Miles To Go.

The Social Network is a hell of a movie, but the real people upon whom the characters were based have stated that the film’s version of the founding and growth of Facebook was overly dramatized. And appeared way more fun than it actually was.

Face it, entrepreneurship is hard. Angel investing is doubly hard. While we read about spectacular successes, one can hardly keep up with the many outright failures preceding them. The thin veil  can really only be perceived once you are on the right side of it-it’s practically see through! But if you are on the wrong side, the thin veil might as well be a brick wall.

Someone once said the two best traits an angel investor can possess are a strong stomach and a sense of humor. The strong stomach will tolerate its share of quick deaths from being too early, too late, poor execution or leadership, lack of funds, or just tons of competition. The sense of humor will come into play when you attempt to tell your God which element of your portfolio is going to be The Big One. God will invariably laugh and throw at least one thunderbolt, wreaking havoc with your “sure thing” — but turning your also-ran into a winner. (No kidding, it’s happened. But to protect the innocent, we won’t name those we feel were luckier than they were skilled.)

Other sources of angel heartburn include those frustrating periods of illiquidity…the fast pace of technology which upends business models and proprietary positions quicker than at any time in history… the global markets bringing competition to one’s door on a massive scale… the high valuations of exposed deals,…the lack of influence when part of a syndicate…the competition with other angels (and now, VC’s). The list goes on.

The angel game can be summed up in the words of the “advert” placed by explorer Ernest Shackleton (1874-1922) ahead of his Antarctic expeditions (none of them successful, by the way):

“MEN WANTED FOR HAZARDOUS JOURNEY.

SMALL WAGES, BITTER COLD, LONG MONTHS OF COMPLETE DARKNESS.

CONSTANT DANGER, SAFE RETURN DOUBTFUL.

HONOR AND RECOGNITION IN CASE OF SUCCESS.”

And yet, we do it.

EO: Great Group of Entrepreneurs

This excerpt is serialized from a whitepaper titled Angel Investing for Single Family Offices (SFO’s) by The Family Office Association and Vaux les Ventures. For a complete copy, visit the FOA website. 

Any SFO considering allocating a portion of their assets in venture toward angel investing has to acknowledge the significant risks in the market. One sobering take from the US Small Business Association is that roughly 80% of small businesses fail in the first year, 10% in the second and 5% in the third, leaving a paltry 5% of new ventures that even qualifies to deliver a return for investors. I am a member of EO (logo at left), a global organization with 8,000+ members that fosters entrepreneurs, and the odds are just slightly better there I think.

Sticking with the digital media businesses discussed in the last section, here’s a brief summary of the early stage venture risks associated with this sector:

Operational Risks are legion in startups. First out of the gate is execution on the development of the product. Many products and services simply fail to launch, whether due to poor specs, loose design
concepts, or from just plain misjudging a market need. Another common problem is never solving the cold start challenge and acquiring users. Assembling talent, accessing sufficient capital, maintaining differentiating advantages over competitors, and a go-to-market strategy are a few more risks to consider.

Timing Risk — also referred to as Luck. Often, an entrepreneur’s vision has merit, but market conditions have not yet gelled to support it. Frequently, capital is wasted on development and/or marketing in
anticipation of a developing market. When the tide doesn’t rise in time, the company is left high and dry. One example? The many mobile/ social networks that tried to deliver hyper-local advertising audience and failed. In the meantime, Gowalla and FourSquare entered the market just as mobile and social converged, and were propelled to higher and higher market caps. Likewise, any mobile/social solution launched now with similar attributes would be too late and face heated competition.

Funding Risk can be mitigated by an SFO in the early stages of the company, but in our digital media example, additional capital will be needed — or at least easy to acquire –in order to scale the business. A good example of funding risk affecting returns would be the inability for mobile ad networks/ platforms to raise capital before mobile was “proven” viable (see AdMob’s sale to Google and Quattro’s sale to Apple within a 6 week period). Before those landmark deals, funding sources constantly questioned whether there was a “real” market in mobile, citing the struggling networks who hadn’t succeeded, despite $250,000,000 of combined capital. Several early stage companies faltered for lack of capital, and several other investors suffered dilution from large downdrafts in valuations. An SFO can, of course, prolong the agony by continuing to fund (Fred Wilson’s famous quote here is “I have a 0% mortality rate- I just keep funding!”) but the effect on returns when others do NOT fund, or fund at lower prices, is undeniable.

So, if you are considering angel investing with your SFO be sure to match the risks with the rewards. There are more of the former than the latter!

 For a complete copy of the complete paper, visit the FOA website. 

Shields up!

This excerpt is serialized from a whitepaper titled Angel Investing for Single Family Offices (SFO’s) by The Family Office Association and Vaux les Ventures. For a complete copy, visit the FOA website.

I am often asked how I have dealt with risk as an entrepreneur and now more often as an angel investor. Short answer is I have just become accustomed to it, and at least always know when it’s there. Here are a few risks that both angels and entrepreneurs should consider:

Structural Risk must also be considered before making angel-type investments. While there are several angels who’ve become well known with their “spray and pray” philosophy, diversity won’t save an investor if the structure of the investments isn’t optimized. Unless the criteria are to be entirely passive and devoid of value-add to the company, then an SFO might consider putting some basic protective structures in place. These can be as simple as board and information rights for the SFO or one of its angel partners; basic protective provisions in the stock purchase agreement or reasonable valuations that still leave room in the cap table for another, larger investor later on.

Super-long hold periods are a recent – and generally unwelcome — development in the angel market. These are primarily a result of the moribund IPO market in the tech market over the last few years, as well as VC’s managing billions of dollars in committed funds. As a result, most companies are being forced into “hold” periods that can last 7-10 years — without liquidity. The VC’s have a vested interest in funding the company for a bigger exit (as they’re paid in part based on the amount of funds they manage). Entrepreneurs and angels are on the other side of this argument, as many have committed their lives, livelihood, and capital, and continue to risk significant portions of their net worth (in the entrepreneur’s case) and investable assets for the sector (for the angels) over an entire decade of risk exposure. The pressure has begun to release in the form of secondary funds like Second Market and Millennium Technology ventures, which purchase founder and angel shares far before the respective VC would consider doing so.

There are so many risks to being a start up, and those risks can be compounded (and/or mitigated) through how you go about angel investing.

Best rule of all: go in with eyes open!

Not exactly the deal honeybadger

This excerpt is serialized from a whitepaper by The Family Office Association and Vaux les Ventures.  For a complete copy, visit the FOA website.

I am often asked- by both entrepreneurs and angels- about where the best places to find superior deals and superior angels. Well, your hang out Group will determine Your Structure (for better or worse). One of the most important – yet frequently overlooked – elements of angel investing is how an SFO or angel arrives at terms for investing in a company. How you source and who you associate with will dramatically affect how successful your investment might be, regardless of how well the company does.

I’ve always trised to keep an open mind as to where ideas come from, and avoid getting locked into all the same sources.

On this point, here are some things to consider:

EIR Program- “create your own deal” is the scenario in which an SFO has the greatest control over terms. They literally dictate. While this seems ideal for an investor, it does leave out of the equation market forces, setting up surprises if outside financing is ever sought. The venture landscape is littered with rejected companies whose cap tables and governances were reflective of a controlled situation — that don’t fit into real-life market conditions.

Angel Networks drive a unique dynamic in funding companies, often referred to as “herding cats,” a/k/a the Syndicate from H*LL. Companies on the prowl for more investors than they can naturally attract will show up at any number of angel networks. They often pay a premium to present to “qualified investors”, and even endure a vetting process to get into the room. But once they present, something troubling occurs: many of these angel investors don’t have the resources or the confidence to take down the entire round themselves. And so, the company attempts to set the valuation and the terms of the placement. The results are often disastrous, with unwieldy expectations and no one investor to keep them in check. The typical result, especially in a frothy market, is that the angels do deals with terms that are not negotiated with any sort of leverage, and no hopes of control or influence on the future of the company. While some companies do get funded this way, and some angels actually emerge with decent returns, the odds are stacked against it.

The Angel Alliance [or, “Buddy Deal”] there’s one significant advantage to a small group with the resources to do an entire round: leverage. If an SFO is fortunate enough to align itself with a group capable of filling every round, it offers the entrepreneur a solid financial partner that allows them to focus on growing the business. This typically results in enough equity for the angel group to share some with the member stewarding the deal, and still leave room for attractive valuations and reasonable governance structures. If the economics aren’t there, most groups have the benefit of enough deal flow to move on to the next opportunity in the sector (as opposed to the EIR), while still maintaining their leverage.

So, while many angels are wondering how they arrive at better terms on more interesting deals, what they sometimes fail to realize is if they look in all the same places, they are likely to see all the same deals, and all the same types of structure.

Said another way: get out more often!

For a complete copy, visit the FOA website.

Hobbes said it: Nasty, brutish and short.

This excerpt is serialized from a whitepaper titled Angel Investing for Single Family Offices (SFO’s) by The Family Office Association and Vaux les Ventures. Those looking for tales of my latest death defying adventure may find it extremely boring. Entrepreneurs looking for angel, or vice versa, may find it shockingly illuminating.  For a complete copy, visit the FOA website. 

People often ask why I have gravitated to digital media. Point number one might be I have been doing it long enough I have seen enough ways to fail that I might know how to succeed- by process of elimination. But Digital is efficient and Angel investing works best with capital- efficient businesses, where startup costs are minimal but exits are still attractive.

• For example, Manufacturing is tough to justify, as the capital investment is significant, the likelihood of finding other capital sources is remote and the necessity of leverage is likely if the business grows. Likewise, the exit multiples are generally based on historical earnings power and don’t command hefty multiples.
• Conversely, Digital Media has many of the attributes SFOs find attractive for angel investing. Here’s some of what drives leaders like Facebook and Groupon:
• They sprout from vibrant eco-systems that help solve the “cold start” problem and give quick scale without huge capital requirements.
• They leverage the power of the social network and the mobile phenomena that symbiotically drive adoption and always-on usage.
• They enjoy lower development costs as the recession and web 2.0 has enabled developers to launch “minimally viable products” for a fraction of the cost of many launches from even five years ago.
• Likewise, go-to-market costs are dramatically lower than five years ago, a result of the leverage of the global affect of social and mobile media.
• Younger entrepreneurs are starting many of these businesses, bypassing the carrying costs of their more established brethren. “Ramen noodles and peanut butter” have a certain appeal for first time entrepreneurs unburdened with mortgages, tuitions and families to support.
• Digital media businesses typically have global potential for an audience from day one, without the costs of setting up operations in multiple time zones. This is especially true with mobile applications and solutions.
• The jumps from Angel valuations to Series A and even exits are significant for those enterprises that execute well.

Factors like these have generated a significant uptick in interest in digital media companies, but consider a few more facts. Those that succeed usually do so dramatically; those that don’t die in equally dramatic fashion. But, because of the dynamics in the market, one success in the portfolio should pay for more than a handful of total failures, and still leave plenty of return.

Downside of all this is: it’s no secret. Plenty of guys coming to compete in this market. Game on.

Cool geometry pic

This excerpt is serialized from a whitepaper titled Angel Investing for Single Family Offices by The Family Office Association and Vaux les Ventures. Those looking for tales of my latest death defying adventure may find it extremely boring. Entrepreneurs looking for angel, or vice versa, may find it shockingly illuminating. I’m cool either way. For a complete copy, visit the FOA website.

The most popular question I am asked as an angel is what forces in the universe do you look for when you invest? That answer has been steady for years now, a side benefit of being specifically vague.

I call it the Golden triangle of start ups: 1) ideas that solve big problems, 2) killer teams, 3) access to resources. And there is an important inflection point as well: financial-able entrepreneurs who’ve just begun to look for capital, and market -changing ideas that have just begun to gel. Catching entrepreneurs at that moment in time, and bringing in a small group that can add value through operational and leadership experience, can secure reasonable valuations and governance, adequate influence and information rights, and enough quality looks to generate a diversified angel portfolio for SFOs.

 Seems like a pretty simple formula. But matching them all up, and matching the market timing and execution on product is easier said than done. The best answer: have more than one hanging around at a time. Walk and chew gum at the same time is my favorite phrase.

 For a complete copy of the entire white paper, visit the FOA website.

Word to today’s angel: you won’t likely create it in house, so Network or Die.

The dot.com mantra still applies today, and even more so. Being able to access timely and quality deal flow before it is over-exposed is a crucial skill. It is one thing to take a flier on the next young faced entrepreneur who will take on Facebook. It is quite another to take a flier on Zuckerberg on the next Facebook! But the networking doesn’t end there: being able to access additional capital to fund the growth stages of a business requires excellent relation with the VC’s mentioned above. A successful round of $1,000,000 of angel will still likely require $10,000,000 or more of capital to get to exit.

“You know, you really don’t need a forensic team to get to the bottom of this… If you were the inventors of Facebook, you would have invented Facebook.” So said Mark Zuckerberg’s character in the movie The Social Network.

 As funny as that comment was, it contains a stark truth: Doing it yourself poses incredibly long odds. There are many Entrepreneurs who are incredibly creative people, driven by ideas they think will change the world. Few of them actually do so. Most SFO’s have accessed these opportunities through venture. But now is the time to seriously consider how that’s panned out. Take a look at the returns- they’re probably negative. Calculate the fees you’ve paid for the privilege of those returns. Then take a look at what you as an SFO have actually learned about entrepreneurship in this case. Are there relationships you’ve benefited from or will benefit from in the future?

Conversely, did you do any direct investing in that period? Even if you washed out there, you saved fees, you take away real direct relationships with entrepreneurs who then go on to start Linkedin out of the ashes, and you’ve had a direct line the CEO and built experience with the next generation. If you’ve continued to allocate, you are set up for huge returns on the way back up.

No doubt, an SFO looking to adjust their strategy in venture to include angel investing will be placing bets on these mercurial persons and their visions. The majority of them will flame out, and the slim numbers that do build viable business still present the SFO with a host of risks that will affect the investment outcome, no matter the business’ fate.

For a complete copy of the whitepaper, visit the FOA website.