SFOs AND ANGEL INVESTING

Transcription

1 whitepaper SFOs AND ANGEL INVESTING Part II By: Dave McClure, Founding Partner, 500 StartUps, Miles Spencer, Founder, Vaux les Ventures and Angelo J Robles, Founder and CEO, Family Office Association

2 2 Plus que ca change... begins an old French saying, but Yogi Berra s french was much more elegant; It s like deja-vu all over again! So much has changed since our White Paper on angel investing for SFO s was first published in [2011] by the Family Office Association, but many of the basic tenets of successful angel investing have remained unchanged. In the tech market Facebook, Apple and Google have exerted themselves in so many ways. While leveraging their core businesses, they have ventured into everything from entertainment to driverless cars, purchased everything from OTT apps to headphone companies, and raided great engineering talent all over the globe. Very busy indeed. Throw in MicroSoft and Amazon to round out the big five of tech players and you have a nexus of desire: Startups want to be bought by them, and talent wants to work for them. And yet, some don t.

3 3 Uber and AirBnB have led the sharing economy, driving possibilities- and enthusiasm- for peer to peer platforms in a variety of fields. Now you can book on demand for everything from dog walkers to valet drivers with just your phone. It s disrupting a lot of old school businesses, and making plenty of municipal agencies crazy with how exactly to tax them. VC s have become brand conscious content machines, trying to add value and maintain relevance with talented genius first-time entrepreneurs who need mentoring and leadership. This tips the scales toward the technical types who can talk code, and away from the mis-fit banker types who were happy to check in every quarter at board meetings and perhaps add a little less value. Guilds have now acquired critical mass, throwing the knowledge base and leverage back in the founder s favor for a moment. YC, Techstars and 500 StartUps (founded by co-author Dave McClure) have funded and nurtured literally thousands of savvy, connected founders who have been able to standardize best practices around valuations, deal structures, product market fit, distribution and the so many other subjects. Bay Area valuations have rocketed for those special few baby unicorns who are showing traction, but ironically, funds from China still think them cheap. Angel Syndicates have allowed founders to access capital more effectively than ever, and VCs have largely had to react by going up market, or making pre-emptive bets in earlier rounds to access to the best deals. This update will attempt to synthesize these new trends with the basic tenets of angel investing published in our prior FOA White Paper.

4 4 Important Rehash - What s Old But before we dive into what is new, let s reconnect with a few of the timeless tenets of Angel Investing for SFO s that haven t changed. And are unlikely to do so Your Funnel: Think about Sources of Deal Flow So many SFO s start angel investing even before they know what they are looking for. It s a sure fire recipe for disaster, or at the very least some disappointment. Both authors have established a few gating factors before diving in further on companies. YMMV, but every SFO should have some top of the funnel statement like this: 1. Great, unique ideas that transform large markets or solve large customer problems. 2. Financeable entrepreneurs who can manage growth and lead great organizations, and 3. Access to capital to start and sustain the business until it reaches cash flow or an exit. Lately, Peter Thiel has added some new twists in his book Zero to One that are worth considering. He argues this: 1. Don t iterate on something that exists. That just means you will be competing to be slightly better than the next solution, a recipe for margin contraction and eternal pain. 2. Build something that doesn t exist, and create a giant, new market. Be a monopoly, but keep it quiet or at least obfuscate it. Yes, he really says that. 3. Then be able to capture meaningful piece of it with a superior solution of team. Where the funnel comes from is also (or twice as much perhaps) important. While we have covered this in detail in the original White Paper, it bears repeating: unique opportunities rarely appear in well-trodden places. And while it s not impossible to source a special opportunity from an large angel group or a venture fair, the general rule is those deals are already attractive interest, and have expectations that are going to price most angels out of the market. Guilds: The idea of Guilds comes from by examining early stage accelerator programs such as 500 StartUps and Y Combinator. Their alumni networks became extremely helpful & influential, and in many ways began bearing some resemblance to a modern-day guild an association or union of craftsmen, or in this case a union of startups & startup founders that was unlike any other. And in addition to helping each other, they also started funding each other, and even help select future batches of founders. Angel Syndicates. Conversely, small guilds of angels or syndicates have also formed and been successful in standardizing around industry, stage, deal structure and terms. They often invest as a small but powerful group. Some have spawned as a by-product of Naval Ravikant s Angel List (Gil Penchina being one of the most successful here), and other are more low stealthy in their offline approach. Incubator related funds. Some incubators, such as 500 StartUps, have funds that are open for SFO s participation as an LP in a vast array of startup companies (indeed, the number of portfolio companies of 500 StartUps is approaching 1,000 at this point) and also invest directly in those that suit the investors angel criteria.

5 5 Ten Questions about your funnel source. No matter whom you choose to align with- angel, syndicate leader, or micro fund manager- be prepared to answer the ten questions that FOA speaker David Rubenstein (Carlysle) once rattled off in a Q&A session: 1. People. Would you cross a desert with them? Or invite them to your BBQ? 2. Performance. Has the performance of the fund been in line with the class. Note, not way above superior, or certainly not inferior. 3. Process. Do they have a documented process for assessing, investing, and managing their portfolio? Do they stick to it? 4. Junior. Do the juniors who are doing the work have the same integrity, work ethic, and domain expertise as the seniors? 5. Seniors. Are the people who may have generated all those returns, back in the day, still around and still part of the execution team? 6. Relevance. Do the skills and experience of the team match the strategy and its requirements? 7. Integrity. Are the people you are investing with of high integrity? 8. Stability. How long has the team and the strategy been in place and delivering returns? 9. Who else is in. Are there other investors I consider smart that are also invested? 10. Core Values. Do they have them? What are they? Do they work by them? Your Filter: Be Well Versed on Criteria Most SFO s have plenty of exposure to asset classes that protect or hedge downside risk, such as hedge, private equity or real estate. These concepts rarely work in angel investing. Honing your criteria and risk tolerance are crucial to your ability to react to opportunities against a screening criteria you have set in place in advance. So, in order for an SFO to have any degree of success with a process in angel, a new perspective on risk is necessary. It is perhaps best summed up by the following nugget: If I am not taking zeros here and there, I am not taking enough risk to drive the big returns I need to make the (angel) portfolio worthwhile. ~Anon Properly structured, this asset class can be very rewarding for SFOs. Here are some basic points to consider: Assertion #1: There is tremendous opportunity in building revenue-focused consumer internet startups for $1-5M valuation that a) attain some level of commercial viability, b) acquire customers predictably using online distribution channels (Search, Social, Mobile), and c) can later potentially be sold for $25-$250M. Assertion #2: Look for the following three when investing in a startup PRODUCT = Do they have a functioning product? Have they identified a problem and built a solution for it? MARKET = How big is the market that they are going after? REVENUE = What s the traction they have in the market they ve identified to go after? If the market traction (revenue, number of downloads, number of active users etc) is limited, revisit your premise on the Product / problem to solve and what the Market demands, reiterate your product until you find the right Product-Market fit Assertion #3: One needs to lean in on winners in this business to optimize returns. Think about making followon investments with adequate resources and proper structure in order to directly can maintain or add exposure to the winners in the portfolio, employing more money to those that are showing traction and building value.

6 6 And What s New The World is Flat, one better get on a Plane One co-author frequently mentions himself as an Entrepreneur, Explorer and Angel. Sometimes all at once. Point is, if an SFO is not prepared to go digging for ideas and talent, you will pay someone else to do the same for you. That s ok, just be aware of the mark-up for your laziness or lack of time and resources. To that end, we should emphasize how important it is for venture to expand its horizon beyond Silicon Valley, and beyond the US market. Most firms don t have the appetite to invest outside their backyard, but there are tremendous opportunities and talent to be found in multiple geographies all over the world. While it will always require local market cultural fluency and expertise to take advantage of this growth, at the same time many of the platforms and techniques for which Silicon Valley is famous have now gone global. There are now billions of people on Google, Facebook, Twitter, Apple & Android, and the ability for communication and commerce to bring us all closer together is more amazing than ever. Entrepreneurs can be found in every corner of the globe, and emerging market consumers and businesses are growing and connected everywhere. With programs like GeeksOnaPlane tours, 500 StartUps has been the most active seed investor in the world. Out of 1,000 companies they ve invested in, about 30% of them are international, spread across 50 countries. For example, in the current accelerator program they run are 34 companies, and 41% of the companies have at least foreign-born founder (also 29% of them have at least one woman on the founding team). By being able to find these great entrepreneurs in every corner of the world, 500 StartUps are leading the change in how VC is investing because talents are evenly distributed while funding is not. What s even so powerful is what we call geo-arbitrage because some international company valuation is at discount simply because their zipcode is non-silicon valley. We see more people will jump on this valuation arbitrage as the world is becoming more global every day. VC Disruption widens: time to choose a team! A few big developments have occurred since our first White Paper that will affect how an SFO approaches the direct angel market. The first is that VC funds are getting smaller (good), & angel investors are growing (also good), but both need to get smarter & innovate to reflect the market. Startup funding needs have come down dramatically in the last 5-10 years, and online distribution via Search, Social, and Mobile platforms (aka Google, Facebook, Apple) have become mainstream consumer marketing channels. Meanwhile acquisitions are up, but deal sizes are down as mature companies buy startup companies ever earlier in their development cycle. The second development is the geeks are more and more on the investing side, either as angel investors or within smaller funds. Many of these new Micro-VC fund managers came from operational backgrounds at companies like PayPal/eBay, Yahoo, Amazon, or Google, rather than finance backgrounds from investment banking or Wall Street. They were familiar with internet startups and technology platforms, and had experience using , blogging, search and social techniques for internet marketing. In short, they were a lot more geeky than the previous generation of fund managers, who started blogging a lot about tech startups and best practices. One example was Naval Ravikant, who with Babak Nivi started Venture Hacks, a blog with tips & best practices for entrepreneurs, and later Angel List, which has dramatically changed VC.

7 7 And What s New (cont d) In a Town of Geniuses, Leaders can be Scarce Silicon Valley, Silicon Alley and a few other areas are nexuses of genius, particularly in the engineering field. So, while sourcing investments that come from these areas (or are inevitably heading there), it is likely important that someone on the founding team have leadership skills, or the likelihood to develop them. Larry Elison, Mark Zuckerberg, and Sergey Brin are brilliant technologists, but it was there leadership (often displayed in different styles!) that lead their companies to greatness. Finding small teams that have that element is another key and difficult- consideration. Some Sectors are hot, but which have leverage? Doing what you know is surely the path to comfort, but that may not be a good thing for an SFO considering angel investing. Operating on the assumption that any reader would be relying on a fellow angel, syndicate leader, or micro fund manager to vet deals it is safe to assume that venture outside the domain expertise of the SFO or the Principal who created the wealth is necessary for any angel investing process to work. What follows is a brief analysis of markets that are currently interesting to the authors, but the list is meant to simply provoke discussion and help hone criteria rather than transfer an investment thesis to another party. With that, here is the list: 1. Platforms are simply digital way of enabling a marketplace between buyers and sellers. Ebay, PayPal and Craiglist were probably the founding fathers here, but there has been, and there likely will be a swarm of additional platforms coming to market because the economics are so good when they get network affects and scale. 2. Sharing is a subset of platforms, but one that is very hot. Sharing (or renting, or collaborating) typically involves employing technology to better utilize assets or skills. This includes AirBnB and HomeAway in housing, Lyft and Uber in transportation, Angies and Thumbtack in Home Services, and Care.com and Dog Vacay in caregiving. 3. Green tech is needed, but so is a business model for greentech. Some very smart VC s have gone all-in with funds in the past five years, with little to show for it. Maybe the definition of greentech needs redefined. 4. So called Vice investing has a window of opportunity, whereby people are so enamoured of the product they are willing to break the law, or at least skirt the law to use it. Napster was the trailblazer in the category, but lately one has to acknowledge that Cannabis, Porn, Anonymous Payments, as well as just Uber and AirBnB have jurisdictions if not moral issues tied to them. 5. Fin Tech is being disrupted in many angles, as people realize they need banking much less than they need banks. Everything from payments, savings, and investment to wealth management will appear different in five years. 6. Food Tech also has some interesting possibilities, where items as simple as ingredient sourcing and integrity can and will be tracked and be meaningful to consumers. This list is by no means exhaustive, and perhaps by our next update, not even half-right. But it reflects a point of view that gets the conversation going toward angel investing.

8 8 Next Steps - it s up to you If your SFO is ready to consider this type of expedition, consider packing these essential points for the journey: 1. Spend time with other angel investors, syndicate leaders, or micro-fund managers to hone an investment criteria keyed to the market and one that fits within your investment parameters. 2. Think about how your SFO will source on-criteria deal flow that hasn t been over exposed? 3. Ask if your internal efforts will bring enough deal flow to enable my SFO to establish a diversified portfolio within the first two or three years of investing? 4. Can your SFO allocate a manageable amount of funds and a realistic holding period to the strategy? This assumes you elect to add venture capital to fund growth, otherwise and SFO can employ tens of millions of dollars (as a VC would) to reach cash flow and/or exit. 5. Can my SFO rely on an EIR or outside deal leader to reduce my overhead by taking compensation in the form of company equity? Does he/she have operating and leadership credentials to recruit and lead teams of entrepreneurs within my field of focus? 6. Do I have access to capital to ensure future rounds will be secured ie is my network good enough to keep funding growth? 7. Have I allocated enough to follow on with pro-rata when businesses scale and require more funding? Summary This update was meant to be read in conjunction with the original White Paper published by FOA in [June 2011] With the two works, the reader should be able to develop a strategy for angel investing within a SFO, develop a funnel and criteria filter to diligence opportunities, and have a strategy that mitigates risk through a deliberate portfolio approach. The rest, of course, is in the doing.

9 9 About the Co-Authors Dave McClure Dave McClure is the founding partner of 500 StartUps, a venture capital firm and startup incubator in Silicon Valley with over $125M under management. He has been an investor in hundreds of companies around the world including Credit Karma, Twilio, MakerBot, Wildfire Interactive, Viki, Mashery, SendGrid, Mint.com, and SlideShare, among others. Dave has been geeking out in Silicon Valley for over twenty-five years as a developer, entrepreneur, blogger, investor, and internet marketing nerd. He has worked with companies such as PayPal, Founders Fund, Facebook, LinkedIn, Twilio, Mint.com, Simply Hired, O Reilly Media, Intel, & Microsoft. Miles Spencer For over twenty years, Miles has distinguished himself as a creator of ideas, a builder of businesses, and a leader of organizations. His angel group, Vaux les Ventures, has interests in over a dozen companies where he helped form the original team, provided the original capital, or both. Miles vision, combined with Dan and Krish s expertise and enthusiasm, was the spark that became Mojiva. Capital events following his efforts have realized over a billion dollars of value for shareholders. Angelo J Robles Founder and CEO of the Greenwich, Connecticut-based Family Office Association (FOA), a global membership organization that delivers private educational and networking opportunities, proprietary research, and access to salient thought leadership to multiple generations of wealthy families and the professionals who run their singlefamily offices. A member of the Princeton Council on Family Offices and the NYU Stern Family Office Council, Mr. Robles has a long record of leadership positions at top financial-service companies, including UBS. Before launching FOA, he founded and ran several successful entrepreneurial ventures: He served as President of the New England chapter of the Hedge Fund Association, and pioneered online retirement planning for Fortune 1000 executives with two Internet startups KRollover.com and IRARollovers.com. In FOA, Mr. Robles has created a resource unique in the family-office world: a font of keen insights into strategic investing -- delivered personally by some of the world s top investors -- coupled with servings of thought leadership typically confined to gatherings like World Economic Forum and the Milken Institute Global Conference. It s a mix that avails his members of many of the world s sharpest minds: from David Rubenstein, Co-Founder and Co-CEO of The Carlyle Group, to PayPal co-founder Peter Thiel; from James Chanos, Founder and President of Kynikos Associates, to Irish-born Walter O Brien, a scientist so vital to the future of artificial intelligence that the U.S. fast-tracked his visa application the way it did for Albert Einstein. Through this aggregation of many of the world s finest thinkers and doers, Mr. Robles offers his members an enviable look into the future of global business and finance, health and social trends, technology, and philanthropic opportunities most likely to make an impact. And all to advance interests unique to wealthy families and the professionals who serve them: wealth protection and growth, philanthropic impact, and the use of technology to address concerns across the board -- financial, legal and social.

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