Note: A version of this post appeared in my semi-regular column on AlleyWatch.
My friend is at a private equity fund and is now actively looking to move into venture capital…
I get that a lot. Sometimes the friend is at a hedge fund instead and occasionally, I’m approached directly instead of through a friend but the overall picture is the same: they are bored with large, public/established, old-school companies and think VC is cooler.
I get it. Before running Dreamit’s NY accelerator program, I managed a family office and we had investments in many asset classes. I can testify from personal experience that PE & hedge funds are (with notable exceptions) mindnumbingly boring. What would you rather talk about: a rollup of mom & pop industrial gas distributors or shiny new potential unicorns?
And since Dreamit is also a venture fund in addition to being an accelerator, I get why they come to me. VC & PE funds both hold portfolios of generally illiquid investments. They are structured similarly. The exits are even the same: IPO or strategic sale It’s just with younger companies, right?
Actually, it’s fundamentally different.
You see, I work with pretty much the earliest stage startups that are anything more than a cocktail napkin and a dream. To grossly oversimplify, in these situations the key question is “will this (the idea, the team, etc.) work?” In PE, the key question is “what is the right price?”
These questions take very different skills to answer and in general the skills aren’t that transferable. They are analyzing the historical data, adjusting forecasts, looking at comparables. I have no historical data nor any comparables. I look at the team, the idea, the overall market size. When I look at a financial model at all, I have zero expectation that it will be even remotely correct; I use it to figure out what the make or break assumptions are… and to confirm that the founding team knows what those are as well and are doing everything possible to prove those assumptions out quickly & cheaply. Heck, a lot of the time PE funds go into the deal with a new team ready on the wings to replace senior management. I’d *never* go into a deal with a team that needed replacing.
Also, the key marketing challenge for seed stage investing is wading through the masses of under the radar startups and finding the gems before anyone else does. The startup is going to take the money and it is a rare deal when a startup turns down your money for someone else’s (although it really stings when it does happen).
In PE, they typically have more information to find and screen initial prospects (especially if they take public companies private). The real challenge is either to get the prospect to do the deal at all (e.g., an unsolicited purchase offer) or to choose that specific fund to work with.
Lastly, seed deals are ridiculously simple to structure. The outlines of the deal are largely standard; we typically just need to fill in the amounts. (Only a slight exaggeration.) The reason for this is simple. Startups typically come to the table with a blank slate and their outcomes are binary: win big or bust. There’s no need to get fancy. When it comes to terms, “don’t make me think” is solid advice.
PE deals have to account for a much wider range of possible outcomes and protect the fund from anything in the company’s past that might pop out of the closet. There are elaborate payout formulae, reps & warrantees sections the size of epic novels, and fees up the wazoo.
(Did you know that PE funds get paid if the deal doesn’t go through? Really. They are called “Broken Deal” fees. That’s chutzpah….)
So what’s a poor PE analyst to do?
I suggest looking at later stage VCs. At that point, the idea/team/market is largely derisked and the question is more about whether the growth potential supports the valuation so spreadsheets start to matter more in the traditional way. Also, the prospects for C- or later-stage investments should already be on the fund’s radar. The challenge is to convince the especially hot ones to take your money instead of some other fund’s. And as an added bonus, you get to have fun with liquidation preferences and other terms to come up with a deal that both the fund and the founders like.
Good. Because I need you in those later stage VCs. I’ve got a lot of startups getting ready to raise follow on rounds…
In preparation for AccelFest in Montreal in 2 weeks, I have retooled my “8 Types of Fund Investors” as a Slidebean presentation:
Link to presentation: https://slidebean.com/p/CASr7YHPRx/The-8-Types-of-Fund-Investors
So the presentation that I was about to give when I wrote this post went over so well that they asked me to keep talking for another 20 minutes. Good thing I had another presentation ready to go… or almost ready to go to be precise. I was planning to give this presentation to the current DreamIt NY startups on Wednesday but hadn’t quite finished it yet so the version that went onscreen in front of 100+ startups in Warsaw had a slide saying “More Stuff Here” in lieu of slides 19-22!
DreamIt, PitchIt, FundIt: Prospecting for Investors and the Art of the Elevator Pitch
Here’s a link to the (now complete) presentation:
(No, I don’t have mad presentation skills. I simply use Slidebean)
Landed in Warsaw a few hours ago, shaved, showered, grabbed a coffee, and headed over to the Palace of Culture and Technology where I’m scheduled to speak in less than 30 minutes. Good thing I’ve finished my presentation!
DreamIt, BuildIt, CrushIt: What accelerators do, do you need one, and how to chose the right one
Here’s a link to presentation: https://slidebean.com/p/D4qGyACtGs/DreamIt-BuildIt-CrushIt
I’m only in town for a day(!) but I’ll try to follow up with some thoughts about my trip in a few days.
UPDATE: This one went over so well, they asked me to keep talking!
(No, I don’t have mad presentation skills. I simply use Slidebean)
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.