Wednesday, October 30, 2013

Angels Take the Field! Did the 1918 World Series Create Our Angel Groups?

We consider it self-evident that the towns that produce the best baseball teams are those with the most active Angel groups.  Consider the current World Series in light of recent HALO reports on Angel Activity. In 2012 the St. Louis Arch Angels investing group was lauded as one of the most active in the region. In Q1 2013 they were recognized as one of the most active in the entire country.

In Q2, 2013, New England Angels edged out California in the total dollars invested during the quarter, with the Launchpad Venture Group  remaining a perennial top performer.

So naturally, it is the St. Louis Cardinals vs. the Boston Red Sox in this year's  World Series.

It’s time to warm up. Angels take the field, entrepreneurs to the bullpen, while I retell the tale of how we  became “Angels.”

Back in the mid-1970s, at the University of New Hampshire, Bill (Prof. William) Wetzel was researching how new companies raised startup funds.  His studies uncovered a new class of investor:  high net worth self-made individuals who were willing to take greater risks or accept lesser returns than others. More importantly, these investors provided more than money; they provided the benefit of their experience, which was often of more value than the amount of money they could invest.  A typical investor would develop a portfolio of four or five companies, typically located within a day’s drive of his home.

But what to call these patrons?  It occurred to Wetzel that these investors had much in common with the legendary “angels” of Broadway, who supported young artists out of a sincere interest in promoting the careers of talented people.

Thus Wetzel began to call his business investors “angels.”  “We didn’t originate the term, we stole it from Broadway,” he says.  Then along came Inc. Magazine, where the term first appeared in print in an article, “The Truth about Angels, More Than a Myth.”  Thus did we become angels, are angels, and most likely will be called angels in the future, as the term becomes even more institutionalized  in the names of many angel groups and in internationally recognized  trade groups, such as our Angel Capital Association.

Epilog: How art thou fallen from heaven, O Lucifer, son of the morning! Isaiah 14:12

Most Broadway angels have faded from memory, but here in the Northeast the fame, or rather notoriety, of one particular super-angel may serve us as a cautionary tale.

Handsome Harry Frazee, a well-known Broadway angel, added the Boston Red Sox to his portfolio in 1916. The team, which won the World Series in 1918, was stocked with great players, including a young pitcher/hitter named Babe Ruth.

But by 1920 Frazee’s finances were depleted, so he sold Babe Ruth to the New York Yankees for $125,000 in cash and a $300,000 mortgage on Fenway Park.  No trade, just cash. In rapid order, Frazee, who had purchased the Red Sox for $500,000, sold and traded additional players for at least $155,000. In 1923 he sold the team, now the worst team in baseball.

With money from the Ruth sale, Frazee backed several Broadway plays, one of which, when rewritten as a musical comedy, became “No No Nanette,” the biggest hit of the era. Once again Frazee was wealthy, but in the minds of my parents and grandparents generation, he became the most despised man in Boston history. RIP Harry Frazee, reputed drunkard and letcher (we said they didn't like him). 

So what Had Frazee become? He had bought a great team, sold off the assets, destroyed the hopes of millions of fans young and old, while enriching only himself. Had he passed in rapid succession through angel investing into venture capital and straight on to private equity? They say that just because a vegetarian starts eating meat doesn’t mean he has to go all the way to cannibalism.   All we know for certain is that from 1920 onwards, Harry Frazee was most assuredly   Ruth-Less.

The Red Sox didn’t win another World Series for 86 years, a drought often called “The Curse of the Bambino. They also haven’t won another world series at home since 1918, although they have two chances to do so starting tonight.

Epilogue.  For the first time in 95 years, the Boston Red Sox won the World Series at home, defeating the St. Louis Cardinals 6-1 at Fenway Park in the sixth and final game of the 2013 series. Reversing the memory of the Frazee years, the Red Sox had climbed from  the basement of the American League East to the World Championship in just one year.

Subscribe to the Angel Investing News

Monday, October 28, 2013

Are Increasingly Active Corporate VCs Good Partners For Angels? Q3 2013 Corporate Venture Capital Report published today.

Angels looking for expansion capital for their deals might be well advised to look to Corporate Venture Funds (CVC) according to the Q3 2013 Corporate Venture Capital Report published today by CBInsights.

With limited partners continuing to reduce their investments in traditional VC funds, the large balance sheets of corporate investors are becoming increasingly important in the VC ecosystem. In Q3, CVCs participated in deals that represented just under 30% of overall VC funding. And while corporate VCs typically invest in later stage deals, many of them have worked with angel groups in the past.

Of the most active CVCs shown in the chart below, our local group, the eCoast Angels, has invested alongside Intel Capital and Motorola. James Geshwiler of the Common Angels says they have invested with several of these CVCs, Google Ventures and Intel Capital, as well as Salesforce and Autodesk. Chrstopher  Mirabile at Launchpad Venture Group cites Google Ventures and Intel (and perhaps In-Q-Tel  in the past).

Some highlights from the report.

Google Ventures tops the list of most active CVC investors in U.S.-based companies in Q3’13, followed by Intel Capital, Samsung Ventures and SAP Ventures. Only two healthcare CVCs, Johnson & Johnson Development Corp. and GlaxoSmithKline’s SR One were among the top 10 most active.

The average deal size with CVC participation rose yet again in Q3’13 to hit $17.0M on average. The deal size gap versus overall VC averages in Q3’13 was the widest in five quarters, highlighting the concentration of CVC funding at the mid and later stages and strong balance sheets of corporate venture investors.

New York’s share of corporate venture deals topped Mass. for the first time in five quarters. But despite more deals, NY’s share of CVC funding fell to just 7% - a five-quarter low.

Despite early stage (Seed, Series A) CVC deal share increasing from Q2’13, CVC funding share at the early stage matched a five-quarter low at a combined 9%. A whopping 81% of CVC funding went to mid and later stage (Series C+) funding rounds.

The number of CVCs actively investing remained consistent with Q2’13 levels. But compared to Q4’11, the number of CVCs in the market has jumped 29%.

The most active CVCs in Q3 have also recorded the most exits (M&A and IPO) in the first three quarters of 2013. Intel Capital leads CVCs based on total exits by U.S.-based portfolio companies, followed by Google Ventures and a three-way tie for the #3 spot between SAP Ventures, Samsung Ventures and Mitsui Ventures.

The top 3 mobile & telecom CVC deals took 70% of Q3 mobile CVC funding, which more than doubled Q2’13’s funding amount and marked the highest quarterly total since the start of 2012. On a year-over-year and sequential basis, mobile CVC deals increased 68% and 39%, respectively.

CVC investment in healthcare hit a five quarter low in Q3’13. Compared to Q2’13, deals and funding in the quarter declined by 41% and 27% respectively. Deals and funding were also down on a YoY basis.

Clean Tech saw under 10 deals with participation from Corporate VCs for the third quarter in a row. Funding levels were anemic in Q3’13, dropping below $100M for the second time in five quarters. 

For the first time since Q2’12, California saw CVC funding cross the $1B mark behind a surge in mobile funding.

Many of the observations above are illustrated in the published report, which contains more than 50 pages of geographic, industry and funding round stage breakdowns.

 Most Active CVCs

Thursday, October 24, 2013

My Own Strategy: Fabrice Grinda on Angel Investing

They say that whenever two Angel Investors team up, there are at least three investment strategies in play.  Here at the AI News, we hope to entice a few well known angels to share their strategies.  The post below is by Fabrice Grinda.

I was reading The Checklist Manifesto by Atul Gawande which shows the efficacy of checklists in complex situations. It resonated with me, because Jose & I use a checklist as part of our angel investing strategy. The checklist does not lead to an invest / don’t invest answer, but it helps us make sure we cover all the bases and keeps us grounded. It’s especially useful when we encounter very eloquent founders or products we love, which tempt us to be less disciplined. 

I alluded to the checklist in my last angel investing blog post, And then there were a 100…, but here it is more explicitly:
  • Is the product live?
  • Are the unit economics attractive?
  • Do we like the market?
  • Do we like the team?
  • Do we like the deal terms?
The thinking behind the heuristics
You might argue that as early stage seed investors we should be willing to invest in pre-product companies. However, it’s so inexpensive and easy to launch a site these days, that if someone can’t get the site out of the door with $50-100k of love money, it speaks negatively of their ability to execute leanly and convince others to join them. It also makes us question their ability to raise money if they can’t even get love money from fools, friends and family. 

With regards to unit economics, we don’t expect the business to be large and successful. They would not need angel money otherwise. $10k / month in revenues are enough. We don’t expect the business to cover its fixed costs, but we want to make sure the business is profitable on a unit economic level. We typically invest in a company if the net contribution margin per customer over a 12 month period is 2x greater than the customer acquisition cost. We also want to see that the customer acquisition channel can scale. For instance we want to see that there is enough volume in the keywords the company buys such that it can increase its marketing budget from $1k / month to $30k / month without needing to increase the CPCs. There are counter examples of massive businesses that did not have business models or unit economics for a long time and figured it out later when they got to scale. Google, Facebook and Twitter notably come to mind, but it’s a much riskier approach.

Note that our requirement of unit economics does not mean we expect to see financial projections from startups. When a plan meets reality, reality wins every time! Startup financial projections are not worth the paper they are written on. However, if founders know how much money they are making per customer and know how much each customer costs them, they should have a good sense of where they can be in 12 months with a $500k – $1 million seed investment.

Attractive unit economics are not enough. It’s possible that the business has attractive economics in a small market and is more suited to being a lifestyle business than a venture funded business. We use our 9 business selection criteria to evaluate the market. 

What makes for a great team varies based on the category. As we focus on consumer facing businesses we come across many super smart product driven founders – which we love. It’s also not enough. In consumer facing businesses, it’s essential to have a viable customer acquisition strategy. Of late, we have been disappointed by the lack of business savvy of otherwise super smart, product centric founders. This is especially true of Y Combinator founders, who also have a tendency to be very arrogant. This is unbecoming given how early all their businesses are. In startups so much of the success comes from rapid iteration, entrepreneurs need to be accept that they don’t typically have the definite answer and that they will figure it out through execution.

With regards to terms, we are price sensitive. 99% of startups sell for less than $30 million, many for less than $10 million. Entrepreneurs think that raising money at a high valuation or with a high cap is a badge of honor, but raising money at a high valuation prices you out of exits and makes it harder to raise follow-on capital. There is so much frothiness in the seed market today that it’s not uncommon to see startups raising on convertible notes with $5-10 million caps. Given the Series A crunch and the difficulty of raising follow-on money, we are seeing startups with $5 million in revenues raising at $5-10 million pre. As a result if we deem the seed valuation too high, we just wait for the Series A. 

We also expect all the terms to be fair, not just the cap on the note. For instance if the company sells before the note converts we expect to get the greater of whatever our equity stake would had been if the note converted or a multiple on our investment, not just our money back. After all we are equity investors, not debt investors. We use notes only because they are cheaper and easier to setup. 

Why this approach works for us
I would actually not be using this strategy if I was running a $200 million venture fund based in Silicon Valley. As Peter Thiel points out in his venture class, venture returns follow a power law distribution (read Blake Masters Class 7 notes for more details). A VC portfolio makes money if the best company ends up being worth more than the whole fund. In this type of environment it makes sense to come up with convictions about companies that can be bring 10x returns and not worry too much about what the entry valuation is or whether they already have unit economics. Such a fund does not need to worry about minimizing losses from bad investments, it’s all about finding THE investment that will make the fund.

As I previously mentioned, with our heuristics we would not have invested in Facebook, Pinterest or Twitter. But it’s also important to note we did not have the opportunity to seed invest in them either. There are plenty of great companies coming out of New York, London, and around the world, but if you look at the Internet companies that created most of the value ($10+ billion exits), they are highly concentrated in Silicon Valley. I choose to live in New York for a combination of personal and professional reasons and Jose lives in London. As a result we don’t see the best Valley deals. If we wanted to be professional angels or venture capitalists, we would move to the Valley. We don’t intend to do that and thus leave the best companies to Y Combinator, Ron Conway, Jeff Clavier, Mike Maples, Founders Fund, Sequoia and the like.

Given we don’t expect to be able to invest in the next Facebook, Google or Linkedin, we came up with an approach that makes it probable for us to get 3-5x returns on most deals while minimizing our downside. That’s why of the 30 exits I had in my angel portfolio (which don’t include the companies I created or incubated), I made money on 17 and lost money on 13 – a 57% success rate. I made money on many of the exits that were below $10 million and even several below $5 million. I also managed to recoup part of my investment on most of the 13 companies that I lost money on. Overall for these 30 companies, I invested around $2 million and recouped around $10 million with a 62% IRR.

That’s not to say we don’t have stellar performers in our portfolio – I made 31x on one of my investments, but even that standout performance only accounted for 15% of my overall returns. Admittedly our approach is suited for the limited amount of capital we deploy and would not work if we had to invest significantly more capital. However, as we don’t want to be professional investors, it serves our purposes. It allows us to support many entrepreneurs, while keeping our fingers on the pulse of the market.

For many entrepreneurs, especially first time entrepreneurs, our approach works as it increases the probability that they make money on an exit. On top of that we don’t join boards or have reporting requirements. We decide rapidly whether to invest or not and give direct and honest feedback. We also bring expertise on how to maximize unit economics: long tail dynamic bidding on keywords, purchase funnel optimizations, liquidity building strategies in two-sided marketplaces, etc.

It’s probably worth pointing out that the heuristics and strategy are not set in stone. We adapt to changing market circumstances. I will publish a post in early 2014 detailing how we modified our strategy in 2013 because of the dual impact of seed stage frothiness and the Series A crunch. However, even when we change the approach we keep using a checklist to add rigor our thinking. This might reflect my Cartesian way of looking at the world or assuage the need of my inner economist / management consultant for frameworks and models, but it seems to work. 


The post above appeared originally in Fabrice Grinda's blog, Musings of an Entrepreneur, under the title "Why We Play Moneyball Rather than Powerball."   He describes himself as an Internet entrepreneur, angel investor, student and lover of life, aspiring Renaissance man and co-founder of OLX, one of the largest free classifieds sites in the world. He currently lives in New York.

Subscribe to the Angel Investing News