Note: A version of this post appeared in my semi-regular column on AlleyWatch.
I was judging a speed pitch competition the other night to recruit startups for DreamIt NY’s summer accelerator program when it happened.
After a series of crisp (and not so crisp) one minute pitches, I opened the floor to walk-ins. The last guy to raise his hand stepped up. He began with, “This is just an idea I have.” I smiled a little more broadly and mentally wrote off the next minute of my life.
As it turned out, he had strong domain expertise in a large market with a real problem that was still horribly backward and the problem was amenable to automation. While we do not fund cocktail napkins, it was something that I thought worth his exploring, and was actually looking forward to him coming up to me afterwards for feedback.
When he approached me for advice, he launched into an all too familiar litany that I call, “I need before.”
Him: I need funding before I can build my solution.
Me: Investors generally won’t pay you to build your alpha, but you can start by getting your ideas onto paper by wireframing how you think your solution will work. It will be all wrong, but it will be enough for you to take to potential tech cofounders to begin the discussion.
Him: I need funding to pay a programmer,
At this point, one of the other attendees who had stuck around piped up, “I’d build that for you.” This developer had pitched a different, equally half-baked concept, but he liked the other guy’s idea better. And he had experience in the same industry. Problem solved.
Him: I need funding to pay a lawyer to work through all the regulatory issues.
Me: No, you don’t. Lawyers are trained to say no. They are paid to avoid risk. They are never rewarded for getting a deal done faster or simpler. If you ask, ‘Can I do X?’ they will tell you all the reasons why you can’t. You need to use lawyers correctly. You need to ask instead, ‘I need to do X. How can I do it legally?’ They will tell you all sorts of hoops you need to jump through, but at least you are past the Reflexive No. Now you have to push back on each one of their requirements, starting with the most onerous, and ask, ‘If I do Y instead, what’s my exposure?’ I suppose you could say that you’re looking for the minimally legal product. It is a rare and treasured lawyer who will get you to this point on his own. Most lawyers need to be led to it.
But you may not even need to do that. Are you actually causing users to assume any incremental liability? In this case, your potential customers are already doing this process, albeit manually and poorly. They are already exposed. You are not increasing their exposure and, if anything, you are actually decreasing it. Legal could turn out to be the least of your issues.
Him: I need a working product before I can approach potential customers.
Me: Why? You have connections in the industry. You can show them what you are working on and ask for their input. People love to give advice, and odds are that a lot of what they tell you will be things you intend to build anyway. Then, you can later go back to them and say, ‘I built what you suggested. Now how about being a pilot customer?’ It’s hard for them to claim that your service does not meet their needs when you built exactly what they asked for.
By this time, I sensed that this could go on for a while, so I preempted his next question by saying, “If I can be blunt, your biggest obstacle right now is your mindset. Instead of thinking about all the things you need before you can get to the next step, you need to flip it. You need to think about all the steps that you can take, without any additional resources. You will be surprised to see how far you can go, once you start thinking about it that way. After all, you walked into this room with just an idea, and now you’re standing next to a developer interested in, at least potentially, building it for you. That’s a lot of progress for one night.”
He nodded thoughtfully and slowly smiled. At that point, I knew that he had taken his first, small step to becoming a true entrepreneur.
Note: Angel Profiles is my semi-regular column appearing on AlleyWatch.
Why do you angel invest?
I started out as an entrepreneur—just like you—and learned the hard way that sometimes, VC money is not all that it appears to be. It can make you feel like you gave your shirt, your house, your car, and your shoes away. I know what it takes to be an entrepreneur and put everything you have: your blood, sweat, tears, ALL your time and sleepless nights, into a startup. So to have an angel come in and support us would have been a godsend. This perspective probably makes me more sympathetic towards entrepreneurs than it does non-entrepreneur investors. VC money is good for some ventures, but just be very clear about what you are getting into, especially if you are post revenue and can get better funding elsewhere.
I’ve done three startups and they’ve grown. Angel investing, if done correctly, can be a wealth generation tool, but it is not an exact science. A lot of it is your gut. A lot of it is your experience and your belief in the product, the person, the team, or the market.
What was your first angel investment? How did it turn out?
Wow, this was a while ago – let me think. I started in my late 20’s. I invested in a Mexican “white glove service” bank that catered to well-heeled Mexicans in the US. These guys are very well off, they travel to the US all the time and when they do, they expect the same level of service that they get in their home country. and there was a gap: there was nobody doing it. There was a pay out a last year so, yeah, I’d say that this investment went pretty well.
What investment do you most want to brag about?
Yes! How did you know? The one that I really want to brag about is actually a company I invested in called New York Distilling Company. It is an artisanal gin and whiskey distillery right here in Brooklyn and was co-founded by folks from the Brooklyn Brewery. I just love the idea of supporting local jobs and food and it has been great to watch them grow. Another is Hayward, one of the first American lifestyle luxury brands – they make stunning bags and accessories and is getting ready to open their first retail experience location in NYC!
Can I tell you about another company I invested in? The other one is a Vietnamese-style sauce company The Saucey Sauce Company. They produce all natural, artisanal Vietnamese inspired sauces and ketchups – they are awesome and makes everyone look like a rock star home chef!! I use it daily when I cook. I am proud of that one because I’ve seen it really seed and grow as a family endeavor.
Any notable or amusing train wrecks? Any lessons learned?
It’s still too soon to say if there are any train wrecks yet. That said, there are some that are struggling and pivoting. An example is a curated personal healthcare “birch box” concept – we thought it would be snapped up quickly by the big box pharma chains but that hasn’t happened.
I have found that a good way to manage your angel investments is at the beginning of the year you say to yourself, “Here is my bucket of money for angel investments this year” and it makes up a certain % of your overall investment portfolio And you tend to be generous at the beginning of the year – as the year progresses, angels may start to think, “Wait, I invested here, I invested there, my portfolio’s filling up. I don’t have room for more investments.” So you have to be more picky and do more due diligence.
Any startups you backed that should have hit but didn’t? Any idea why not?
Yeah, there was a social media site, like a digital “Dear Abby” for the young women of today. Say you get a text from a boy and you don’t know what it means. You post it and all the lady friends you know log on and comment. You also have male ambassadors commenting as well. Essentially, it allows you to crowd-source advice about dating based on texts guys send you. They had a movie deal with major networks, they had a series deal, like they had all this stuff kind of going on. Those projects probably are still in the works and will probably grow in the next several years as consumer trends change .I’m still waiting for the up, though. [laughs]..but I am patient!
Most humbling experience (related to angel investing)?
Humbling? Well, I am turned off when an entrepreneur is obnoxious enough to say that you cannot invest unless you write a huge check. Entrepreneurs like that sometimes miss the point of angel investing. It is not just the money. It is the entire network that that person could bring to bear – if they care about you and buy into your vision, the angels can bring a lot to the table. But humbling? Gosh, I don’t know.
What’s the smartest thing someone pitching you said or did?
Once I asked an entrepreneur, “Tell me what I would miss if I don’t invest.” He said, “Look, if you didn’t invest – and I get why you are not investing – but just picture this: 5-10 years from now, I’m going to be here…. I’ve put it all on myself. I’ve put in all my life savings.” He understood that in order for me to buy in, I had to understand my return pretty explicitly and that he was willing to be in that ride with me.
One of the first red flags for me when evaluating an investment is to understand how much money the founder has put in himself. This is actually pretty key, because you want them to have skin in the game, right? You have to make sure you understand the motivation behind a business and that you agree with it.
What financial returns do you target for an angel investment?
I don’t have lofty dreams for angel investment, to be honest. If I or anyone else gets a 10x or 100x return, it’s a rarity. You look for a 10x plus return, knowing that you are lucky to get a 2x plus return. And I’m pretty realistic on time frame – between 3–7 years. I know the funds are locked up and I’m not going to see that money any time soon.
What makes you better than the average angel?
Hmmm, I don’t know if I am better than the average angels. but I manage the angel investment like a portfolio. It’s an investment vehicle; it’s not emotional. My husband and I agree this is what we have and that’s it. If later anyone finds something really interesting, we’ll say, “Look, we can’t do it this round, but maybe next year.” We run it like a little PE shop.
Sometimes, when you get excited about an idea or a team, you do make emotional investments. When it is emotional, I cap it.
I do have specific expertise in cloud technologies, food tech, fintech and a personal interest in education and women’s and children’s health – so I have view points on these that might be helpful.
Pretend that it’s 2019 and complete this sentence, “[Technology X] is less than 5 years old and now I can’t imagine life without it.”
I think that five years from now I’m going to have a home device or office device that can actually know my habits: know what I want, know what I need, know what I do in what order, and help me manage my personal and professional life in a meaningful way. A life assistant – you know what I mean? I would love to see a product like that.
What’s the best way for entrepreneurs to reach out to you?
Check me out on LinkedIn.
If you are an active NY-area angel (or know someone who is) and would like to be profiled for AlleyWatch, please contact me here.
I’d raised money for startups before. How different could it be? Just add a zero or two to the ask, right?
It turns out that raising money for a venture fund is a heck of a lot different than raising money for your startup… and certainly not any simpler.
You see, angel & VC investors are all pretty similar when it comes right down to it; we want you to make us money. Show us good odds (by startup standards) to make a lot of money and we’re in.
Fund investors are far more complicated. Prospective Limited Partners (“LPs”) have a variety of motivations and each type of LP needs to be approached differently. Here are the 8 different types of LPs I have encountered in the course of raising money for the fund DreamIt uses to invest in the startups we accelerate:
4. Pipeline Fillers
6. Economic Developers
8. Fund of Funds
Winning strategy: Show them the money
Maximizers are the most like angel investors. They are sector agnostic; they don’t care if the investment is in real estate, a cupcake shop, a tech startup, or your fund – you are competing with every other opportunity out there for their investment dollar. They just want the biggest bang for their buck. To win, you need to show that your fund’s combination of risk, reward, and time frame is the best. Don’t waste too much time on strategic differentiation. Cut to the chase and stress the overall performance of your sector vs. other sectors, your team’s past performance and other relevant experience, and (if you’ve already started investing) the performance and potential of the companies already in your fund’s portfolio.
Winning strategy: Be best in class
Allocators are typically individuals or family offices who take a top-down view of their portfolio and have decided that they want a certain amount of “exposure” to VC. You have to show them that you are the best option in your venture asset class. It often helps if you can redefine the class somewhat. Make it narrower and it’s easier for them to see how you come out on top. For instance, DreamIt doesn’t simply position itself as a VC fund investment. We are angel stage investors and in that extremely early stage there aren’t many alternatives; there are just a handful of other top accelerators with funds. Beyond those, the Allocators’ only other options are second tier accelerators and direct angel investing. Allocators are allergic to the former and don’t have the time or skills for the latter.
Note that, while you don’t have to sell your sector to Allocators, it does help if you can show that your sub-sector outperforms. Fortunately for us, overall VC returns for the past decade plus have been pretty dismal whereas early stage / angel returns have been stellar.
Winning strategy: Be best in class… and be patient
Institutionals (e.g., pension funds, endowments, insurance companies) are essentially very large Allocators. They are run by professionals and tend to have standard (and often slow & painfully thorough) due diligence processes, in part because they tend to be more conservative and focus heavily on preserving capital. Their challenge is to keep a lot of money at work at all times. Small investments are the same amount of work to assess for them as large ones are but even super returns just don’t move the needle for them unless their initial investment is big enough. At the same time, most institutions don’t want to represent more than 10% of your fund. So if their minimum check size is $5M and you have a sub $50M fund, you are likely wasting your time.
One caveat: Pre-existing relationships are very important to Institutionals so if you expect that your next fund will be in their strike zone, it pays to set aside some time to meet them anyway and to start building the relationship,
Type: Pipeline Fillers
Winning strategy: Create portfolio envy
Pipeline Fillers are looking for dealflow. They may be later stage VC or PE funds who know that it is extremely hard to get into the hottest deals if you are not already on the cap table. Or they can be large family offices or corporations who like to invest in particular industries but don’t have the skills, connections, resources, or inclination to invest in raw startups. For Pipeline Fillers, you need to understand their investment focus first and then show how your portfolio matches their need. You also want to highlight how they will get access to your portfolio. At DreamIt for instance, we stress the early introductions we make such as invitations to session kickoff events and “LP Day” where our investors get a preview of the newest DreamIt startups well before the general public meets them on Demo Day. We also point out that, as a relatively small fund, DreamIt rarely invests beyond the B round which leaves a lot of pro rata investment rights for later rounds that we can make available to our LPs.
Winning strategy: Show portfolio fit
Strategics want to know what disruptive technologies are just over the horizon. They are often corporations who want an opportunity to partner with the best startups before their competition gets to them. They may even want a chance to make some targeted investments and/or acqui-hires. Portfolio fit is critical here. Selling a generalist fund is difficult because only a small share of the startups will be relevant to that particular Strategic but pitching a fintech focused VC fund to a bank or an IoT/smart device fund to a large electronics conglomerate makes a lot of sense. While return does matter, they are largely buying insight so focus your pitch more on your deep industry knowledge and your access to disruptive seed stage startups in that space.
Type: Economic Developers
Winning strategy: Show them the headcount
Sometimes, you may even pitch your fund to the government entities that are first and foremost Economic Developers. Increasingly, the SBIC, states, and even a few of the larger cities have allocated some of their economic development budget to VC investment. This is an entirely different kind of conversation. They want to know how many jobs you will create in their region so be prepared to talk headcount, not returns. Also, there will be strings attached – limits on non-region investments, co-investment requirements, etc. You may even need to set up a side fund for their investment to exclude startups that don’t meet their mandate. Oh, and don’t expect them to move quickly either.
Winning strategy: Share their passion
Impactors make up a similar but separate group of potential investors. These may be government entities or non-profits with social goals. Often referred to as double bottom line investors, Impactors want to invest in particular types of ventures such as minority or veteran led businesses or startups targeting environmental or anti-poverty causes. Impactors vary from wanting to maximize profits while constraining their universe of investments to those that meet their mission to those who want to maximize their impact on their primary social metric while at least meeting a minimum target return. Impact investors are typically a poor fit for VC LPs unless your VC fund was constructed specifically with their goal in mind or predominantly targets a closely related industry such as environmental impact investors and a clean tech fund.
Type: Fund of Funds
Winning strategy: Finding them is 80% of the battle
The last category is Fund of Funds. Their value proposition to their LPs is that they can pick the better VC funds, justifying the fees they charge. These fees apply after the underlying VC funds take their fees. There’s been a mini revolt against “Fees on Fees” so these guys are a vanishing breed but if you do meet one, your pitch should be similar to the one you use for Institutionals, only stressing returns instead of capital preservation. Fund of funds may also be looking to slot your fund into their pre-defined set of target buckets so take some time to figure out what their buckets are and show where you fit in. Plus, if your fund doesn’t quite fit cleanly and neatly into their framework, that’s one strike against you. Lastly, because of the fee issue, be prepared for the Fund of Funds investor to ask for a discount of your management fee, carried interest, or both.
So the next time you sit across from a VC and think wistfully about how much nicer it must be to be the one writing the checks, remember this: every few years we go through the same wringer as you do and it’s no picnic for us either!
Acknowledgements: I’d like to thank my colleagues who contributed valuable feedback on earlier drafts of this piece including Skyler Fernandes (Simon Venture Group), David Teten and Katie Bluhm (ff Ventures), Sumeet Shah (Brand Foundry), Amanda Nelson (TCP Ventures), Jorge Torres (VenSeed) and Steve Berg (Antecedent Ventures). In case you are wondering, I’ve opted to list them in the order with which they responded to my request for feedback in the (likely misguided) hope that this will encourage them to answer my emails even more quickly.
Nice piece in TechRepublic about how to find the right mentor:
And I’m not just saying that because the author quoted me in it. :-)
Two additional thoughts that didn’t make it into the final cut:
Advice, Connections, or Credibility? Mentors can bring one or more of these three benefits to the table. What you need most will direct your search. Bear in mind that the senior guy at company X who looks awesome on the Team slide may not have time for much more than sharing some vague, but enthusiastic endorsement of your company if asked. Someone more junior may be more likely willing and able to put in the hours it takes to give worthy advice and direction. And while pure corporate types often just don’t understand the ‘startup’ side of the equation enough to advise properly, they can be excellent connectors.
Mentor or Consultant? Don’t mistake the need for expertise with the need for a mentor. Ask yourself this: What will I talk about with this guy in six months? If you come up blank, he’s probably not a mentor. For instance, if you need to speak to an Information Architecture expert about what tech stack to build on, just pay for a one-time consult outright (or beg a free meeting over lunch) rather than to give away part of your company. Similarly, the master sales / biz dev guru who can get you those critical first customers isn’t really a Connector. You can often compensate him with a percentage of all revenue he generates and (if necessary) a small monthly retainer and save the equity for a true mentor.
It was not so much a debate as a “frank exchange”.
I was exchanging emails with the founder of one of the larger startup pitch conferences. He had asked me if I would promote his event with some of the DreamIt startups who are currently fundraising. His events are pay-to-pitch and it’s fair to say that, as a general rule, I’m not a fan of that model.
I (politely, I hope) explained my reservations. I’ve dealt with the issue in more depth here but the gist is that getting in front of key decision makers is a core competence for successful entrepreneurs. If you can’t get a warm intro to early stage investors who, by and large, are some of the most networked people on earth, how will you get in front of potential customers, distribution partners, etc.? Paying for access to investors often signals a lack of this core competence, and, more generally, an attitude that something so fundamental to their business should be outsourced.
When I was done explaining, he responded with this deceptively simple question:
“How is presenting at our program different then presenting at your demo day? Those companies pay you with equity. Couldn’t you make the point that if they need your services then they are [equally lacking]?”
Respectfully, I disagree. There is a world of difference between participating in an intense 3 month program where you master key skills vs. simply writing a check.
Putting aside the heavy filtering that is a result of the intense competition for admission into the top accelerators – having seen the numbers first hand, I can confirm that it is statistically easier to get into Harvard than it is to get into DreamIt – that in itself virtually guarantees a better pool of demo day startups than pay-to-pitch presenters, anyone who has been through a top accelerator will attest to how much they have learnt. In particular, the alumni who graduate from top accelerators leave the program fully capable of networking to investors, clients, partners, etc. Startups who use bankers or other intermediaries leave with some business cards. It’s the difference between mastering a skill and renting it, between going to med school or just going to the doctor.
But then again, I might be biased. :-)
What do you think?
On Saturday, October 25, Jews around the world (or at least those who actually go to services) heard the story of Noah’s Ark. And so, with apologies to every rabbi who ever tried to teach me anything, here are a few things that Noah can teach entrepreneurs:
- Plan ahead. Noah didn’t wait until it started raining.
- Be different. The big winners are the ones who zig when everyone else zags.
- Go big or go home. Would a row boat have cut it?
- When you find the right mentor, listen carefully.
- Expect critics. I’m sure Noah’s neighbors had a good laugh at his little hobby. (“Hey funny guys, how long can you tread water?”)
- Build a diverse team. That said, you can probably get away with fewer than two of everything.
- Speed isn’t everything. In the ark, the cheetahs bunked with the sloths.
- Bad times can be good for survivors. Be the low cost producer in a price war, or stay lean when others are splurging and you can be the last man standing in an open field.
- Timing matters – don’t miss the boat!
Note: This post originally appeared as an article on FOCAPNET.
Angel investing is hot… and not just because it’s so cool.
When for over a decade single-digit Venture Capital returns qualify as “top quartile”, seed stage investments have generated 27% ROI. (2) So it is only natural that family offices and high net worth individuals are eager to get exposure to this sector. The only problem is, they often don’t have the experience they need to do it right.
Here’s a typical family office startup story:
- A family office decides it wants to get into angel investing.
- One of the investment professionals goes to a few meetups and generally gets the word out that he is in the market for interesting startups.
- He starts getting pitched (directly, via LinkedIn, etc.) by a host of “investment advisors” representing “hot startups”.
- A few of these startups look pretty good so the family office invests.
- These investments fail miserably.
- The family office decides that startups are a “bad investment” and goes back to what it was investing in previously.
Hint: Step 3 is where things ran off the rails. I’ll get back to that in a moment.
Why family offices are ill-equipped for angel investing
The more sophisticated family offices employ investment professionals who have deep experience analyzing the strategies and returns of public equities, hedge funds, private equity funds, etc. These are all well defined instruments, within generally limited investment universes, for which substantial data is available. Even if you are considering seeding a hedge fund or committing to a newly minted PE/VC fund, you can still mine the principles’ track for a fair number of data points. Furthermore, there are well-established channels for learning about new opportunities (e.g., “capital introduction” dinners) in these spaces.
Now reverse every single one of the above characteristics and you get angel investing. Every halfway decent startup opportunity is unique, solving unmet needs in different industries – sometimes in industries that don’t even yet exist. There are no registries or directories of startups, no associations to join. And you can forget about data entirely with a pre-revenue company. At best the founders have one or two reasonably successful prior ventures under their belts. (If they had a real home run under their belts, they wouldn’t need investors at all.) Furthermore, the best way to find great startups to invest in is to know other great startups so if you aren’t already deep in that community, you’re already disadvantaged.
Unfortunately, most family offices don’t realize how fundamentally different early stage investing is from other alternative asset investments. So they don’t see anything amiss when investment adviser brings them startups to invest in. (I told you I’d get back to step 3.) They are used to meeting emerging hedge fund managers that way so why shouldn’t they find a great startup that way too? Because the best startups are never, ever represented by an investment advisor.
Think about it. VCs are the most networked people on the face of the earth. VC present at panels or judge pitch events practically every week. They meet dozens of entrepreneurs every week and know – and have often co-invested with – virtually every other VC in our area. If a startup founder can’t network his way into a warm introduction to a VC or angel, how is he going to find customers or key strategic partners? Is this advisor going to be holding his hand then too, after your check has cleared? Plus, the very fact that the founder thinks he can waive his hand and simply have someone else take something this crucial to his business for him is huge red flag in and of itself. So any startup that has an investment advisor fundraising for them is already automatically suspect. In practice, the deals the family offices are being shown by these advisors are the hairy, old, over-shopped deals that every VC and halfway serious angel have already turned down. It’s no wonder they fail miserably.
To be fair, to the untrained eye they don’t look that bad. Perhaps they have a cool piece of ad tech that you are convinced will take agencies by storm. You have to really know the industry to understand why agencies turned them down two years ago when they first tried shopping their solution around. That fantastic social media marketing tool? It’s so wonderful that five other companies are already doing it and they are all making better progress than the one you were pitched. But if you aren’t seeing dozens of startups each month, there’s no way you could be expected to be on top of all these trends.
So what’s a family office to do?
In theory, a family office could hire a seasoned angel investor to invest on their behalf. But good luck finding one. Many angels are running their own businesses and/or are entrepreneurs who had a large exit and have no interest in working for a family office. Also, angel investing is a numbers game. Most startups will fail, and many of the rest will be modest successes. You have to invest in many, many startups to have a reasonable chance of 1 or 2 of your investments being a home run. There’s a reason Dave McClure named his fund (now an accelerator as well) “500 Startups.”
Fortunately, there’s a better option: Startup Accelerators.
Accelerators(3) are the boot camps of the startup ecosystem. Companies accepted into top accelerators are the very best, earliest stage startups in the world. The top accelerators typically get hundreds of applicants for just 10-15 spots. Having just run the screening process for DreamIt NY’s summer 2014 program I can personally attest that this is no exaggeration. The odds of getting into Harvard are slightly better than getting accepted into DreamIt.
Accelerators give the startups they accept a little cash ($20k-$40K on average), co-working space for the duration of the program (typically 3-4 months), and extensive mentoring, coaching, and introductions. Finally, on “Demo Day” the startups graduate by pitching their business to an audience of hundreds of active angel investors hand-picked by their accelerator. In exchange for all this, the accelerator gets equity in the startup (usually 6-8%) and the right to co-invest in the startup’s seed round.
From the perspective of the family office, accelerators can be the capital introduction dinners for startups. Unlike the shady investment advisors discussed above, accelerators are personally invested in the startups they accept. Accelerators do not get commissions on the fund they help their startups raise; they only profit when their portfolio companies have an exit so their incentives are aligned with the other angel investors.
But they are more than just a trusted recommendation from a fellow angel investor. Accelerators like 500 Startups, DreamIt, TechStars, and Y Combinator invest in dozens of startups each year and can bring a structure and rigor to the investment process that few angel investors have. Established accelerators bring unparalleled networks and reputation to the table enabling them to source the very best new companies out there.
Many accelerators are structured much like VC funds. But there is one crucial difference: co-investment. Even the most co-investment friendly VCs only make their portfolio investments available to LPs if they are unable or unwilling to invest their full pro rata. If it’s a great portfolio company, the VC will continue to invest until it runs out of powder or starts bumping up against position caps. And if the VC is able to but does not want to exercise its full pro rata, do you really want a bigger stake in that company? In both cases, the VC eats first and the LPs get leftovers.
Accelerators on the other hand, rarely invest in more than a small fraction of the portfolio company’s seed round. As I mentioned above, early stage investing is a numbers game so they reserve most of their investment capacity for new startups. As a result, 75% or more of the round goes to new investors.
Think about that for a moment. Here’s an entity that filters out 98% of the startups they see, takes the top 2% and gives them all the help a young company could ask for, and then willingly steps aside and lets any other angel or VC swoop in and invest in those elite new ventures. No commissions, no membership fees. Wow.
If all a family office did was go to the Demo Days of the top 4 or 5 accelerators and invest in the presenting startups, the filtering effect alone would give them a high quality portfolio of early stage investments, no additional effort required.
For the family offices who want to build their own experience base and startup network, there is an even better option: invest directly in the accelerator. Accelerators typically give their LPs early access to their new class so LPs can track a startup’s progress over a longer period of time before deciding to invest and/or can invest before Demo Day and avoid the risk of missing out on the hottest prospects. Furthermore, most accelerators will gladly explain their selection process, describe how they are assisting the startups, and introduce LPs to other members of the startup community. This practical education is not something you can buy anywhere but you can get it for free simply by investing in something you already want to invest in.
Investing directly in a top accelerator also makes sense from an efficiency perspective. Even investing the bare minimum $25K per startup (and some startups insist on $50K or $100K minimums), creating a portfolio of 100-200 startups would cost a family office $2.5M-$5M. But this leaves no money for follow on investments. As a rule of thumb, you want to set aside $1 for follow on investments for every $1 initially invested so getting that 100-200 startup portfolio actually means committing $5M-$10M to early stage investing. In contrast, you could invest $1M (4) into the accelerator’s fund for the same portfolio of 100-200 startups, including follow on investments. That comes out to just $5K-$10K per portfolio company.
So let’s re-write the family office story:
- A family office decides it wants to get into angel investing.
- It researches the accelerators in its area and invests in 1 or 2 of them.
- It spends the first few accelerator cycles learning the ropes and making connections.
- As it gains confidence, the family office invests directly in a few of the accelerated startups, effectively doubling-down on a few, high conviction plays.
- The diversified portfolio does well
- The family office makes disciplined, intelligent, efficient angel investing a formal part of its allocation strategy
Now how’s that for a happy ending?
(1) Just in case you were wondering, “For fools rush in where angels fear to tread” was first written by Alexander Pope in his poem An Essay on Criticism.
(2) Right Side Capital analysis of eight large studies of historical angel investing returns in the US & UK (http://rightsidecapital.com/assets/documents/HistoricalAngelReturn.pdf)
(3) Sometimes called incubators, although incubators are more often shared co-working spaces with some additional services that are of value to startups. Unlike accelerators who rigorously screen their applicants, incubators are generally open to all, space permitting, as long as they can pay the rent.
(4) Many accelerators will allow family offices to invest as “individuals” rather than “institutions” enabling them to qualify for minimum investments of $500K or even as low as $250K, which comes out to as little as $1,250 per startup(!)