2018 in Review - Category Kings Rule

A new year’s beginning is the customary yet arbitrary time to review last year’s market movements and portfolio developments. The main theme for decacorns, unicorns, and my own portfolio companies was category leadership; .

The undiminished power of that leadership in SaaS was again on display when Qualtrics decided to sell itself for $8 billion to SAP. Shopify, Veeva and Twilio are examples of these category leaders that have already reached or surpassed $10+ billion valuations and continue to go strong.

Picture credit: Forbes

Public markets and private tech startups

The longest bull market in history may be coming to an end. The DJII started at 25,461.70 and finished the year 5.8% lower at 23327.46 points; the Nasdaq Composite lost 4.6%. Cloud software stocks were still doing well though and massively outperformed the overall stock market where the Bessemer Nasdaq Emerging Cloud index rose by 37% from 621 to 851.

It pays to be a thunder lizard and create a new category. The plethora of tech IPOs continued and was led by some notable SaaS leaders such as Anaplan, Elastic, Docusign, Eventbrite, Pivotal, Zuora, and Dropbox. Even Domo made it out in time, although they raised a ton of red flags when they announced that they would have to IPO or go through a major restructuring.

SurveyMonkey debuted on September 26 and is trading at a market cap of $1.4 billion at the time of writing. Their IPO was soon  overshadowed by SAP’s announced $8 billion acquisition of Qualtrics on November 11. Also worthwhile mentioning is Plangrid’s $875 million sale to Autodesk. Plangrid was first introduced to the public at the Y Combinator day in March 2012 and raised a Series A not until 2015. I saw the team at the demo day and liked them, but did not pursue an investment in this vertical SaaS startup that set out to revolutionize workflows on construction sites.

Relayr was the only notable SaaS exit in Germany. Getting to a $300 million exit in five years is great by any measure, and growing into a full fledged unicorn in the IIoT space would have required a lot more capital to expand more aggressively and internationally.

Venture capital continued to flow freely according to PwC’s Q3 Moneytree report.  Late stage unicorn funding rounds drove up dollars invested in the U.S., but deal activity declined for the first time since Q4’17. In addition, seed-stage deals continued to decline, and early stage deals only increased very slightly and for the first time since Q4’17. The U.S. median seed stage deals cost $1.5m, down from the previous quarters but still very high based on historical figures. Historically, all these are signs that the funding market is a the end of the cycle.

Total investments in startups in Germany increased by 7% to reach 4.6 billion Euros, and the number of financing rounds increased by 21% to reach 615. European startups raised a median $1.2 million in Q3 for seed stage deals, less than in the U.S., but the money lasts a lot longer when taking into account the lower salaries compared to Silicon Valley.

The year started with Initial Coin Offerings (ICO) being all the rage, but the SEC quickly cooled buyer interest in the U.S. and subpoenaed 80 cryptocurrency firms in April. Global activity seemed to come to a complete halt shortly thereafter, tet Andreessen, USV and others invested $12 million in the inventors of the Cryptokiddies in March. Steem.it announced it had to lay off 70% of its employees in late November, and one of the more interesting experiments clearly is in deep trouble.

My portfolio

2018 began with 17 active investments and the value of the portfolio rose significantly due to the follow-on rounds in Wandelbots and in Kreatize.

There were 13 transactions in total: Two exits, two warrant deals, three bridges, three follow-on equity financings, and three new deals.

• Exits: Practice Fusion sold to Allscripts for $100 million in cash and Savvy was sold to Global English
  
• Follow-on financings: Truevault raised a venture venture round in August. Wandelbots continued to receive strong customer interest and raised €6 million from Paua Ventures and EQT in December. Kreatize changed their business model to provide a turnkey service for the sourcing of custom made parts and have been on a tear since January 2018. I participated in a bridge round in May, and in December they raised €5.5 million from Earlybird VC.

New investments

Some of my 2017 resolutions were 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. I did end up investing in two Germany based companies and in one enterprise SaaS company located in San Francisco.

• The AIPark team led by Julian and Johannes provides predictive parking information just based on data and without owning sensors.  Traditional parking is evolving as cities, drivers, and other stakeholders will need to rethink the curb as ride sharing services proliferate and self driving cars appear on the horizon. I helped the team sharpen their pitch and made introductions to VCs. As in most of my investments, I was the first money in, together with Atlantic Labs, Jens Lapinski and other angel investors. 
• I first talked Jan-Philipp from Hashplay in late 2017.They are building an AI powered business intelligence platform to translate operational data into digital twins and are garnering great interest from multiple verticals in a space which Gartner terms immersive analytics. The team is based in Hamburg and in San Francisco, with development resources in East Asia. 
• I got to know Oomnitza’s CEO Arthur when he raised an initial seed round in 2014. Oomnitza builds a connected, automated, and visualized Thing Management that tracks everything that makes a business run.  I was more than happy to join the bridge round in December.

I also deeply looked into two startups that planned to use tokens as an incentive mechanism for their respective market places. But the ICO market collapsed, and the collateral damage is that most token markets will likely remain frozen for a while. My other activities were concentrated on coaching and mentoring and helping fundraise some of my existing investments, and growing the deal pipeline of B2B SaaS startups  in Germany.

Observations and pontifications

The tech sector is continuing to go through seminal changes at every level of the tech stack and in every aspect of the business model.

• The Iaas market is growing in excess of 35% CAGR. Enterprises are finally moving their production environments to the cloud and to the multiple cloud providers. AWS and Azure are in the lead, with Google Cloud investing heavily to differentiate via AI and AliCloud staking their claim in China. These hyperscalers will to continue to move up the stack via acquisitions to better serve the needs of large enterprise customers and achieve customer lock-in.  
• Kubernetes fundamentally changes how complex SW is being developed. Again Google has disrupted the market with open sourcing their SW, and as a result, startups in the ecosystem are in the crosshairs of these hyperscalers. Heptio and CoreOs have already been acquired, and Docker and Mesosphere are going through massive changes to reposition themselves in this environment. 
• AI has matured from algorithms to the life cycle management of training models. But data and models are customer specific, and scaling these solutions creates challenges far more complex than for bread-and-butter SaaS solutions. In turn, this will lead to more activities in automating data labeling, model scaling and other areas which are not addressed by Tensorflow and other AI libraries.
• Tokens hold great promise in removing friction in marketplaces, and provide incentives for buyers and sellers. The market for security tokens crashed completely in 2018 and all tokens seem to be in the phase that Gartner calls the ‘trough of disillusionment’.
• IIoT customers understand the value delivered by SaaS ‘products’, but they are still expecting a full solution. On top of that, larger buyers in that segment are not yet used to paying recurring revenues. Industrial IoT (IIoT) startups need to be super disciplined about the engagement cycle from first contact to demo/proof of concept and then to pilot and to recurring revenue. Relimetrics and Amper have templated this approach and are preparing to reach escape velocity.

2019 outlook

Dark clouds? R.I.P. Good times? It pays to be prepared, although the VC guns are still loaded and there is plenty of money to go around.

The probability of a downturn becomes more imminent the longer the bull market continues. GM’s announcement of a significant streamlining of their operations notably implied an expected economic slowdown in 2019.

The time to get back into investing in Silicon Valley startups will be when seed stage and bridge valuations become more reasonable. In the meantime, lower valuations and great technical talent can be found in continental Europe. Celonis and Signavio are already category leaders in their respective segments, and Kreatize, Relimetrics and Wandelbots in my own portfolio hold great promise.

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 3ten8.ai 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 who are 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 the Blockchain and tokens.

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 he 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.”

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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

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: fanpop.com

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

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.

Picture credit: Earlyboyd.com

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.

Attention

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.