things?

It is worthwhile recalling the elements of a generic network infrastructure and the developments in the telco space

  • Sensor packed end point devices.
    In the telco industry these are mobile phones and DSL/cable modems. Mobile phones in particular have developed into platforms with an ever growing number of applications leveraging the many sensors in the phone. The mobile phone manufacturers have consolidated.
  • Wireless or wired data transport from from the end point device to an aggregation point.
    In wireless, WiFi for short distances, and cellular networks for longer ranges. Wireless carriers have spent billions on licensing spectrum from national regulators. Cable companies have cleaned up their coaxial cable infrastructure to transport increased bandwidth. Fixed line phone companies have even put fiber in place of the twisted wire copper pairs.
  • Concentrators to aggregate data from the devices.
    Cell sites, DSLAMs, or CMTSs are all owned by the telco providers.
  • Backhaul networks to transport signals from the concentrators to the backbone.
    Initially these were owned by incumbent carriers, but starting in the late 1990 massive amounts of fiber were deployed to create multiple backbone networks.
  • Platforms to manage the network and distribute applications.
    In the mobile space, the phone has emerged to be that platform and bifurcated into one high end closed system (iOS) and one open device ecosystem (Android).
  • Application services running on top of the network. Google, Facebook. Enough said.

The winners in IoT will invent new uses cases and creatively deploy devices. In the consumer space, the ‘Things’ can be the human body, the home, the car, or anything else owned by a person. Wearables and home automation are off to an early start, and cars are not far behind.

In the enterprise space, the owner of the ‘Thing’ location will pick those devices and applications associated with the most promising use case. Beacons may be an early use case for retail, and there is a wide range of industrial use cases emerging.

As these deployments and applications scale and reach critical mass, platforms emerge. Nest’s platform program is a case in point for the home, and others are likely to follow.
For many IoT applications, wireless and wired networks are already in place. The evolution of the IoT landscape can leapfrog the network deployment phase and its captive devices and fast forward to the IoT equivalent of 2007.