Category Archives: Funding New Enterprises

Angel Resiliency during COVID-19

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Angel investing in the US has been remarkably resilient during COVID-19 as angels have adjusted to remote operations and actively sought new opportunities, as well as loyally supported their portfolio investments.

Angel investing showed the greatest growth in the number of deals done in the Fourth Quarter of 2020, according to On Grid Ventures analysis of Pitchbook/NCVA quarterly data.

Angel investing deals done grew 9% in the Fourth Quarter, while Seed and Early Stage, activity contracted -35% and -26%, respectively, and Late Stage increased 6%.

What’s going on?  I suspect Angels think like entrepreneurs, and see opportunity in times of extreme change.  Since they are basically accountable just to themselves (and, as some angels are quick to point out, their spouses!), they are freer to take risks as they seek opportunities. 

VC’s may have similar instincts, but are more heavily influenced by fund investment considerations and LPs.  Fundraising for some has been severely limited, and available funds were diverted to support troubled portfolio companies.  LP’s also tend to be far more conservative, and many lobbied their VC funds to cut back investing, and not make planned capital calls.

This is nothing new. It repeats the pattern from the Global Financial Crisis in 2009 when Angel investing grew 45%, while Early Stage and Later Stage VC contracted -35% and -21%, respectively.

  • Angel Resiliency During the 2009 Great Recession

When Should I Apply for Angel Funding?

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So you decided to apply to an angel network for funding.  When is the best time to apply?

Before you run out of money, of course.  But most startups these days have some flexibility given the low cost of lean design as well as funding from self, friends and family.

If you have a truly exceptional startup, or a truly exceptional track record, don’t wait, apply asap.  What is a truly exceptional startup?  As Justice Potter Stewart said in 1964, “I know it when I see it.”

If you are in the other 99.8% of startups, you should be more strategic about timing.

Some angel groups like to be the first outside funding source.  These favor earlier companies with lower valuations, and regularly lead rounds of $500k and up.  For them, the sooner you apply, the better.  Consider them as soon as you need funds beyond friends and family, and have a hint of demonstrable traction.  New York Angels is one of these groups.

For most all angel networks, better to try to wait until you have basic business traction, which I see as:
  1. A working product,
  2. Some revenue and market validation,
  3. Your co-founders are in place (e.g., “I’m looking for a co-founder with [insert skill]” is a red flag.)
It is also better to wait will you have some basic financing traction.  This means:
  1. You have a credible lead investor,
  2. You have at least $100-200k and 20% of your round committed,
  3. You have deal terms largely agreed by the lead and committed investors.

Yes, this is an chicken and egg problem. How do you get there without funding?  Wing it?  Sorry about the pun.  Here’s where being a scrappy entrepreneur is a plus.

Most companies that raise angel network funding successfully do so after they have some business and financing traction.  There are many more entrepreneurs seeking funding than there are early stage angels and VCs.  Supply and demand means that investors can wait, at least in most cases. Harvard Business School Alumni Angels is one large angel network that prefers companies with at least some basic business and financing traction, and most angel networks fall in this group.

Waiting and self-funding for more months than you’d like isn’t fun.  But it may save you time and money, and lead to more fun over the long haul.

Some additional suggestions as your move ahead:
  1. Focus first on angel groups and micro-VCs who could lead your round.
  2. If you do pitch before having a lead investor committed, be prepared for other investors to wait until you find a lead.
  3. Put forward your ask for funding amount and terms, and indicate that you are negotiable once you identify a lead.  [If you say that terms are “TBD and up to the lead” you risk coming across as clueless].
  4. Don’t be so greedy that spend too much time with a funding ask that is above the market, and you run out of money and never raise a dime.
  5. Never insist on a SAFE note with a serious angel.  They know that is so unfavorable to angels that it can easily be a worthless investment in at otherwise successful company.

Good luck!

 

The Facts on Deal Valuation and Structure

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Attention Entrepreneurs:  Investors at different stages have varied interests so you are likely to get different counsel from Big VCs, Big Accelerators, and other Big Shots.

I’ll keep this post brief and fact-based.  Early stage financing has supply and demand, and deal terms and valuation are determined by market factors.  When you determine valuation and deal structure for your company, consider the current data on Angel financing.

66% of Angel financings are done at a pre-money valuation of $4.5 million and under.60% of angel financing is done with Preferred Stock.

The source of this data is the Angel Capital Association’s new Angel Funders Report, dated August 2018 and released October 2018.  Drawn from 432 investment rounds in 2017 across 393 companies totaling $102 million invested.  Companies were located in 36 US States, Canada, and Israel.

So when you set your terms, the closer you can price your deal based on its merits relative to other angel deals getting funded, the faster your funding round will go, and the quicker you can get back to your business fundamentals.

Crash! NYC Angel/Seed Funding Down 25% in 2017

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2017 was a down year for angel/seed funding in NYC!  Despite the continued growth in NYC’s startup ecosystem, particularly from eager first-time entrepreneurs, the number of seed deal funded in 2017 declined to 235 from 328 in 2016, a decline of 28%, according to AlleyWatch.

 

 

 

 

 

 

Seed stage funding in NYC declined to $361 million in 2017, from $483 million in 2016, a decline of 25%.

While the data from other markets has not been assembled, I don’t expect NYC is an outlier:  2017 was the year of me-too startups, with companies piling on and overhyping areas like AI and Big Data.  Investors saw through the clutter to be more selective in 2017.  Median round size increased to $1.25 million, up 25% from $1 million, a sign that investors were more confident concentrating more money in fewer deals.

Top 15 New York-Based Venture Capital-Backed Exits 2012 – 2017

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The Top 15 New York-Based Venture Capital-Backed Exits 2012 – 2017

As the NY early stage and VC community grow, so do the number of larger exits.  From CB Insights, here are the top 17 NY VC-backed exits for the past five years, with Yext at number five with its April 13, 2017, IPO.

 

 

What I Look for in an Entrepreneur

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  1. Uncanny drive in a clear direction. Conviction.  
  2. Knows his/her companies secret sauce and guards it, grows it.
  3. Complete integrity.  His/her past decisions and actions should be evidence of this.
  4. Manages leanly.  Avoids waste.  Manages time and money well.
  5. Builds and inspires his/her village:  employees, investors, advisors
  6. Minimizes risk.  An entrepreneur is by definition comfortable with risk; but the best ones don’t seek risk, they seek to minimize risk
  7. Business ability.  There is no free lunch.  The usual qualities of successful business people are important:
    • Intelligence
    • Decision making skills; particularly knowing when its time to wait and assess, and time to decide and act
    • Organization and time management
    • Leadership; motivating and managing people
    • Education (of note, First Round reviewed their 10 year history, and found that their portfolio companies with one or more founders with a degree from an Ivy League School, Stanford, MIT, or Caltech, performed 220% better than other teams).
 Red flags
  1. A cavalier attitude to failure. Failure is not a virtue, despite what you might read or hear.  Failure has no inherent value and is the worst outcome for investors.  Of course, many monumental successes have been born out of failure — it can create time to think, learn, change, and be brilliant — but its what you do after a flop that counts.
  2. A lack of relevant experience and skills, especially when you don’t appreciate what you don’t know, and don’t build a “village” to compensate.

The Venture Capital One Pager

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From VC John Backus, here is the Venture Capital One Pager!  A great primer on how the various rounds of financing work together — at least according to the standard playbook.

Big Caveats:  There are other playbooks!  Like the “take no outside capital” playbook, and the “one round and done” playbook.

rosetta_table_original

More info here.

QSBS: The Death Knell for Convertible Notes in Early Stage Investing?

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no exit taxThe 2015 tax bill contains a giant incentive for early stage tech investors.  Investment gains on exit, subject to certain conditions, are now exempt from capital gains tax and the investment tax.  This means a reduction in federal tax from 23.8% to zero.  Congress apparently feels that early stage investing in tech businesses is an engine of growth for the US economy and US jobs, and removing the 23.8% tax on gains will be a net positive for the country.  This Qualified Small Business Stock (QSBS) tax treatment has been on and off again for years, but is now a permanent part of the tax code since the Protecting America from Tax Hikes Act of 2015 was passed in December 2015.

So, what’s the catch?

  1. The exemption applies only to the first $10 million of gain
  2. The stock must be held for at least five years (most successful angel exits take longer than 5 years)
  3. The stock must be purchased after September 27, 2010 directly from the company
  4. The stock must be in a C Corporation
  5. The stock must be, well, stock. (It cannot be a convertible note!)

The company must be a qualified small business, as defined by Section 1202.  Some requirements are that it have gross assets of under $50 million, and not be in any traditional business categories like a local restaurant, motel, bank, farm, or doctor’s office.

Consult your tax adviser for more information, of course, but by making this tax incentive permanent, early stage investors and entrepreneur’s have a shared and vested stake in working to make sure their investment structure takes advantage of this, as well as aiming for big gains on an exit after 5 years.

Many angel groups and sophisticated angel investors avoid convertible notes and SAFEs since they typically do not afford the protections and advantages of investments in preferred stock.  This new legislation adds a considerable advantage to equity investment – the prospect of tax free gains on exit.

To begin to get equivalence for investors, the typical “discount” in a convertible note would need to increase from 20% to more than 40%.  And that just might be the death knell for convertible notes in early stage investing.

For more information, see Alan Patricof’s column for TechCrunch, this Forbes article from Lowenstein Sandler, or wealthfront.  The Angels Capital Association has posted a very comprehensive 9 page memo on the details of how to qualify for Section 1202 from accountants Godfrey & Kahn written for Golden Angels.  And VC Fred Wilson of Union Square Ventures has a well-reasoned post here “Unsafe Notes” explaining why convertible and SAFE notes are not in the best interest of founders.

Seed & Early Stage Returns Dominate VC Returns

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Why invest in seed and early stage companies, with all the risk of picking winners early, and dilution down the road?  Because that’s where the money is, according to Cambridge Associates.  Seed and early stage investments have accounted for 75% of VC investment gains in recent years!  This is based on the top 100 investments in every year.  Seed and early stage investments have accounted for two-thirds or more of investment gains in every year where data is available.

 

seed returns

 

Winning

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Winning.

A path to market leadership.   I look for this in every investment I make.

“It’s a big industry…there will be many players…we just need a x% slice and we will be a success.”  What b.s.   That a prescription to be one of the 9 in 10 early stage companies that fail and fail soon.

A great idea is the first step, but  there are lots of smart people out there and their attention is often focused on the same problems at around the same time.  At the dawn of search, there was Infoseek, Alta Vista, Dogpile, Excite, Lycos and others.  Now google dominates.  When it comes to profitability, the winner takes it all, and the runner ups are burning cash trying to catch up.

number one“Winning isn’t everything; it’s the only thing.”  So said Vince Lombardi.*

Information and intelligence can spread like wildfire. Network effects are an accelerant.  The biggest network quickly becomes the most useful and shortly the only one needed.  Market share and profitability correlate.  The premium to being #1 is increasing all the time.

Sure, there exceptions, like when the relevant market is just your local neighborhood, and there is a dry cleaner on every block.  But the most attractive markets are national and global.

 

What does this mean to an early stage investor?  That is a full topic for another day, but I’d rather hear “We want to be #1 and here’s how” instead of seeing an entrepreneur wave a giant red flag with “We just need our share.”

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*And UCLA’s Red Sanders…read “What it takes to be Number One” if you are interested.