I received a message on LinkedIn yesterday. It read:
Martin! It has been like 23 years since we met in Silicon Valley. I so enjoyed our connection. You still in digital media? How have you been?”
A couple clicks reminded me of our connection and the memory popped into my head of a couple of drinks at a conference reception. Didn’t think anything of it at the time. One of the maxims I keep top of mind is:
Respond with Kindness
I remembered our conversation. He was pitching me a start up and I showed curiosity and was impressed by his authenticity and passion. While I didn’t invest, I gave him kind attention. Apparently he appreciated it and remembered for 23 years.
“I hope you don’t get what you want in life, because then you are Fucked.”
For over 20 years, this phrase has been one of my guiding principles. Today I am softening it.
Why soften it? I want my guiding principles to be in the positive frame, not the negative. While this has been great click bait and jolts the system, it does so by triggering a visceral emotional reaction: “What do you mean not get what I want? Isn’t that the point of life?” That reaction is why I like the principle, but I don’t want to relive the negative shock every time I hear it.
While I haven’t figured out exactly how to reframe this principle, something along the lines of :
“Process goals are what you want in life”
Process goals trump outcome oriented goals.
I hope your goals support your values.
The [[good life]] is a process not a goal.
Basically, the value of the positive frame in most things I do has risen in my value stack, and I am reframing whatever I can in that way. Give it a try.
Over 8,000 companies received pre Series A funding in 2019. 2020 is on pace to surpass that. How does one separate the signal from the noise? Over 25 years of Angel Investing, I have made every mistake there is and built a process from all that learning. This is the process I use to select deals for my Angel List Syndicate. Here is how I do it.
The top of the funnel is not every possible deal, you must apply a filter. The first filter is my personal network built over decades as an LP in over a dozen Venture funds, Angel investor in over 100 companies, CEO having raised over $500M for my companies (and all those venture and banking relationships), Founder of the Angel network Element8, and all the management and investor relationships over that time. From that network, I see thousands of deals a year.
The second filter is the Meta Themes I have found deliver outsized returns when present. They are listed below. If you want to get into the weeds, there is a very detailed dive into it on my blog.
Software eats everything
Great founders figure shit out
Disruptive innovation creates new markets
Americans are lazy
Invest only when I can be helpful
Invest along other very smart, committed people.
After screening hundreds of deals through the Meta Themes, less than a hundred get the concentrated diligence process and end up with a weighted score. With every check I write of any size, I want to have a greater than 80% confidence in a 10x return on my capital. If you want to get into the weeds on the ranking algorithm, head over to this blog post. There are 5 major risk areas for every startup. I assign a confidence level from low (weak, unprepared, or insufficient) to high (easy, will crush it). The five components are:
Management (50% weight)
Product (10% weight)
Market (10% weight)
Regulation (10% weight)
Terms (20% weight)
Less than a handful make it through to writing a check. My check size goes up along with my confidence interval. I usually write checks up to $50,000 between 80-90% confidence. Over 90% confidence, I will write checks up to $1M either alone or with friends and other smart investors. These are typically the deals that go through my Syndicate.
While there is likely a whole post on errors I have made in the course of decades of Angel investing, the major ones that have cost me the most capital are listed here (in stack ranked order).
Weak management. Management that can’t execute and pivot over time. Most management have nice looking resumes, but until you dig deeper and understand how they execute and the kind of culture they create, you won’t understand if they are up to the startup challenge. Everyone has an idea. The winers out execute everyone else.
Underfunding. Most startups run out of money before they find a product/market fit. Many startups fundraise hand to mouth, never gaining enough capital to mitigate the big risks of the business. Underfunding can also be caused by overspending by management on the wrong problems at the wrong time (see above).
Big Market, unclear entry strategy. I have fallen in love with large market size numbers, we all do. Without a clear product path to enter the market with some sustainable advantage, the market size doesn’t matter. Without product/market fit, the size is irrelevant. Also, if the “market” is already big, there are likely lots of competitors, a red ocean. There are better returns creating a new market with your product.
Me to products. Never invest in a follower. Unless there is some geographic, language, or market reason. There has been alot of money made copying innovation from the US in Europe for example. But copying a product in the same market tends to lead to low returns for investors. Invest in the leader, category creator.
Following investors without personal theme fit. I started out Angel investing with an “any good deal” strategy. How did I decide if it was a “good deal”? If other “smart” investors were in it. You will never know why other investors write checks, or even if they are “smart”. Plenty of “smart” people put money into Theranos. They all lost their money playing the momentum of others without doing their own thinking.
In addition to being asked how I decide to invest, I am often asked WHERE I look for investments. The short answer is where I have an ADVANTAGE. Some kind of information, insight, or talent advantage that is not available or at least non-obvious to others. The long answer is the rest of this post.
I love games of all sorts. Sometimes I play games without even understanding the rules being at a clear disadvantage. Tennis with my daughter who played on the Varsity team. SlapJack (whatever that is) with my 9 year old. Wall sit competitions. “Who can hit the softest” with my 5 year old. When the stakes are low and there are other benefits to playing, count me in.
As the stakes rise, especially into the tens of thousands in Angel Investing, I want an advantage. This is why I stopped actively trading public stocks. I had no advantage against the professional traders in the market. While I am approaching the 10,000 hour level in poker, I rarely sit down at a poker table full of professionals, I would be at a serious disadvantage over time.
Having far exceeded the 10,000 hour rule over decades of Angel investing, I have found an advantage when I follow these seven Meta Themes. I search for investments that fit 5 or more of these Themes. While I occasionally do invest with a looser fit, (say in an extremely strong founder outside technology), approximately 90% of my Angel risk capital is deployed in line with these Themes.
Software eats everything
Great founders figure shit out
Disruptive innovation creates new markets
Americans are lazy
Invest only when I can be helpful to company
Invest alongside other very smart, committed people
Great software significantly reduces market friction and creates new markets and value. Bezos is right: “Your margin is my opportunity”. Amazon’s software ate retail. Ebay’s software ate the classifieds business. Online banking software ate retail banking. Uber software ate the taxi market. Redfin’s software enables efficiencies that they pass onto customers while remaining profitable. Software “eats” another industry when it delivers greater value at lower cost. In eating an existing industry, the best software can actually grow bigger babies. There are 100x more people hiring drivers through Uber than anyone who ever took a taxi. I buy stuff on eBay which is NOT available locally, new purchases that are impossible without eBay. This is especially true when your competitors’ core assets are not software or technology based.
I have a friend who started shorting Amazon around $300 saying Walmart was much more profitable and had better physical assets. Yea, but those physical assets were costly, not scalable, and created friction in the retail process (get in car, drive, check out lines, etc.). Amazon’s core assets were software which fundamentally reduced customer friction allowing Amazon to grow sales much faster than Walmart. Software won. Investors in Amazon have been rewarded with orders of magnitude greater returns than investors in Walmart (a $10K investment in both in 2000 would yield approximately $100K for Walmart and $9.2M for Amazon) by mid 2020 (a $10K investment in Amazon’s seed financing would be worth over $1B).
Not all software “eats” another industry. Many software companies are competing against other software companies. That is not eating, that is competing in a red ocean. These can still be great companies, but the greatest software companies “eat” an inefficient, slow industry.
I recently invested in a company that has replicated the therapeutic effects of most drugs and over the counter medicines (anything with a non-covalent bond method of action) in software. They have double blind placebo controlled scientific proof that it works, and patents. Yes, software may eat one of the most profitable industries on the planet, pharma. Didn’t see that one coming did you? I was looking for it.
Investing in “software eats…” ideas tends to produce superior returns.
Great Founders figure shit out.
“Everyone has a plan, until they get punched in the mouth,” Mike Tyson said. A startup founder is going to get punched in the mouth over and over again. Great founders can take the punches and figure out how to win anyway.
Management commands a 50% weight in my decision process for a new investment because of this Theme. A start-up is a journey through a land of incomplete information with limited resources. Opportunities abound and resources are limited. Great management is skilled as guiding the ship through the journey. This is a constant decision process, under pressure of where and how to allocate limited resources. Great founders pivot often. They attract other great people. They inspire customers. They modify their original plan to meet the engagement they find in the market.
I often ask founders to explain a failure (or two) as well as a success. How a founder talks about failure and success is very instructive. During the failure, were they animated, doing every next right action they could think of? Or paralyzed. Are they accountable for their part, or do they put blame or not credit on others? How much did their actions contribute to the success and how much was right place right time? Many founders from successful companies overvalue their contribution to the prior success and underestimate their own role in failures. I avoid these founders. Great founders are very self aware of their strengths, weaknesses, and those of their team. Great founders are very accountable for their actions.
Disruptive innovation creates new markets.
How big was the ride share market before Uber? The cell phone market before iPhone? Premium coffee before Starbucks? Streaming video before NetFlix? Great innovation allows people to buy stuff they never thought they needed. This is the Blue Ocean Strategy. While the “Software eats…” theme is looking for technology companies disrupting traditional businesses, this theme is looking for innovation to OPEN NEW MARKETS.
So I look for category creators. The first brand to reach scale in a new category, or the early start up who could possibly create a whole new category. This is related to the “winner take most” fact behind category creators. The followers of Ebay, Amazon, Netflix, etc. all have crumbs compared to the category creators.
Platforms exploit network effects and investments in integration to create outsized value and make replacement very difficult. Amazon is a platform. Microsoft is a platform. Facebook is a platform. Slack is a platform. Zillow is a platform. Adobe is a platform. Apple is a platform. Google is a platform. Cisco is a platform. SalesForce is a platform. Shopify is a platform. Coca Cola is a platform. Cargill is a platform. A platform is any company which has very deep customer relationships, controls multiple parts of the value chain, has a shared infrastructure across multiple product lines, has an ecosystem connected to products and services, and continues to deliver new innovation into the ecosystem.
Very few start-ups ever reach platform scale. Those that do are deliver orders of magnitude greater returns to their investors.
Most start-ups are solving a niche problem. These can be great investments and I have made good returns with best of breed companies with a single product. And the absolute best returns have come with companies that were able to become platforms. So I keep an eye out for those.
Americans are lazy.
While I would like to believe consumers are rational and make considered choices, I have found that whatever product enables the the consumer to be the most lazy usually wins. Even if it is more expensive. If it is less expensive, you have a unicorn. Why drive to Walmart when you can One Click Amazon from your couch? Who go to movie theatre when you can sit in your underwear on your couch? Drive through coffee that costs 100x making it at home? Starbucks crushed that.
While this is somewhat true across the world, this theme is on steroids in America. Americans are always looking for the easy, quick solution. The One pill, The One Diet. The One Click purchase. While there is much snake oil sold this way (don’t invest in those), the companies that actually deliver a quality product that enables laziness tend to win.
Invest only when I can be helpful to the Company.
I have found Angel investing to be a two sided conundrum. The best companies can easily raise money, so why would they take mine? I have more opportunities than capital, so how do I convince the best companies to take my money? While a company may look great in the deck, if I can’t come up with three ways to help the CEO before my call with him, I will pass. Being helpful to the company will improve their chances of success, growing my investment. Startup companies always need help. Customer, employee, business development, product development referrals and review.
I recently invested in a consumer products company selling paleo baby food. While outside my normal technology focus and failing a number of my major themes (Software eats.., new markets, etc.), I had kids, a paleo influencer wife with a huge network, and some retail relationships for business development. I made the investment and delivered the influencer network and retail leads. The company exceeded their sales projections for the next three quarters and just closed an up-round at 3x the valuation I invested at. Being helpful is good insurance after the investment.
Remember, these themes are all about how to improve the odds that the Angel investment returns 10x or more. Investing in companies where I can be materially helpful improves the odds materially.
Invest alongside other very smart, committed people.
Lets unpack that a bit. There are three key words here: “alongside”, “very smart”, “committed.”
As an Angel I am rarely the lead investor. That means I am following other investors who have done some level of diligence. You are always “alongside” other people, so you better figure out who they are and if they have a track record of good decisions. The deeper their diligence, the deeper their relationship with management, the more confidence I have. Some Angel investors will blindly follow other name brand investors, and companies will often roll out their name brand investors to attract others. I am aware of this trick, and dig deeper. Figure out who you are in the boat with. People just along for the ride (momentum players), or thoughtful, driven people?
There are smart people and then there are Very Smart people. Bill Gates, Jeff Bezos, Elon Musk, Steve Jobs are all Very Smart. Very Smart people are the top 5% of smart people. When I was at Microsoft, when someone was called “smart”, that was translated “average” (everyone there was “smart”). But “Very Smart”? Ok, you better listen to her. Investing with smart people is a given, table stakes. Investing alongside “very smart” people has produced outsized returns for me over the years.
I always want to know the level of commitment from my co-investors. What is the ratio of their check size in this deal to their net worth or typical investment? The higher the ratio, the stronger the commitment signal. Also, how active are they? When was the last time the CEO spoke to them. I once looked a deal where the CEO was shameless flogging a name brand investor. During the call I asked the CEO when the last time he talked to the name brand investor was. “Actually never, one of his team made the investment.” Pass. That is not commitment. In fact it is dis-honest for the CEO to flog the name which signals a deeper issue with the CEO.
“Crowdfunding” platforms, while significantly increasing access to products and even angel deals at very low levels of risk capital, simultaneously put your investment alongside the masses of not so smart, not very committed novices. That is on reason I prefer the Angel List platform as a Syndicate Lead.
These seven Themes are the top level filter every deal goes through in my Angel investing funnel. If a deal ticks 5 or more or a couple super strongly, I move the deal down the funnel to “how to decide”. These themes have given me and advantage over time and kept me out of investments where I do not have an advantage. While there are plenty of people making money in areas where I don’t have an advantage, they likely have animating themes in those areas which give them an advantage. For those areas, I invest in Venture Funds with competent managers. I can’t have an advantage everywhere.
I have invested millions of dollars directly in over 100 startups over the last 25 years. Many more through Venture funds and other syndicates. I am often asked how I decide to write the check. Well here is my process which has produced a 3.5X return on capital (so far). This is my process for an investment of $50K or less. The process for larger checks is the same but requires a higher confidence score (>90%). This is basically an investment specific application of my Next Right Action decision framework which I use for all decisions.
Minority investments are bets. Bets are by definition risking capital with incomplete information. You should bet when you have a high degree of confidence in a positive outcome (10x capital for an Angel investment) based on a sufficient amount of incomplete information you have at the time of the decision (bet). You should not bet if you don’t have the basic information to form a hypothesis with a high degree of confidence. You should not make any bet when you are not willing to loose 100% of your money (even a small chance of an existential threat is too much). You should bet when you have sufficient information to form a reasonable hypothesis with a high degree of confidence.
In many games, like poker, collecting the basic information can be very challenging. For the angel investor, the company should have all the basic information in a 20 minute pitch or call with the CEO. They may be bluffing, and you have to adjust your confidence level if you detect that.
The process takes less than an hour to collect all the information and make a decision. Remember my Next Right Action framework is Problem, Explore, Hypothesis, Action. For an investment the problem is “Should I write a check?” Explore is diligence, collecting the basic information. There are only two Hypothesis, invest (confidence > 80%) or not invest (confidence < 80%). And only one binary action. Invest or not invest.
So most of my time on an angel investment is spent in “Explore” to collect the basic information to produce the confidence interval which will drive the action decision. There are three steps.
Read the pitch deck.
Hear pitch from CEO (or read investment memo from the lead investor)
Rank deal on 5 (weighted) key start-up risks. Write check if deal scores > 80% confidence of a 10x return.
The first two steps are self-evident and take 30-45 minutes. It is important to talk to the CEO or at least a lead investor you trust who knows the CEO well because 50% of the confidence interval is based on your trust and confidence in management’s truthfulness and ability to execute.
While you may hear many different approaches to investing from thematic, to momentum, to the shotgun, etc., I look at the 5 major categories of risk and score each based on my confidence (from 1-10) that the company is weak (1) or strong (10) in this area. Management is weighted 5x for 50% of the weight, terms are weighted 2X for 20% and the rest are equal-weighted for 10% each. Max score is 100. If funds are available, invest in companies with a score of 80 or more (>80% confidence). Pass on all rest.
5 Key Start Up Risks
Management: The start-up bet is first and foremost a bet on management. They run the company. Management’s ability to execute over time in a fast-changing environment is the single biggest predictor of success or failure.
I only invest in CEOs who have a resilience practice of some sort. Startups are a firehose of problems and opportunities. Management needs some “reset” practice that puts them into flow doing some non-work thing so that the subconscious can make sense of the work stuff. And your system 2 can get a break from work. Burning the brain on work 100% of the time is a well-worn path to burn out. I don’t want management to burn out. For me, meditation, mowing the yard, going for a walk with my kids, surfing, fixing the motorcycle, and riding the bike give me the reset. Most great leaders had some kind of resilience practice. For Seneca, it was writing philosophical letters to friends and family. For Epictetus, we can infer it was weight lifting. For Marcus Aurelius, it was hunting and possibly wrestling. For John Cage, it was mushroom hunting. For David Sedaris, it’s walking back roads and picking up trash. For Herbert Hoover, it was fishing. Reading, boxing, biking, surfing, swimming, puzzles, coding, journaling, golfing – whatever it is, management need something to take your mind off work. It is a critical skill.
Management of a startup is a “wear many hats” problem. You must LOVE the firehose and thrive on figuring shit out. I started my first company after a career as a programmer. I had never hired anyone, raised money, signed an office lease, created a sales and marketing organization, or basically any of the things that would take up 90% of my time as CEO. I wore all the hats and figured that shit out. I hired a very smart programmer with a PHD and put him on bug fixes. He complained about fixing other people’s code and just wanted to write his own. He was out of his comfort zone and didn’t want to even tilt his hat a little. Not the right mentality for a startup.
Prior success in similar stage startups is a plus. Success at a big company and the first time in a start-up is a minus. Look for obvious holes in management. Technical founder when it will be a sales-driven company? Given that every management team will need to grow, how ready is access to top talent? Is the stage and company attractive to top talent? What is the culture like? Will the CEO share responsibility, or is it a follow the leader culture? Who are the “fundable” management team members? the more fundable team members, the higher my confidence in management.
Examples that Increase Confidence in Management:
Prior startup success through superior execution
Meritocracy culture driven by KPIs and dates
Multiple “fundable” management team members
Management with proven track record of attracting A team members
Management is thoughtful, accountable, and trustworthy
Management can explain prior failures and what they learned
Examples that Decrease Confidence in Management:
First time CEO out of large company as mid level decision maker
Strategic positions missing (CTO in tech driven company)
Follow the leader culture.
“B” players in key roles
Lacking recruiting network
Management relies on market projections and external indicators for goals and drive
Management has not displayed growth from prior failures
1: First time CEO from Big company, used to be a CFO. Weak technical co founder, no marketing team, consumer sales channel.
5: Second time CEO (prior success) with new team in a market tangential to what they worked in before with tier 2 investors backing them.
10: Third time CEO with two successful exits working with a complete management team that she has worked with before and known for more than 10 years in a market they have competed in before and been backed by tier 1 Venture capitalists prior.
Product. What stage is the product in? Can it be built? Is version 1 the right set of features? Are they building the product they are passionate about. I recently heard a pitch from a company who had a clear vision of a transformational product. But it was too hard to build so they wanted to start with a different product to”make money now” and build their vision later. Pass. Build your dream product. Build it in logical stages sure, but don’t do the easy thing. Tesla wanted to build electric cars for everyone but the market wasn’t ready. So they build electric cars for rich people and started building the supply chain and innovations to drive toward a car for everyone. It was a logical path to the promised land.
Single product companies also tend to loose to platform companies over time. If your product fills a small niche in an ecosystem, and customers start to want it, eventually others with deeper customer ties in the ecosystem will copy your product and replace (or buy) you. Facebook is a platform not a product. Slack which started as a product has become a platform and is now much harder to dislodge despite others in the ecosystem copying the features (microsoft, facebook, etc.) Products that have network effects are superior to products without network effects. Products that require other users to be useful, that reward connecting new customers, etc. are superior to products sold to individuals one at a time.
If the product is creating a blue ocean, expanding a market instead of competing for one, my confidence goes up. What was the market for ride hailing services before Uber? The product created the market. The product/company that creates a new product category ends up with a far greater share than the followers. Invest in product category creators, not competitors in crowded markets.
Every product must fundamentally remove some friction in the market. The core invention should depend on technology which is innovated in the company. Amazon used technology to fundamentally reduce friction in retail. It took traditional retail with their physical locations as their primary assets a long time to adapt, and most did/could not follow because their core assets were not based in technology.
The 10x rule applies. A new product must be 10x better to get people to change. Back in the early days of search I used AltaVista and Yahoo. When Google launched, I tried it and the results were 10x better. I switched and never looked back. What will be 10X better than Google? Hard to imagine, especially since Google understands the 10x rule and keeps going.
Examples that Increase confidence in Product:
Clear MVP with short term product roadmap that fits in the funding window.
Customer demand, especially wait list, for MVP
Measurable metrics on friction reduction from product.
Network affects apply – product is a platform
Product creates a blue ocean (its own market)
Clear product milestones, questions within the funding window
Efficient customer feedback loop to development
Very short, limited scope development sprints
Product is in the power position in the value chain.
Examples that Decrease confidence in Product:
Scale of MVP too large and complex.
Building an “easy” product for short term $$, not transformational product
Product has only a few feature differences from competitors
Product innovation not key to competitive advantage (sales channel is, or marketing, etc.)
“fishing expedition” product development
Long, complex development and release process
Product not designed for customers to leave it easily
Product is an add-on or incremental product to others in the value chain
1: Complex product vision with long development cycle going against established competitors with limited innovation (10-20% better) and easy to copy innovation.
5: 2-4x better specialist product in emerging market with some traction, little opportunity for protection or branding or network effects, enterprise sale.
10: Leading platform company with huge viral component, virtuous cycle already going and proven, creating market demand for new product category, clearly reducing market friction by an order of magnitude or more, clear customer pull for product, proprietary, protectable technology key to innovation.
Market. How big is the market for the product? Does the existence of the product expand the market (see Uber)? Does the market have a clear leader? Do customers show a willingness to buy innovation? Why now? What is the mega trend that the existing competitors are missing that the company sees that they can capitalize on now. The fact that a market is growing at double digits a year is not a reason to be in it. Why does this market need YOUR product NOW? Is there a clear path to $$? Does the company have an active pipeline? Is there a thin edge of the wedge to get into the market? How do you get to market? Direct to consumer? Enterprise? use a Chanel? influencers? Is there a Blue or Red (competitive) ocean market? What mega trends that you see in the market are you betting on? Are these trends long term or short term? Betting on market rebound from COVID is short term. Betting on Moores law is long term. The expansion of work from home is long term. Telemedicine is long term. Selling to hospitals is short term.
There also has to be a product/market fit. The right product at the right stage of the market. A very innovative product in a market which doesn’t buy innovation will languish. Determine the switching costs in the market. Is it easy for customers to switch? or Hard? How much of the product/market fit has been proven by the company to date? How long will this take? The product/market fit should also be exploiting a long term dislocation or trend also. I remember talking to lots of start ups who wanted to do banking for the emerging cannabis market using existing banking infrastructure and taking the new market risk for higher fees. Banking is an incredibly efficient business and traditional banks were prohibited by regulations to be in it. But those regulations could change quickly and the arbitrage would disappear quickly. Since the start ups did not bringing innovation to the market, simply taking risk, their market would evaporate quickly. I passed.
Examples that Increase confidence in Market:
Blue Ocean, product innovation creates new market space
Efficient, cost effective channels to customers.
Many diverse market segments (industries, customer sizes, etc.)
Positive CAC:LTV which can scale
Way customers like to buy matches way customer sells
Customer revenue goes up with product purchase.
Customers proven desire to embrace change, new products
Consumers can pull product into Enterprise (apple)
Proven product/market fit
Examples that Decrease confidence in Market:
Customer concentration (small number of customers control most of market)
Many look alike customers
Customers change adverse
Enterprise market for SMB focused startup and vice versa
Few or expensive clear leveraged channels to customers
Too large geographic market for startup (world wide for small company)
Enterprise only sale.
Way company wants to sell is mismatched with how customers want to buy
Customer revenue not affected by product.
Risk adverse customers
Unproven product/market fit
1: Small market not growing (<$1B) with customers averse to change. Like selling software to municipalities or healthcare.
5: Growing market (> 10%/year) with clear leader (s) taking 70%+ share and a few concentrated customers. A few possible new segments but all very small, company has early traction in some of these early markets and customers.
10: Product creates its own market demand. Many market segments, company innovation expands market to 10x or more new customers. Customers show proven desire for new product or service, can switch quickly. Can prove positive CAC:LTV very easily. Clear leveraged channels to reach customers.
Regulatory. Many investors never consider the potential regulatory hurdles facing startups. Uber faced serious ones. So do everyone in Healthcare (the FDA). Facebook and Microsoft did not until they got huge. While some investors see regulatory hurdles as a positive (healthcare) because they are expensive to get over and may come with market exclusivity and ability to print money for some time (drug discovery), i see regulatory hurdles as generally negative for the investment decision. You can have the most innovative product in an amazing market and the regulators can tell you you cant sell it, or could stop you from selling it (see Uber in California recently or AirBNB). A complex regulatory environment or unclear regulatory framework lowers my confidence that the company can clear the regulatory hurdle. How many biotech companies have consumed $100M investor dollars and failed to get approval for their drugs? Most. Take the recent interest in psychedelics. Lots of investor and consumer interests. Very murky regulatory framework, in fact criminal penalties for getting it wrong. Until the framework or mega trend toward clear regulations are in place, I am unlikely to invest directly in products. In unclear regulatory markets like psychedelics, it is often better to invest in the early media properties, or unregulated parts of the market very early (I have one of those).
Examples that Increase confidence in Regulatory:
No clear regulatory body
Clear lack of regulation of similar products
Many similar products in market without regulation.
Clear, inexpensive mature regulatory framework
Examples that Reduce confidence in Regulatory:
Regulatory “grey area”
Company success depends on regulators “looking the other way”
Growing trend toward regulation driven by existing bad actors
Existing, clear regulatory body
Many level of possible regulation (city, county, state, federal, etc.)
Immature regulatory framework subject to sudden shifts.
Politicians attention in market likely to cause knee-jerk regulation during black swan event.
1: Product clearly requires complicated, expensive regulatory approval. Like an FDA approved drug.
5: Regulatory framework unclear, but others are selling into the market, regulation may come but it has not yet and profits could be made before regulation comes. Like early stem cell therapy, Hemp products, supplements. No clear regulatory body yet.
10: No obvious regulatory hurdles on the horizon. Facebook and Microsoft early. Many companies selling unregulated products into markets, or completely new product in new market.
Terms. What are the terms of the deal. This includes price, pro rata rights, share class, co-investors, is the deal “hot”, and more. I recently found a company with an 8 management team, a 10 product, 10 market and 8 regulatory but the terms were 2. The company was based in Canada (where Americans have problems owning shares), they were selling common shares without any pro rata rights, no top tier investors (all retail) and was over priced relative to traction and comps. If the terms had been 8 or above I would have likely invested $500K. With crappy terms, I invested $50K.
At every point in the life cycle of a company investors should expect higher returns for higher risk and this should be reflected in the terms. In poker this is called “pot odds”. What is the expected return for the capital I am putting in versus the odds of that return? If I have a 20% chance of winning and I am getting more than 5:1 on my money (basically the return odds outweigh the win odds) I should make the bet even with low odds of winning because the implied return will be worth it. In the very early stages, pre-seed, seed, you should have a very high confidence of a 10x or better return. At $100M valuation, with a-lot of risk washed out of the business, you should expect a 2-3x return. The terms should reflect the risk/reward gamble you are taking.
I put co-investors into the terms section. If they have already committed to the terms of the round. If I am following other smart investors who have approved the terms, it increases my confidence that the terms are fair and appropriate. I also check the “smart” investors check size against their bank roll. A common tactic of unscrupulous companies is to name drop smart investors with “undisclosed” investment sizes. Active investors may write small checks just for laughs and may hot have really engaged in diligence or verifying the terms. I looked at a deal once that was touting Peter Thiel as an investor (he put in $250K). The size was so small relative to Thiel’s bankroll that it didn’t improve my confidence in the deal that much (but I am sure other investors were swayed).
Positive investor terms include low valuation versus comparable stage companies, low valuation versus mature companies, pro rata rights, preferred shares, capped notes, interest on notes, redemption rights, voting rights, top tier, smart co-investors and a trusted partner doing diligence.
Negative investor terms include common shares, high valuation relative to comps, a “hot” deal where you are pressured to decide quickly, uncapped notes, and lackluster co-investors.
Examples that Increase confidence in Terms:
Terms approved by credible co-investors who performed significant diligence.
Pro Rata rights
Valuation at a discount to comparable stage companies recently
Limited investment allocation due to oversubscription of Terms
Pari Pasu preferences (for early investors)
Minority blocking rights
Weighted anti dilution
Revenue traction implying low multiple vs public comps
Examples that Decrease confidence in Terms:
Lack of Tier 1 co-investors
Premium valuation to comparable stage companies
lack of pro rata rights
Stacked preferences (last money in, first money out)
No minority voting rights
Ratchet on later rounds without weighted anti dilution
Revenue traction implies high multiple vs public comps.
1: Small investment into a late stage company trading at a premium to public comps. I actually saw one of those on Angel list from a top syndicate.
5: Reasonable valuation relative to stage and traction, without pro rata rights and few followable co-investors.
10: Sub $10M valuation, preferred shares, pro rata rights for company with >$1M revenue growing > 100% a year, profitable with amazing co-investors. I have actually done a handful of these terms.
So there it is, my high level framework for making Angel Investments. This is by no means exhaustive, but it is directional. The key is to quickly assess the 5 risk areas and determine a confidence level that the investment can deliver a 10X return within 5 years. If > 40 (80%), I write the check.
This is a question that I get multiple times a week talking to CEOs of startups. Having raised over $500M for my own startups and invested in over 100, here is my best advice.
Decide the two or three most important measurable questions your company has to answer in the next 12 months, calculate a budget to get those answers. Double that amount. That is how much you should raise.
The #1 question every start up must answer is “Is this a good business?”. This high level question has many subcomponents which must be answered methodically. Lack of a method, distractions, in my experience, is the #1 reason for start up failure.
Startups are all opportunity, you can do anything you want, innovate all over the board. Except you can’t. You have limited capital. So you must decide what are the most important Next Right Actions to take given the limited resources. I spoke with a startup this morning who laid out 10 ways they could grow the company from $10,000/month to $100,000. That is too many. Investors don’t want to fund a fishing expedition. Lack of focus wastes time and money. I said pick two, budget them and get back to me.
Budgeting is also always a tricky thing. Maybe the two ideas you pick to grow don’t work. So you need extra money to pivot and try something else before you run out of money.
The other critical part is measurability. What are the EXACT KPI’s I am funding with this investment? Revenue growth? Downloads? COGS reduction? Which metrics are most important NOW to answer the top level question of “Is this a good business?” At each phase of the company, these questions are different. When you have a napkin and an idea the questions include: “Can I build a product?”, “Will anyone buy it?”, “Can I sell it profitably?”, “How much does it cost to get a customer?”. These are seed stage questions. If the answers to these are affirmative, the next questions include: “Can I scale customer acquisition profitably?”, “Is there a channel that can fuel growth?”, “What is the next level of cost reduction?”, etc. All of these questions must have measurable outcomes. Without measurement metrics, you don’t know if your investments are working or not. A fundable question is “Increase revenue from $10K/month to $100K/month within 6 months in my home market with a CAC/LTV > 1:3 and a gross margin > 70% with an investment of < $500k.” Compare this to “I want to raise $500K to try and increase revenue.” The first one is clear and can be answered within a funding window. The second one is a fishing expedition which has no end and is likely to fail.
In my experience, companies that have clear measurable questions they need to answer for the business within a funding window are the most successful.
Common fundraising errors I see:
#1 Not raising enough to answer meaningful questions. Funding the burn rate rather than making meaningful progress. Many early startups have rolling fundraising, taking small checks from whoever comes in the door. While this is easy money and can keep the lights on, it rarely is enough to answer the BIG questions and make progress on the fundamental questions.
#2 Lack of focus, chasing the shiny thing. Distractions which don’t make progress on the fundamental questions. Like considering foreign expansion too early. Or putting all your resources behind ONE BIG COMPANY MAKING DEAL.
#3 Expecting investors to grow your business. While many investors can be helpful, they do not and will not understand the business as well as management. Good investors will not compensate for bad management. As CEO you should pick the most helpful investors you can, but in the end execution stays on you.
“I am super stressed out about living on campus at college, I think I want to live off campus,” my daughter said as I picked up the Facetime call.
My neck got tight. Eyes narrowed. Child in danger, get ready to fight.
I pulled up the Next Right Action worksheet in my head and started through it. Pause. Let her talk. As she talked, I explored. Problem: How to switch from on-campus to off campus 10 days from start of semester. Finding apartments, getting room/board refund, roommates, etc…
“Don’t give me any of that Stoic bullshit, just listen to me.” she says.
Process interrupt. Error. Error. The problem was suddenly unclear. Maybe it was not solve the on/off campus tactical details. That problem would not be solved on a 15 minute Facetime call anyway. The acute problem was that she was stressed and needed some empathy and venting RIGHT NOW. After that she may be ready to move toward solving the on/off campus problem, but her FIRST problem was not THE problem.
So I listened. Put all problem solving on hold. Many times the best solution to a problem is to exit the problem solving loop at Explore and just be curious and listen.
After we both calmed down, we brainstormed a couple of things to explore to get more information to solve the on/off campus problem. We are going to talk again in a couple days. While THE problem of stress and venting was not 100% solved (she was still worried), it was reduced probably 70% and that is progress.
Remember Martin: Look for THE problem behind A problem.
For as long as I can remember, I have had goals. At the end of a goal (successful or not) the question is always the same: What now? For a long time, the answer was another goal. This has been a treadmill to nowhere. When I started asking the question of where do the goals come from, it became clear that it was my values. My values determined what goals I thought were important. For a very long time I was unconscious of my values. I now spend most of my time exploring values and the goals follow from that. This can be either an unconscious process or a conscious process. The fact is that values drive goals. You set goals based on what you value. Life becomes enjoyable and easy when goals come out of considered values. The goals don’t seem to be so much work anymore.
Step 1 is to wake up to the fact that values drive goals.
Step 2 is to become conscious of your values.
How to take step 2? Take step 1 first. There are good value exercises like this one, which can get you started. Consider a purpose statement with my handy dandy tool. Don’t worry about getting them all right the first time, it is a journey, a process not a goal. I have found it useful to keep a values document which lists my values and some animating principals that I review on a regular basis. Figure out what is missing, what may have changed, if I want to re-order any of them. The win is to understand, not to get it “right”. I have shared mine below.
Sumner Redstone died yesterday. The media called him a “fighter”. He said himself, “I like to win.” He won over $4B for himself. All that fighting and winning: still dead.
Yesterday I crushed the hillclimb on my bike ride and “won” the leader board. I felt elated by the win! Coming in the door my 5 year old was sitting on the toilet waiting for someone to wipe her. So much for winning.
Last week, I “won” an argument with my wife on the merits, but the distance between us noticeably widened for awhile.
In my experience, tactical “wins” tend to become hollow when inconsistent with the meta environment. The first company I took public added over $500M to my balance sheet. A couple years later I was divorced, alone in a huge house.
I no longer fight to “win”. I fight to understand.
My wife was not “wrong”, I didn’t understand how she came to a different conclusion that I did. In a second conversation that focused on understanding rather than the “win”, we figured out the stories and values behind our positions and found a way to bridge to understanding. We still have different views on many things because we are different people, but we don’t fight to convince each other, we fight to understand each other.
Yesterday I had to drive to the store and couldn’t find my keys. Of course, I used the Next Right Action worksheet to find them, but this note to myself is about a subset of the problem solving: the “call a friend” part. In this case, ask my wife, Jen. How to ask for help is a whole category of problems in itself and the key I have found is how the ask is made. Here are the hypotheses I formed for how to ask along with the Likely/Easy rankings.
“Do you have my keys?” (3,5)
“Have you seen my keys?” (5,5)
“You were the last person to use my truck, where are the keys?” (2,2)
“I can’t find my keys.” (8,9)
The first three press the urgency of finding the keys, but deliver some level of problem transference and responsibility to the person being asked for help. They could even be a trigger for offense. The last one also has urgency, but none of the transference or potential offense. It ask for help by stating my problem clearly and without blame or transference. I went with that.
Jen hadn’t seen my keys. I found them in the pocket of my pants yesterday. And avoided a fight. The fight wouldn’t have found the keys any faster.