Moneyball: A Quantitative Approach to Angel Investing (Austin, TX - Aug 2012)

500.co/challenge #moneyball4startups

MONEYBALL STARTUPS +
IT’S NOT SPRAY AND PRAY. IT’S A PROCESS.

PAUL SINGH

500 Startups

@paulsingh・paul@500startups.com・angel.co/paulsingh


GETTING TO KNOW

500 STARTUPS BECAUSE WE’RE KIND OF A BIG DEAL

PAUL SINGH

@paulsingh・paul@500startups.com・angel.co/paulsingh


THE BIG OPPORTUNITY IN EARLY STAGE TECH INVESTING:

API TO VENTURE CAPITAL
& FUNCTIONAL EXPERTISE
(FOR FOUNDERS. FOR INVESTORS. FOR GOVERNMENT.)


FOUNDERS:

BUILD SOMETHING
PEOPLE WANT


INVESTORS:

WRITE CHECKS AND
ADD VALUE


GOVERNMENT:

MAKE LIFE EASY
FOR INVESTORS &
FOUNDERS


“ VENTURE CAPITAL IS
OPEN TO ATTACK BY
DISRUPTIVE NEW
BUSINESS MODELS AND
TECHNOLOGY.
-- NAVAL RAVIKANT (@naval)


(R)EVOLUTION IN THINKING


EARLY STAGE
STARTUPS
HAVE CHANGED


WEB GETS BIGGER.
WORLD GETS SMALLER.


CLOUD, OPEN SOURCE AND ONLINE DISTRIBUTION DRIVING

STARTUP COSTS
LOWER THAN EVERBUT SCALING STILL COSTS MONEY


TRACTION IS THE NEW
INTELLECTUAL PROPERTY
PLATFORMS (SEARCH, SOCIAL & MOBILE) PRIMARILY DRIVING THE CHANGE.
NO LONGER “GOOD ENOUGH” TO DEPEND ON TECH DIFFERENTIATION.


CAPITAL
INCREASINGLY
COMMODITIZED
RISE OF THE ANGELS, YO!


NEW REALITY:
MONEY FOLLOWS
FOUNDERS


SIGNALS ARE
EVERYWHERE
BIG DATA + OPEN SOURCE ANALYTICS = NEW TECHNIQUES FOR VC


WALL STREET
BEAT US TO IT


“ UBS PROPRIETARY
SATELLITE PARKING LOT
FILL RATE ANALYSIS
POINTS TO AN
INTERESTING CADENCE
INTRA-QUARTER AND
POTENTIAL UPSIDE TO
OUR VIEW.


WALL STREET
ISN’T ALONE
THESE TECHNIQUES ALREADY USED TO UNDERWRITE IN-VITRO
FERTILIZATION LENDING, PAYDAY LOANS, SUBPRIME AUTO
LENDING, HOME/PERSONAL/AUTO INSURANCE AND MORE.


IT TURNS OUT,

WE CAN DO IT, TOO SURPRISE!


+ “GUT” + TRUSTED MENTORS + MUCH, MUCH MORE DATA.


SENTIMENT
ANALYSIS
WHAT IS THE TEAM THINKING? WHAT DOES THE MARKET THINK?
WHAT DO MY PEERS/MENTORS THINK?


NEEDLE IN THE
HAYSTACK
REAL USE CASES: SIGNS THAT A FUNDING ROUND IS ABOUT TO
OCCUR AND/OR SIGNS THAT A PRODUCT IS ABOUT TO EXPLODE.

VERY HARD TO DO ACCURATELY BUT PAYOFF IS BIG & FAST.


FASTER PORTFOLIO
TRENDS
CURRENT SYSTEMS OF QUARTERLY/AD-HOC REPORTING IS
BROKEN -- SELF REPORTED DATA IS OFTEN BIASED.

THE RAW DATA IS THERE, THE SYSTEMS TO COLLECT IT AND THE
ALGORITHMS TO ANALYZE IT ARE MISSING.


500 CHECKLIST
Product solves a problem for a specific target customer
Capital-efficient businesses - operational @ <$1M funding
Primarily internet-based distribution - search, social, mobile, local
Simple revenue models - transactions, subscriptions or affiliate
Functional prototype before investment (or previous success)
Small but measurable usage - some customers, early revenue
Small but cross-functional team - engineer, design/UX, marketing


EARLY STAGE VC
IS CHANGING
HAS CHANGED


STATE OF THE ART IN EARLY
STAGE INVESTING IS NOT
VERY SOPHISTICATED
AT THE EARLIEST STAGE, YOU HAVE LIMITED DATA TO MAKE DECISIONS
WITH -- BETTER TO LOOK FOR DEAL FLOW VIA TRUSTED REFERRALS, USE A
CHECKLIST, DECIDE YES/NO QUICKLY AND KEEP LEGAL/FINANCE SIMPLE.


MONEYBALL
IT’S NOT SPRAY AND PRAY. IT’S A PROCESS.


MY PRIMARY GOAL IS TO

BUY WINS
NOT NECESSARILY BUYING INTO THE HOTTEST DEALS.

FOCUS ON TEAM, EXECUTION, TRACTION & DATA.
(STICK AROUND... I’M GOING TO SHOW YOU HOW)


INITIAL BET DESIGNED TO
GIVE US MORE DATA FOR
SUBSEQUENT BETS


QUANTITATIVE
PORTFOLIO
APPROACH
BENEFITS: CONTROLLED RISK + OUTSIZED RETURN POTENTIAL


Monte Carlo Simulation of Angel Investing
5

mean median std dev
3.75
Exit Multiple

2.5

1.25

0
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30
# of Deals

MODERN PORTFOLIO THEORY:

RISK MITIGATION
THROUGH
DIVERSIFICATION


HIGH VOLUME
INVESTING ALLOWS
FOR HIGH ERROR RATE


TRACK IRR &
VALUATIONS WITHIN
YOUR PORTFOLIO AT LEAST YEARLY. RECOMMEND QUARTERLY.


CONTROLLED RISK:
OUTSIZED RETURN
POTENTIAL


PORTFOLIO IRR
QUICKLY POSITIVE
(WITH SMALLER EARLY EXITS AND PROMISING DEALS GETTING FUNDED)


EVEN “SMALLER”
EXITS CAN MOVE
THE NEEDLE DON’T FORGET: YOU CAN SELL POSITIONS TO
DOWNSTREAM OR SECONDARY BUYERS TOO.


LAW OF LARGE
NUMBERS FTW!


INDIVIDUAL BETS
ARE SMALL
MUCH EASIER TO RUN AN EXPERIMENT ON A
$50K INITIAL CHECK INSTEAD OF $250K+


BAD BETS
FAIL FAST
SMALLER CHECK SIZES FORCE COMPANIES TO PROVE THEORIES FASTER.
ALLOWING INVESTORS TO QUICKLY ITERATE OUR FORECASTING/FUNDING
MODEL. FEWER “LIVING DEAD” AND QUICKER RETURN ON RESULTS.


FAILURE RATES
ARE HIGH
DIVERSITY OF HIGH VOLUME INVESTING ALLOWS FOR HIGH ERROR RATE.
FUND IRR QUICKLY POSITIVE WITH SMALLER, EARLY EXITS AND PROMISING
DEALS GETTING FUNDED.

DILIGENCE HAPPENS IN THE REAR VIEW MIRROR, NOT THE CRYSTAL BALL.


ALLOCATE FOR FOLLOW-ONS
30% Capital - Initial Bets
target 10-20 deals

70% Capital - Follow On
filter out failures, follow-on the top 20%

(...OR “HOW TO AVOID GETTING SQUASHED”)


DEAL TERMS
SO YOU FOUND A STARTUP YOU LOVE?


DEBT VS EQUITY


CONVERTIBLE NOTES
ARE OK (REALLY!)
LOWER LEGAL FEES, LESS DOCS, QUICKER TO EXECUTE. WHEN
CAPPED, THEY FUNCTION SIMILAR TO PRICED ROUNDS.


STANDARD DOCS
ARE YOUR FRIENDS
WHEN IN DOUBT, DO NOT INNOVATE IN FINANCE OR LEGAL


PRO RATA &
INFO RIGHTS
ALWAYS. ALWAYS. ALWAYS. ALWAYS. ALWAYS. (GET IT?)


FOCUS ON
VALUATION &
MULTIPLES
OWNERSHIP % MATTERS MUCH LESS. FOCUS ON REQUIRED EXIT
SIZE RATHER THAN SOME MYTHICAL OWNERSHIP TARGET.


IT’S HARD TO MAKE
MONEY ON
VALUATIONS > $5M
(PRO TIP: CONSIDER MIN. RETURN REQUIREMENTS FOR DOWNSIDE SCENARIOS)


YOUR PRIMARY GOAL

LET FOUNDERS GET
BACK TO WORK
THIS IS A LONG GAME: AVOID LOSING YOUR REPUTATION OVER 1%.
WHEN IN DOUBT, LEAN TOWARDS THE ENTREPRENEUR.


AVOID BOARD SEATS


MOST BOARDS
PROVIDE MINIMAL
VALUE-ADD


BEST DEALS USUALLY
REQUIRE LIMITED
BOARD SUPPORT
SPEND YOUR TIME SOURCING NEW DEALS. LIMIT TIME ON
SIDEWAYS DEALS. LET THE WINNERS KEEP ON WINNING
(AND ANSWER YOUR PHONE WHEN THEY NEED YOU).


DO NOT INNOVATE IN
FINANCE OR LEGAL


INVESTING
IS A PROCESS
DABBLING IN INVESTING IS (AT BEST) GAMBLING. BETTER TO
WALK AWAY OR PURSUE INVESTING NEARLY FULL TIME OR
FIND SOMEONE TO MANAGE YOUR MONEY


BE AN ACTIVE
INVESTOR
PORTFOLIO EFFECTS & THE LEAN STARTUP MOVEMENT ARE YOUR FRIENDS

YOU CAN EXPECT FAVORABLE WITH 10 DEALS BUT IT TAKES 20+ TO BE SAFE


BE A SMART
INVESTOR
FOCUS ON INFORMATION ASYMMETRY & PRICE/MULTIPLES.


“ BY ITS NATURE, THE
INTERNET UNDERMINES
ANYONE WHOSE STATUS
DEPENDS ON
PRIVILEGED ACCESS TO
INFORMATION.
-- MICHAEL LEWIS


500.co/challenge

Moneyball: A Quantitative Approach to Angel Investing (Austin, TX - Aug 2012)

Moneyball: A Quantitative Approach to Angel Investing (Austin, TX - Aug 2012)

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