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Angel guide to startup investing


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A guide to the fundamentals of how to think about investing in startups at angel stage. This is useful both to early stage investors for how to critically evaluate startups, and for startup founders to understand what is (or should be!) important to investors when thinking about pitching them for funding and evaluating their own business model. I teach founders to evaluate their business model not to pitch investors, but to give them a better shot of an exit. If you are fundable, you are fundable.

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Angel guide to startup investing

  1. 1. Angel guide to investing in startups
  2. 2. 0.00067%
  3. 3. That’s the chance of a startup having a Unicorn exit
  4. 4. <1%
  5. 5. That’s the chance for a Seed funded Unicorn exit
  6. 6. 1,100 tech companies that raised seed rounds in the US in 2008-2010
  7. 7. And as Angel… 1. There’s not many good companies to invest in 2. It’s not necessarily the best use of your time 3. The economics of angel investing work against all but a select few 4. The structure of angel investing works
  8. 8. But….
  9. 9. Those that invest in the diamonds in the rough do well
  10. 10. Peter Thiel seeded Facebook $500k became $1 billion
  11. 11. Jeff Bezos seeded Google $250k became $1.5 billion
  12. 12. You want to win too
  13. 13. Yes, there is a lot of luck involved, but
  14. 14. You need to know how to tell what’s fundable and what is not
  15. 15. We are going to cover 1. Understanding founders, startups and you 2. Why startups fail 3. Key things to look for 4. Importance of an investment thesis 5. Considerations for doing deals
  16. 16. Hi! I’m Alexander Jarvis This is me looking at yet another pitch
  17. 17. The story of (almost) every startup you will invest in
  18. 18. stabbed in the back by cofounders, investment rounds falling through, massive technology fuckups that brought sales to a halt, visa problems, lack of money, lack of traction, lack of a team, hiring the wrong people, firing people I didn’t want to fire, lack of product- market fit, and everything
  19. 19. “Within 3 years, 92% of startups failed”
  20. 20. Every founder is the exception
  21. 21. Over 90% of tech startups fail, but I never thought my baby, 99dresses, would be one of them.
  22. 22. The only control you have is to invest or not
  23. 23. Alexander, why so much drama about failure?
  24. 24. Failure is your Default
  25. 25. Your job is to learn how to avoid and manage the reasons for failure
  26. 26. Key things to look for when evaluating a deal
  27. 27. How painful is the problem? 1
  28. 28. Customers should scream for morphine Painkiller vs. Vitamin
  29. 29. Eisenhower Matrix: Urgent and important Sales Pain Sales cycle #Fail
  30. 30. Enterprise: Is this in the top 2 of the top 3 of decision maker’s problems? 1. Problem 2. Problem 3. Problem … 99. Problems and your startup ain’t one
  31. 31. Maybe you don’t understand the problem… Oli Samwer only copied Birchbox (Glossybox) after he asked his wife why shebought a magazine… (The free lipstick)
  32. 32. Learnings 1. If it’s not a big problem, stop wasting your time 2. It needs to have urgency if you are going to have a short sales cycle 3. You might not understand the problem, so socialise ideas you aren’t sure about (*love team)
  33. 33. Is the market big enough? 2
  34. 34. Size matters
  35. 35. Andy Rachleff’s Law of Startup Success 1. When a great team meets a lousy market, market wins 2. When a lousy team meets a great market, market wins 3. When a great team meets a great market, something special happens
  36. 36. Who cares if you have 100% market share of the hippy commune if it is worth $100k???
  37. 37. But, the market Now and the market in the Future are different
  38. 38. Angel passing on Airbnb -> market size NOW
  39. 39. It’s not air beds, it’s an alternative to hotels AND expansion as people
  40. 40. Aswath Damodaran wrote “Uber Isn’t Worth $17 Billion”
  41. 41. You need to redefine the market from ‘black cars’ to the future market of
  42. 42. But, as an Angel… A $40m exit may work for you (Just not for VCs)
  43. 43. VCs have a very different business model to angels… they have to have huge
  44. 44. Learnings 1. Nothing matters if the market is small 2. The market now and in future are different 3. An exit for an angel and VC are different
  45. 45. Will the solution win in the market? 3
  46. 46. Better, not cheaper. 10x better or you don’t get market adoption "We want to see companies that we can somehow measure and see are 10 times better than what's second best. It's no good if you’re one or 10 per cent better.“ – Peter Thiel
  47. 47. Price is a race to the bottom
  48. 48. You end up with long run perfect competition
  49. 49. Shrinking a market and owning it, is one smart pricing strategy though “The relational database market is a $9 billion a year market. I want to shrink it to $3 billion and take a third of the market.” - Mårten Mickos pitching INDEX
  50. 50. mySQL sold to Sun Microsystems in 2008 for $1 billion…
  51. 51. How do you know at angel? Look for a few customers that love the startup, not a 1000 eh, who cares NPS is an metric, look at cohorts and retention (if they have)
  52. 52. What about defensibility?
  53. 53. Patents are bullshit. How much $ do you have? $2m Average cost to litigate in the USA
  54. 54. Patents only illustrate you made some tech that is worth patenting
  55. 55. Few things are defensible, but they are hard to build • Network effect • Brand • Data exponent • A few other things…
  56. 56. Learnings 1. 10x better 2. Do customers love them? 3. Cheaper is race to bottom, but there can be smart strategies 4. Defensibility is hard (Ignore the BS founders say)
  57. 57. Timing matters 4
  58. 58. You have the problem, the solution, the market… But is the timing right?
  59. 59. Bill Gross found timing was the key factor between companies that succeeded and failed
  60. 60. How many NFC companies failed before Apple decided to do it?
  61. 61. Learnings 1. Timing matters 2. There can be reasons a company set up 2 years might have failed and why it will work now (Understand why) 3. If the timing is wrong you don’t get adoption
  62. 62. Is the team right? 5
  63. 63. Team should be your key decision “I am fond of quoting that about 70% of my investment decision of an early-stage company is the team. My rationale is simple: everything goes wrong and only great teams can respond to competitors, markets, funding environments, staff departures, PR disasters and the like.”
  64. 64. Team harmony matters!
  65. 65. Trust me, founder blow ups are real, and ugly
  66. 66. My favorite question to see if team is aligned: “Who is the CEO?” (If you see that, it’s bad)
  67. 67. Chicago O’Hare test. Would you spend time with a person and enjoy it?
  68. 68. Missionary vs. mercenary
  69. 69. Hunger for money is tots ok. Hustlin drives a lot of people (but most feel they can’t say it)
  70. 70. VCs created the myth mission matters as they need founders to stay around to make the company valuable enough
  71. 71. A mission to believe in is far more powerful though That to me is a narrative that I can relate to because I am thinking: "I can hire people against that narrative, I can build partnerships against that narrative, I can market against that narrative - and, it's imbued with a sense of purpose.” - Fred destin at Accel "I'm helping people with complex conditions live better, I'm giving them... my mission is to help people live better lives through better pharmacy,” - Tj Parker
  72. 72. If they want “smart money”, they have to be coachable to get the smarts after your money!
  73. 73. ‘Coachable’ is a big reason my ‘smart’ friends pass on deals even if they like it
  74. 74. Do founders get defensive with feedback? They won’t do well with customers…
  75. 75. Team size: Ideal is 3. Solo founders suck “Solo founders take 3.6x longer to reach scale stage compared to a founding team of 2”
  76. 76. Team age: Older is better The average age of people who founded the highest growth startups is 45
  77. 77. Can the team hire awesome people? Who have they hired to date? That tells you
  78. 78. Pro tip: You see a team slide with the founders. Ask about the minions… Did they hire A grade?
  79. 79. Avoid death dumb spiral or ‘bozo explosion’ A->A B->C C->Donald
  80. 80. Ultimately, you need to love the team. Here is Paul Graham trying to get Fred Wilson to invest in Airbnb… it’s a long thread from: Paul Graham to: Fred Wilson date: Wed, Feb 18, 2009 at 12:21 AM subject: Re: airbnb So invest in them! They’re very capital efficient. They would make an investor’s money go a long way. It’s also counter-cyclical. They just arrived back from NYC, and when I asked them what was the most significant thing they’d observed, it was how many of their users actually needed to do these rentals to pay their rents. –pg
  81. 81. Learnings 1. Don’t do a deal is the team isn’t awesome 2. Is there harmony in the team? 3. Are they coachable? 4. Can they hire A? 5. Do you LOVE not like the team?
  82. 82. Execution Is key 6
  83. 83. Ideas are a multiplier of execution
  84. 84. But, what did you achieve with what? Put results into perspective with the resources they achieved with it 0 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 9 10 11 12 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1 2 3 4 5 6 7 8 9 10 11 12 $100k $1m
  85. 85. How focused are the founders? Focus matters with no resources 1 thing done 100 things not shipped
  86. 86. You want to hear “We know we want to do 100 things, but we only have the resources to do x
  87. 87. Learnings 1. Does the team get shit done? 2. Are they ‘capital efficient’? 3. Are they focused?
  88. 88. Unit economics work or you die 7
  89. 89. Passion is overrated. I love boring too You can get passionate about anything that works
  90. 90. There are only 3 things that matter in a business model 1. CAC- how much to acquire customer 2. LTV- how much you make from them 3. Payback time – how long to recycle cash to get more customers?
  91. 91. If your unit economics are not profitable, it won’t scale (unless funded by VC $)
  92. 92. Old VC joke…
  93. 93. Learnings 1. Boring is great if metrics work. Screw sexy 2. CAC, LTV and payback time (to recycle cash) 3. You can’t scale crappy unit economics
  94. 94. Developing an Investment thesis
  95. 95. We know survival rates are low at the start
  96. 96. You get a low valuation because a lot of things are not known which means more risk Figuring things out Scaling
  97. 97. Figure out what is known and unknown? Hard
  98. 98. At every stage a company is derisking themselves by proving distinct known unknowns
  99. 99. If founder says what they need to prove, embrace it! They get it and aren’t lying to you! 1. Friend lied to me to get me to help him with his raise 2. Had multiple portfolio companies steal a lot 3. Angel friend got shut out of a company in Vietnam 4. Financial forecasts are always BS, lol Founders lie
  100. 100. Develop an investment thesis for what needs to go right for this company to work 1. Seek to prove and disprove your null hypothesis 2. Do it with logic and no emotion. It’s an investment 3. You have limited information 4. Remember, there will always be another deal
  101. 101. You can figure out a lot with desktop research, especially if you focus on specific sectors 1. Is the market actually big, or will it be in 3-5 years? 2. Who has failed before and why? 3. Why is the timing right? What’s changed? 4. What is competitive pricing and dynamics? 5. Will the sales cycle work? 6. What are the potential CAC and LTVs?
  102. 102. You have one goal as an angel What needs to be proved at this stage to get funded at the next stage? Can it with the investment?
  103. 103. ‘Pass the startup’ is a grown up game of pass the parcel Startup Angel S-+ Seed
  104. 104. You won’t fund a startup forever. You need next stage investors to take over. What will they fund? Angel Seed S-A Growth
  105. 105. Does the investment make sense for the milestones? I want $250k 18 months runway 10 developers Get to $1m ARR (BS)
  106. 106. What if things don’t go to plan? Need headroom as it never does 2x as much and 2x as long
  107. 107. Talk to potential next round investors and see what they what metrics they will fund! “Hey Peter, What metrics would you want to see to fund [startup] at their seed round? If they got to $20k MRR would you fund them?”
  108. 108. You can forecast a startup to exit (I made a tool)
  109. 109. Ultimately, take a calculated risk 1. You can start to ‘love’ the team and idea now (I personally want a deck before a meeting as I want to rely on logic and not allow bias enter my thinking) 2. Help the startup prove the key known unknowns and then make them the seed investor’s problem
  110. 110. Considerations for doing deals
  111. 111. Invest in what you know and can add value 1. Founders will get annoyed with you eventually if you keep asking dumb questions 2. You will lose sleep if you don’t understand them/industry 3. You build a brand for knowing a sector to get deal flow (SaaS for Jason Lemkin) 4. You really can help the startup get to seed with a lighthouse customer etc which derisks your investment
  112. 112. Screw ‘idea stage’. Expect some traction. There are a lot of startups who have it
  113. 113. Should you lose a deal on price? Hmmm… 1. A $m change in pricing impacts RoI by a few % (Can’t find the source!) 2. But returns follow a power law. Accept higher valuation for the ‘best” deals because it doesn’t matter if it works out 3. Valuations are lower in some countries as there aren’t exits. If they want a $20m pre, go to America…
  114. 114. Invest when they ‘need’ the $ - will be no major change for 6m without your funding
  115. 115. Founders hate milestone based funding 1. It’s often predatory behavior (Take over company) 2. You need to trust the team to execute 3. They are less likely to recommend you to founders 4. It’s a pain in the ass to define milestone achievement
  116. 116. Don’t take 40%. You screw the company 1. Seed/S-A investors will pass on the deal 2. Force you to recap (If they care enough) 3. You won’t make friends with downstream investors 4. Be reasonable. 25% is about the max (Many angel deals are in 15% region)
  117. 117. You set the watermark for future rounds 1. Terms get worse over time for everyone 2. If you have a participating preferred, 2x liquidation preference, all future investors will too 3. You are almost the last to get paid! 4. Keep terms vanilla
  118. 118. Convertible notes are common 1. SAFEs regarded as overly founder-friendly 2. Don’t do uncapped notes 3. Reasonable discount ¬20% 4. No board seat 5. Preemption/pro-rata rights = double down!
  119. 119. Priced vs convertibles 1. Nikesh Arora “I don’t do CNs. I want to know how much I own”. You don’t know what you own in a CN 2. But CNs can be faster to get done and ‘can’ require less sophistication on your part if you are new to the game 3. Do priced round when deal is >$1.5m. You will care more if you know what you own
  120. 120. Treat founders fair, you need them to bat for you if later stage guys try screw you 1. Later stage investors may not honor your terms
  121. 121. Convertible note standard venture capital terms 1. Average convertible note size: $1 million 2. Number of investors: “party rounds”Are pretty common here, The average is 13 3. Interest rate: 4% to 8%, 60% of the times 4. Conversion discount: 20% is standard, 70% of the time 5. Valuation cap: $7.5m 6. Conversion valuation caps: Caps are totally standard. They are used 95% of the time 7. Warrants: Never used 8. Conversion at change of control: This is standard, 70% of the time 9. Change of control premium: This is not standard, but is becoming more popular. It is used 40% of the time and typically it is 2x their money back. 500startups put in their KISS note 10. Duration/maturity of note: 12-24 months is standard and used 76% of the time 11. Secured notes: Not standard. Never supported by personal or company assets 12. Board seats for note investors: None. 5% of the time 13. Most Favoured Nation: Not standard, used 15% of the time. Typically this is used when uncapped notes are used and the note holder doesn’t want notes issued over them that are capped 14. Preemption/pro-rata rights: Pretty standard, used 50% of the time
  122. 122. Priced round terms standard venture capital terms 1. Participating preferred stock: this is not standard and don’t accept it. There are investors who ask for it, unless your valuation is totally out of whack there is no reason for you to accept this. Explain to the investor if you give them it, all future investors will get them too and being bottom of the stack is not where they want to be 2. Pro rata rights: these are totally fine to accept. Anything you might want to consider doing is setting a minimum floor for whom receives these. These days it’s pretty standard for everyone to have pro rata rights 3. Liquidation preference: this is standard, every investor will ask for one, there is no point in fighting this. 4. Anti-dilution protection: This is also fairly standard but not as much as this report suggests. Only accept ‘broad weighted-average” since this is used 99% of the time (a least for later stage deals). Do not accept full ratchets. 5. Cumulative dividends: These are not normal. In later stage deals they are only seen ~5% of the time 6. Redemption: don’t except redemption, you will only see you this 3% of the time. Later stage deals this is only seen around 10% of the time
  123. 123. SAFE note standard venture capital terms
  124. 124.