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.

Most Accidents Happen Close To Home - An Example of Startup Failure

In 2011, I invested in a promising gaming start-up. The promise was to license TV and movie content for related games, and get a jump start by using the brand name and co-marketing agreements to quickly build an audience. The leadership team was strong, the company attracted many experienced angel investors, and internet gaming sector was buoyed by Zynga’s impending IPO.

Yet, not even a year later, the investment ended up a complete failure.

When a company comes out a winner, everyone takes credit. When a company fails, it is like the scene of the traffic accident: Car drivers, passengers, bystanders, perpetrators, victims, police, ambulance - they all have slightly different perspectives about what happened. In this situation, one needs to peel back the onion to understand what really happened.

Research indicates that angel investors’ outcomes can be positively influenced by spending more time on due diligence, leveraging industry expertise, and frequently interacting with portfolio companies. To get a better understanding of the events, I talked to a number of board members, investors, and company executives. What were the early warning signs that something was going wrong? Was it a lack of due diligence? What actions should have been taken?  Did the board not take corrective action early enough? And would the outcome have been different?

The obvious answer is to point to a market failure. After its IPO in December 2011, Zynga’s stock price briefly rose and peaked in March 2012.  In March, Zynga acquired OMGPOP, the maker of the Words With Friends game, so there was an brief opening for gaming companies to be acquired. Even as this acquisition was consummated, Zynga’s stock fell off a cliff in April, taking with it the hopes of many start-ups to be acquired. The disappointing Facebook IPO in May further put a chill on the market. Raising funding for a gaming startup in early 2012 certainly was a challenging endeavour to say the least.

Both founders had worked together on the project part-time for two years before raising the initial funding. The energetic and talented CEO had a strong product vision and experience as a founder. The COO had a background in finance and operations, start-up experience and connections in the media business. The board consisted of several highly experienced angel investors. And yet, majority of stakeholders thought the founding team had failed. The money was wired in July of 2011 and the team started to ramp up. At the first board meeting in September, the directors had trouble getting financial and market information. It became clear that the CEO lacked business acumen. Soon after, the CEO, who also was the CFO and the chairman of the board, started behaving increasingly autocratic. By late fall, the relationship between the two founders had deteriorated to a point where the board started counselling the CEO. Checks and balances between the two founders disappeared, and the relationship became emotionally charged. To make things worse, the COO developed health issues  in November and the CEO was hit by a car, partly incapacitating both founders during a critical time. And none of the outside directors had experience in the online gaming industry.

At the end of 2011, revenue had come in short, and cash reserves were rapidly dwindling. January saw a rapid succession of board meetings where the CFO responsibilities were finally removed from the CEO and moved to the COO. At the same time, the COO faced a declining health situation and ended up having to step down at the end of January. The CEO ventured to raise more money, but the money never arrived in the bank accounts. Almost weekly board meetings continued throughout February. In late February, the CEO obtained a short term loan in exchange for company common stock and receivables to stave off immediate bankruptcy. In doing so without informing the board and without its consent, he breached the investor rights and was subsequently removed as chairman. The money that had been promised never arrived, and in early March all employees had to be laid off. Only a minimum amount of cash was left. In April, the company missed a royalty payment for the marquee game, and the game was cancelled by the content owner. The outside board members resigned.

But all the executive changes and board actions were merely too late. Coming out of the 2011 summer break, the marquee game had good metrics per user but did not get the expected traction. The company had been struggling grow the number of users, and made no progress until December. The introduction of new features during the Halloween and Thanksgiving holidays did not move the needle. And a critical co-marketing agreement and a new TV season would only kick in in April 2012. In retrospect, the product issues were apparent in the fall already. Instead of focusing on fixing the game, the team embarked on a multitude of projects such as replatforming the game for mobile, developing a second game, and taking on project work on behalf of others. Moreover, resources were diverted to build a proprietary metrics platform to save money paid to 3rd party providers.

The truth lies in the eye of the beholder. In this case, it appears that some of the best practices for a successful angel investor outcome were ignored, and that events spiraled out of control faster than anyone anticipated.

How To Run A Hyper Growth Company - Free Advice From The Coach

Update: Bill Campbell passed away on April 18, 2016, at the age of 75.

Successful startups undergo significant changes as they approach an IPO. Increasingly late stage funding rounds put management teams under even more pressure to grow faster and faster. However, these expectations often overwhelm the capabilities of the founders and their teams. And while the preferred startup narrative is a rocket like ascent from launch to success, the reality consists of blow-ups and misses.

The Coach is an almost mythical authority in Silicon Valley when it comes to dealing with those situations. Bill Campbell was on the boards of both Loudcloud/Opsware and Netscape and has been a long serving board member at Apple. He is frequently mentioned in Ben Horowitz’s book 'The Hard Things About Hard Things'. He is a self-professed operator and has been a CEO at Claris/Apple, Go, and Intuit.  Kleiner Perkins Caufield & Byers brought him in to advise the founders and CEOs of Google, Zynga, Twitter and many others on how to improve company operations.

There is no substitute for working with the Coach. Unfortunately, there is no documented methodology, but are four valuable lenses the Coach has repeatedly and successfully applied, and which form a logical combination - staff alignment, business plan, team meetings, and operating reviews. Here are some of his insights as told by others.

The Staff Alignment

It was Bill Campbell’s idea to gather a few key Googlers together and hammer out a set of the young company’s corporate values.                             Steven Levy - Inside The Plex

Rather than simply focusing on whether a manager has achieved his financial goals - which can lead to short-term thinking - Campbell gives equal weight to four areas. The first is traditional: performing against expectations. But then he looks at management skills, working with peers, and innovating. If you aren't good at all those things, you aren't good. CNNMoney - The Secret Coach

I push hard on innovation and best practices. In the absence of true innovation, there’s no excuse for not knowing where the best practices are. And a lot of best practices can come as tweaks that will make a practice more innovative. I give high grades to anybody who knows exactly what’s going on in the industry and can adapt to this quickly. McKinsey Quarterly - Inside Coaching

The Business Plan

Campbell next initiated a strategic planning process for [Intuit]. Intuit’s VMOVA (vision, mission, operating values) effort had set the cornerstone for strategic planning by identifying the company’s values and missions. Campbell built on these to codify and energize strategic operational thinking. In the middle of each quarter, Campbell held an off site at which each manager submitted a business plan with numerical goals and reviews performance against these goals. Business leaders presented quarter-to-date results and objectives for the next quarter; at each meeting leaders had six weeks’ performance data for the current quarter and six weeks to plan for the next one. Each manager could change key variables - staffing, expenses, direct-marketing spending, tech support, and so on - before the quarter began. ...Over a period of time, Campbell’s meetings generated a perpetual quarterly plan. Inside Intuit, Suzanne Taylor and Kathy Schroeder

The Team Meetings

My contention today is that that if a month is 20 working days, you’ve got to spend a day doing nothing but reviewing projects. A whole day, with the whole management team, so that we can clean up those projects, clean out the ones that aren’t going to be good, and take the bodies that are recovered and put them on the projects that look like they have the best prospects. McKinsey Quarterly - Inside Coaching

These management planning offsites [...] unified the company. ...Campbell valued the social as much as the strategic elements of the meetings because he knew that stronger relationships would improve teamwork and business results. After a few quarters, he had a management team working effectively together, both formally and informally. Suzanne Taylor and Kathy Schroeder - Inside Intuit

The key skill is not in convincing people of your point of view with rational arguments, but, when circumstances require, in build a feeling of consensus in the face of uncertainty or adversity. Bill’s strength was his ability of select a straight course through the swirling darkness, then create a deep emotional reserve in his team that drives them to victory, even when defeat seems inevitable. he metered out sufficient time for open discussion, then closed debate with a fatherly decision that all were expected to accept as their own, in the service of the greater good. Jerry Kaplan - Startup: A Silicon Venture Adventure

One of Bill’s first acts as CEO was to establish a kind of corporate rhythm, a weekly sequence of meetings by which the company shared information and made decisions. This organizational pulse started on Monday morning at nine-thirty with ‘estaff’ - a meeting of the executive staff, where large issues and strategic initiatives were discussed - and ended on Friday at four-thirty with the ‘comm’ meeting, where the entire company gathered to communicate new, make announcements and give demos and awards. estaff started as late as nine-thirty because Bill, who usually arrived at the office around six, liked to spend the early morning talking to the East Coast, before people there went to lunch, and meeting privately with any employee who had a problem that couldn’t be solved through normal channels. Following the comm meeting was a ‘beer bust’, with drinks and munchies, a Silicon Valley tradition that Bill had followed since his Apple days. Jerry Kaplan - Startup: A Silicon Venture Adventure

The Operating Reviews
   

He instituted monthly operations reviews, in which senior managers provided updates so that Campbell could help set goals and track revenues and expenses. Cook welcomed the discipline in these monthly reviews, which harkened back to the quantitative analysis and metrics he’d introduced to marketing. Suzanne Taylor and Kathy Schroeder - Inside Intuit

I care about the ones that care a lot about operating values, that care about durability and lasting value. I’m not interested in ‘quick in and out’. McKinsey Quarterly - Inside Coaching

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.

How To Become A Super Angel, Part One: Seven Steps To Lift Off

Historically, angel investors have been retired high net worth executives and entrepreneurs. But as of late, super angels and micro VCs have emerged as a new type of new angel investor.

The archetype of the super angel is Ron Conway who got his start in 1995. Since then, others such as Jeff Clavier, Aydin Senkut, and Chris Sacca have emerged, some of which have leveraged their early successes into building partnerships akin to the venture capital firms of the early days.

Even without a formal definition of a super angel, one can identify remarkable similarities by inspecting the early days of these investors. Without further ado, here then are seven steps to achieve super angel lift-off:

1. Have an immigrant mind set. This can encompass anyone from outside of Silicon Valley. Jeff Clavier grew up in France, Aydin Senkut hails from Turkey, Manu Kumar came to the U.S. at the age of 17. Chris Sacca grew up in Buffalo, New York, and carefully cultivates the image of a small town kid. What matters is the mind set.

2. Build your skills in adjacent roles. No one is born a super angel. The more prominent super angels had operating experience at a start-up. Launching your own company or being a member of a founding team is the best place to start; business development and product management roles can come pretty close. But realize that training wheels have to come off at some point.
   
   
3. Quit your day job. Spending more hours on due diligence and interacting with portfolio companies at least a couple of times per month correlates with greater returns. With a large size investment portfolio, there isn’t enough time to be a super angel while holding a day job.The price is high: You must be ready to spend years without receiving a paycheck. And the next step makes the financial picture even worse.
   
   
4. Spend your own money. Most super angels spent the first three years investing their own money in 10-20 startups. Chris Sacca’s story is the exception: He had just enough cash to invest in Photobucket, and had to immediately move on to steps #5 and #6.  

5. Hustle. Hustle. And then, hustle. Ron Conway is the consummate networker, and was able to invest in Google by getting both Sequoia and Kleiner Perkins to sign up for the Series A . Chris Sacca bootstrapped himself into Twitter by charging $25,000 to his credit card. Aydin Senkut got into Helsinki based Rovio - not exactly a drive-by Silicon Valley location. Reminder: This step is closely connected to step #1.
   
   
6. Get lucky. Jeff Clavier had a massive return after 18 months when AOL acquired Truveo, and had many other early exits in his first portfolio. Chris Sacca’s investment in Photobucket more than returned its money in less than a year. Three angels - Jeff Clavier, Aydin Senkut and Dave McClure  - have claimed Mint’s sale to Intuit as a significant early exit. Note: End customer related internet start-ups rule when it comes to quick exits.
   
   
7. Raise first outside money from High Net Worth acquaintances. Investment portfolios take time to generate returns even when there are some early successes, and eventually angel investors run out of money. The initial check sizes tend to be small, and hence this hobby is not likely to pay for the daily expenses. But early successful exits allow super angels to raise money from high worth individuals in their networks. In Chris Sacca’s words: He was able to raise money from people he had traveled with and who he had relationships with.

Stay tuned for Part Two: How To Spend It.