Security and technology: Commercial first, production requirements from day one, and programs of capability

The Stanford DEFCON Technology and National Security Student Network organized and hosted a stellar all day event about all things defense and technology with attendees from the whole ecosystem: Government representatives, primes, neoprimes, startups, students, professors, professionals, and venture capitalists and angel investors.

My three favorite quotes of day (without attribution - Chatham House rules 😎 )


👉 The best way to develop is off the government system and go commercial first


✊ Your production requirements need to be built on day one and in conjunction with product requirements - otherwise the cost of change is just to high


👍 The military needs to move to programs of capability and warfare as a service


It used to be that defense tech startups had to be funded by SBIRs and the like, but the massive technology disruptions have given rise to a new dawn that is venture financed.

A version of this post was first published on LinkedIn in November 2025

2014 - A delayed reckoning, and more uncertainty ahead

2014 was supposed to be a good news/bad news type of year: More tech IPOs than in 2013, but a reckoning for startups facing the Series A crunch. Both pretty much played out as expected: The Dow Jones Industrial Index started at 16500 to close the year end at 17824, Alibaba went public in the biggest IPO ever in August, Whatsapp was acquired by Facebook for $22 billion, private unicorns like Uber, AirBnB and Box continued to raise hundreds of millions of dollars, and Zendesk, Lending Club, GrubHub, Hortonworks, HubSpot, New Relic were just a few of many notable tech IPOs. All companies that went public had been founded a decade ago or so, except for Hortonworks which was only spun out of Yahoo! in 2011.

Until 2013, round sizes increased, and second seed rounds emerged to stave of the Series A crunch. The largest seed rounds included VC participations and exceeded traditional Series A. While late stage fundings seemed to spiral out of control in 2014, it also appeared that valuations and overall activity on the seed funding side cooled off significantly. For the Band of Angels, the overall dollars invested stayed fairly constant, but the number of deals invested in dropped by half - consequently the amount invested per deal almost doubled.

Players in the seed funding game continued to evolve: Accelerators churned out start-ups at ever increasing rates, and the accelerators and their business model went international. The transaction volume on Angellist reached $104 million. The MicroVC market of super angels and freshman funds continued to expand and fill the gap towards Series A, although consolidation may be on the horizon already .

I spent more time on my existing investments versus seeking new deal flow. My own portfolio comprised nine enterprise focused software companies at the beginning of the year, where some had already raised second seeds and now needed to raise a substantial next round. Retailnext/Nearbuy (2010) raised $30m in July and Navera (2010) $8 million in October. I was reminded that getting to a minimum viable product is so easily said, and yet it is so difficult to achieve: Two of my investments (from 2010 and 2011, respectively) were able to get acquihired, and one (from 2013) closed its doors. The only real surprise was a McKayla Maroney moment when a seasoned CEO sent an email announcing that his company would have no cash left in two days. I do want to give a special shoutout to my Band of Angels colleagues Jack Carsten for taking the lead on restructuring of A6, Ken Arnold for looking for the crazy ones, and Carol Sands for teaching a world class course on being ‘The Effective Startup Board Member’ at Stanford.

Several spaces stood out as potential sources of new deal flow: Workflow and productivity tools, wearables, 3D printing, drones and associated systems, healthcare communications involving patients, nurses and doctors, social media marketing and advertising (still!), and HR applications. Three other broad trends: SaaS applications to every buying center, anything and everything as-a-service, and the continuing API-ification of software. Out of the 100+ companies I saw and the dozens I talked to, I ended up making three investments

• Truevault offers healthcare applications a secure API to store health data in a HIPAA compliant way. Jason Wang started the company in June 2013 and was part of the  Winter 2014 Y Combinator class.

• Secured3D’s encrypted 3D printing cloud allows centralized command and control of 3D intellectual property, 3D printers, and users. John Dogru is maniacal about product development, and his Estonia based development team is peerless.
  
• 3ten8 helps mobile operators better understand and optimize their wireless networks and subscribers experience. Miro Salem drinks from the deep fountain of professional experience and is driven by the mission to make the mobile network world a better place.

I authored a dozen blog posts, mentored at the Alchemist accelerator, and shared my experience at the annual Band member workshop ‘Good outcomes and bad outcomes and the lessons learned’. My resolutions for 2015 are much the same as last year: Work closely with the teams, leverage my colleagues in the Band of Angels. and continue to build my network.

My outlook for 2015: caveat emptor. The tech IPO pipeline is still full, but the overall climate continues to be somewhat uncertain. The huge number of seed funds means that there are a lot of companies testing different things, and that there are many copy cats.

Photo credits: dailymail.co.uk

Angel On Vacation?

It is a common perception is that venture capital firms close down for business during much of the summer. Start-ups should align their fundraising activities with the annual calendar, and not waste their efforts when it is unlikely that a full partnership group is able convene. As an active angel investor, this also rings true for new deals, even if there are no partnership decisions required. Starting in early July, first time meetings with entrepreneurs are postponed until after the summer. Knowing that many other investors also take the time off, the chances of not being able to take part in key deals seems small.

Existing investments are living, breathing organisms where the activities are not controlled by the boards and the advisers. In most of the cases this does not constitute an issue. During the most recent summer vacation period, six of my portfolio companies did nothing which would have required my attention or intervention. For another two companies, planned and ongoing  activities simply spilled over into the summer: In one case, a new CEO was brought on board. In another, the critical introduction to a future business partner was initiated and resulted in a first productive meeting.

However, two portfolio companies provided unexpected, and in one case material, surprises.  In one case, the startup was publicly hit with presumed claim about the company’s intellectual property (IP) and its development practices. Making sure that the IP is rock solid should be one of the foundations for investing, and attacks on these grounds are always cause for concern. While such claims are often not resolved immediately, they need to be put down as quickly as possible and before the next funding round to allow the company to focus on the business. In this case, the founders responded promptly to what appears to be a fraudulent claim.

The CEO of the other start-up company sent out an urgent and surprising email to the company investors. He announced the need for an immediate cash infusion within two days, or else the company would have to shut down and the assets would have to be sold. He also informed that two of the board members had stepped down in the prior two days. All of this after things seemed to have been going well. In hindsight, some warning signs had been obvious, but it was hard to believe that such a perfect storm could arise within a few days. 11 days later and thanks to the hard work of many of the stakeholders, the impending demise has been avoided, the company has been restructured, and new capital has been infused. 

In the past weeks, I took time off from pursuing new investments. For the existing portfolio companies however, the involvement never stops - it may just pause.

Incubators, Accelerators, and Combinators Have Entrepreneurs Cheering - Here's Why

Since the founding of Y Combinator in 2005, the number of incubator and accelerator programs has rapidly proliferated. Akin to popular rankings for colleges and universities, Forbes magazine and Techcrunch have even published rankings of top accelerator programs.

Many of these programs have modeled themselves after Y Combinator. Just to mention a few, Techstars launched in 2006, 500 Startups, AngelPad and the Citrix Startup Accelerator launched in 2010, and Alchemist in 2012. Each of these programs operate based on a similar business system. They source small start-up teams  of one to three founders, screen them in a concise interview process, provide some seed funding, nurture the team in a three to six months long process, and graduate them at the so-called demo day. Most programs offer admission twice a year.  

The impact on company founders and on early stage investors has been profound. This post sets out to shed some light by asking three key questions: How do these programs operate? What value are they providing for entrepreneurs? What impact do they have on the early stage investing landscape?

Sourcing of Founders

Many first time entrepreneurs are looking to become of part of a startup ecosystem. These programs provide an equal opportunity to gain instant access to such network.

Y Combinator initially built a follower community through Hacker News and Paul Graham's blogs. The Google pedigree of Angelpad’s founders helped attract other ex-Googlers. 500 Startups has gone out of its way to recruit entrepreneurs in Korea, Mexico, and many other locations from outside of the U.S.. Other programs are building reputations in specific focus areas. For instance, Alchemist is an enterprise focused program, and Rock Health is health focused. Eventually, successful programs attract founders because of the strength of their program brand alone.

Candidate Screening

Research on angel investment returns shows a strong correlation between investment success and time spent in due diligence. Accelerator programs often attract founding teams with little startup track records, and therefore place an emphasis on the founder versus their business ideas to reduce team risk. Applicants are asked to submit videos and describe critical moments in their lives. The tendency is to bet on teams who have worked or at least studied together. The actual interview process is conducted in batches, is limited to a few minutes, and decisions are made within 24 hours or less. Dave McClure of 500 Startups has further minimized the due diligence process and stated that the portfolio itself replaces due diligence.

The class sizes continue to change and vary from 10 (Angelpad ) to 50-70 (Y Combinator) to hundreds each year (500 Startups). Admission rates are in the single digit percentages, similar of top university programs.

Startup Funding

Y Combinator pioneered a model where the start-ups are giving up a single digit share of equity in return for funding that lasts the team for the duration of the program. The exact funding amount has varied over time, and is a function of team size, duration, and program reputation. Most often the terms are in the form of a convertible note with a conversion cap, although the structures vary and evolve over time.

The funding amount and structure appear to play less of a role in the entrepreneurs’ decision where to apply compared to the program reputation, although corporate programs tend to offer the most entrepreneur friendly terms. For early investors, the prevalent convertible note structure offers an easy way to invest, but often at the price of high valuation expectations.

Incubating and Accelerating

Successful angel investment outcomes are also strongly correlated with mentoring, coaching, providing leads, and monitoring performance. Incubator and accelerator programs have taken this participation to a new level where they emphasize different elements of advice and networking. The class type collaboration, competition, rhythm and co-location facilitate regular discussions, dinners, office hours, and social events. Program participants can show weekly progress on their product development and in meeting their target metrics. For content, many programs leverage Eric Ries’ Lean Startup approach and Steve Blank’s Customer Development process. The 24 week Alchemist program is extending this approach from three to six months by splitting the program in to a first half focused on customer development, the second on product development.

The efficiency of the partner advice is maximized by the condensed time frame, the co-location, and by the partners not taking board seats. And some programs like AngelPad and Alchemist have chosen to keep the class sizes small to deliver consistent advice.

Those programs wanting to further scale are adding more partners, and are growing the network of external advisers. As the accelerators mature, executives from former incubated start-ups are being recycled and brought back as advisers.

As Y Combinator’s Paul Graham has stated ‘... startups at all stages benefit from YC. That’s probably the best word to describe the atmosphere. For 3 months, it’s all start-up, all the time.’’ This is in marked contrast with a more traditional angel approach. There, advice is delivered on a one-on-one basis for the duration of the relationship, and is based on the strength of the individual angel and her network.

Follow-on Funding

The concept of a demo day is an attempt to ‘formally’ graduate start-ups, although the businesses are at widely varying maturity stages. Demo day also creates a 'American Idol' like marketplace where a large number of seed investors and early stage startups compete for attention and money. Some incubators have been able to generate demo day momentum and attract venture capital for a significant number of their incubated companies. For startups, the exposure to a large number of investors and the time saved in fundraising is extremely efficient.

VCs and angels can get early access by participating in the mentoring of the programs' participants. That way there are no signalling risks, and the demo day simply creates the urgency for them to make an investment decision before everyone else.

But the correlation between the ability to raise funds at or immediately after demo day and the eventual success appears to be low. 

The usefulness of the demo day itself has been questioned by many investors. The limited time to get to know the company, to do research on the market and the competitive landscape, or to get meaningful customer references often force investment decisions under duress.

The program's brand can also be strong enough to crowd source follow-on funding for the whole portfolio of class participants. AngelPad is using the Angellist syndicate model where the momentum from the demo day is leveraged to attract additional investors who are not demo day participants.

Summary and Outlook

The impact of Y Combinator and other programs on the entrepreneurial landscape and on early stage investing has been enormous. They have built repeatable processes bringing together large numbers of startups and investors. As Angellist’s Naval Ravikant has stated, ‘Accelerators have branded advice and have institutionalized it.’

Participants in the programs, and in particular first time entrepreneurs, very highly value the advice, the network and the funding acceleration. Post demo day, the power of the program's alumni network also helps recruiting and providing the seeding ground for new products and even new companies.

The corollary is also clear: Why should an experienced founder give up expensive equity if the product has some traction and the founder knows how to build a company? However, there have already been some cases where the team opted to join a program if even only one of the pieces was missing.

Programs make the first investment into founding teams with little track record. As valuation expectations rise significantly in the three months from inception to graduation, the demo day effectively creates a new investment 'gate'. This may leave traditional angel investors for these types of investments in a lurch. At the front end, they may not be able to compete with incubators in delivering services in a consistent and timely fashion. At the back end, valuations at demo day often reach levels which make it unattractive for angels to participate.

Thanks to Ken Arnold, Ryan Nichols, Mike Palmer, Riley Scott and David Wu for commenting on the draft version of this post.

Top Accelerator Generates 50X Return - How Can Investors Participate?

Accelerators and incubators have claimed prominent roles in the earliest stages of startup formation. These programs have seeded thousands of new companies and created significant value.

Y Combinator is the program with the longest track record and the largest amount of publicly available information. As of February 2014, Y Combinator has seeded an astounding number of more than 630 startups. At a per company funding of $15,000 to $20,000, Y Combinator has invested $10 million since its launch in 2005.  Y Combinator receives 6% of equity, effectively valuing the startup at approximately $250 thousand. Kawasaki's law of pre-money valuation assigns a value of $500,000 for every full-time engineer and subtracts $250,00 for an M.B.A. For a team composed of two technical co-founders, Y Combinator's investments constitutes a 75% discount compared to this rule of thumb.

Recently, Y combinator announced that its portfolio companies are worth more than $20 billion. AirBnb and Dropbox account for around 75% of that valuation. Assuming, pro forma,  five successive rounds of funding and a 15% dilution per round, the original 6% stake now is down to 2.7%, equal to a value of more than $500 million. In other words, Y Combinator has achieved a 50X total return on the $10 million invested so far. While almost all of these investments are still illiquid, the likelihood of realizing these returns is high. And since Dropbox and AirBnB were members of the classes of 2007 and 2009, respectively, there may be more hits to emerge still.

Until 2009, Y Combinator only invested its founder’s money. In 2009, Y Combinator raised a $2 million fund from Sequoia Capital and a number of angel investors, followed by a $8.25 million fund in 2010. Y Combinator raised and manages these funds to increase the number of startups it invests in.

Since 2011, startups in the program are offered additional funding after the initial Y Combinator equity investment. Yuri Milner and SV Angel launched the YC managed Start Fund to provide $150,000 in convertible debt to every startup in the program. In 2012, YC VC replaced Start Fund with a reduced amount of $80,000 instead of $150,000. Y Combinator was looking for each of the fund investors to provide the startups with advice, and consequently Khosla Ventures replaced Yuri Milner in 2013. In times when capital is cheap, advice is at a premium.

As the Y Combinator case shows, accelerators may prefer having prominent angel investors and venture capital firms as partners in their own earliest stage funds. Other early stage investors can create their own next stage index fund by spreading their investments over a wide range of accelerator startups. The returns can still be above average, but will require significant capital and effort.

The Best Deals Are Yet To Come: Coupons Are Disappearing But Coupon Companies Are Thriving

Two recent blockbuster IPOs are evidence that the once sleepy coupon industry has transformed into a hotbed of new activity: Groupon has pioneered mass couponing for local retailers and convinced consumers to pre-pay. RetailMeNot has aggregated a large online coupon offering, and has made it easy for online shoppers to save money. At the time of this writing other digital coupon companies such as Coupons.com and eBates and are making plans to go public. And yet, it is only early days in the consumers' transition from clipping printed coupons to receiving relevant offers. The industry is still stuck in an age where 95% of coupons are printed, and the majority of those printed coupons is distributed to consumers as Free Standing Inserts (FSI). Less than 1% of FSI coupons are being redeemed, and worse, there is no easy way for consumer product manufacturers to track when and by whom they were purchased and redeemed. And while couponing as a category is moving online, paperless coupons presented at the point-of-sale accounted for only 2.2% of all coupon redemptions in 2012. Clearly, this is a highly inefficient situation.

Starting with Coca-Cola, coupons have served multiple purposes: To help consumer product manufacturers and retailers acquire new customers, increase the number of purchases of the same item, and incentivize customers to return. Specifically, manufacturers want consumers to switch to their product, while retailers want to increase shopping basket size and increase the number of trips to the store. Going forward, the digitization of coupons promises to make this a more seamless experience for the consumer and demonstrate ROI for manufacturers, in part by directly connecting to loyalty cards and credit cards. This digitization will also broaden the base  of coupon users and deliver coupons that are relevant: Traditionally, couponers tend to be consumers with low opportunity costs of couponing relative to income. With direct targeting, coupon manufacturers will be able to offer coupons to other user groups. It will also affect the coupon mix and physical locales for redeeming coupons: As consumption patterns and retail spaces continue to change, the shift away from food and grocery coupons towards other categories will continue. Already, the share of food coupons has declined from 70% in 2008 to about 60% in 2012.

Couponing marketplaces are two sided markets which require significant investments to acquire large audiences. In these ‘winner take most’ situations the race to dominate local couponing has been won by Groupon.  Livingsocial, once a major Groupon competitor, is struggling to survive, and other local coupon competitors such as BuyWithMe have been acquired or have folded. The rewards of scaling fast are tremendous: Even at this early stage in the digital transformation, and despite short operating histories, companies like Groupon and RetailMeNot are commanding market capitalizations worth billions of dollars.

So while it may appear that the couponing space is consolidating already, there are three reasons why early stage  investors should pay close attention

• Couponing is still in its infancy: Relationships between consumers, manufacturers and retailers continue to migrate online, and existing players occupy only small segments of the couponing space.
• Value networks are continuing to change: RetailMeNot and Groupon have emerged out of nowhere to become public companies in less than five years, and the impact of players like Pinterest on the landscape is only beginning to be understood

• Plenty of exit opportunities exist: The viability of IPOs in the coupon space has been demonstrated, and public companies have proven to be active acquirers.

In couponing, RetailMeNot and Groupon are akin to the first wave of Web 1.0 portals. There are many opportunities of start-ups like Ibotta, Shopmium and Aisle50 to take the consumer experience to the next level and demonstrate ROI for consumer product manufacturers and retailers.

Disclosure: I was one of the first investors in BuyWithMe, an early Groupon competitor. I am an early investor in Aisle50, a leading provider of prepaid coupons for grocery stores and consumer products manufacturers.