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.

Picture credit:

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