Saturday, March 30, 2013

AIPP Data Summary (Angel Investing, Sidebar 1)

The Kauffman Foundation has some data on angel investor investment and returns at their Angel Investor Performance Project. The data has some serious limitations, mainly that it is relatively concentrated in time (44% of the investments with data are '99 or '00), that there's not enough investments to draw fine-grained conclusions, and that valuations at each investment are not available so follow-ons are hard to interpret. That said, data is better than no data. A summary below*.

0x 0x-1x >1x All
No follow-on
Total companies (% of all) 97 (66%) 50 (61%) 158 (81%) 305 (72%)
Average exit multiple -- 0.47 28.27 14.72
Average years invested 2.9 2.8 3.6 3.2
Average invested $88,420 $109,678 $90,125 $92,788
Total companies (% of all) 50 (34%) 32 (39%) 37 (19%) 119 (28%)
Average exit multiple -- 0.33 7.00 2.27
Average years invested 2.8 4.5 4.9 3.9
Average invested
   Initial $346,460 $86,836 $129,730 $209,259
   First follow-on (% of initial/% of companies) $194,345 (56%/100%) $41,946 (48%/100%) $92,524 (71%/100%) $121,705 (58%/100%)
   Second follow-on (% of initial/% of companies) $66.080 (19%/20%) $17,425 (20%/13%) $13,097 (10%/8%) $36,523 (17%/14%)
   Later follow-ons (% of initial/% of companies) $19,600 (6%/10%) $5,625 (6%/13%) -- (0%/0%) $9,748 (5%/8%)
   Total invested (% of initial) $626,485 (181%) $151,831 (175%) $235,350 (181%) $377,234 (180%)
Total companies 147 82 195 424
Average exit multiple -- 0.42 24.23 11.23
Average years invested 2.9 3.5 3.9 3.4
Average invested
   Initial $176,189 $100,764 $97,640 $125,477
   Follow-ons (% of initial/% of companies) $95,247 (54%) $25,364 (25%) $20,041 (21%) $47,144 (38%)
   Total invested (% of initial) $271,435 $126,128 $117,681 $172,621
Some thoughts. The data is noisy and there are outliers that skew it. This shouldn't surprise anyone. I would have expected that the deals with follow-ons would have returned more absolute dollars than those without, albeit at a lower multiple. The lower multiple is there, but the total average dollars returned is about a third. This means one of two things: 1) angel investors primarily invest in follow-ons when the company sucks, or 2) there is not enough data to smooth out the statistical anomalies. I think the second is probably truer. But there is also some truth in the idea that angel investors may not get a chance to invest in later rounds when the company is going gangbusters. The deals with follow-ons also exit later, even the successful ones, so some companies may not have angel investor follow-on because they exit before another round is needed.

Failure rates are pretty high. About a third of the companies fail outright. Another 19% don't return capital. The remaining 46% pay out. Here's a graph of exit multiple vs. years invested.

I cut off one or two multiples above this range and a couple of exits that were more than 14 years out so you could see the structure. I would describe this as consisting of two things overlaid (although I don't think there's enough data to prove it): 1) a group of investments that follow a constrained exit pattern--this is the bulk of the exits, peaking at three years and then declining until it disappears at eight years--and 2) investments that don't seem to follow a particular pattern. This jibes with my gut that says some investments are 'earners', they are less risky but have less upside. These companies build then exit. Other investments are the 'swing for the fences' types. These can exit anytime and for any amount.

Here's a chart of how long the angel investors held their investment before exiting.

And here's a chart of exit multiples.

This is a log-log chart, showing that even with this noisy data, exit multiples follow a power law.

* I cleaned the data. I removed any deals that: did not have exits, did not have a number greater than zero in the 'totalinvested' column, and any where the 'stage' field was not either blank, seed, or startup.

Wednesday, March 27, 2013

Transcending Hobbyism (Angel Investing 4)

A company I really liked was out raising money. They went to a very well known early stage VC and had a great first meeting. A couple of days later the partner got back to them with a no. He said "We really like you and your company, but we have a portfolio construction problem." The entrepreneur called me. "What the hell," he asked, "does that mean?"

As an investor you don't just pick the good ones and walk away from the bad ones. Were it so easy. You are managing a finite pool of money and are looking for the best return on the pool, not just on each individual investment. That means that sometimes you have to walk away from a good one. The easiest way to separate the serious angel investors from the hobbyists is to ask them about their approach to building a portfolio. Serious angels have a plan for what they are trying to build. Hobbyists are just piling up stones.

Here are some questions. They're analogous to the questions you ask entrepreneurs when you're trying to figure out if they've thought their plan through: How much money do you need? What will your burn be? How long until you're profitable? Startup venture funds are not like the startup ventures they fund. But, like startups, they need to have a viable business model. And, like startups, that includes not running out of money halfway through.

First, how much money can you invest in startups?

I'm not going to give you advice on this because I'd be a hypocrite. I long ago blew through whatever reasonable percentage of my cash I should have put into this incredibly risky, close-to-zero liquidity asset class. Do what someone else says, not what I do. Most commenters say you should only invest what you are comfortable losing. That's solid advice*. Big institutional pools of capital often reserve 2-10% of their assets for private equity, of which venture capital is one fifth or less. I'll leave it at that.

Second, how many investments do you plan to make?; third, how much work do you plan to do with each company post-investment?; and fourth, will you have an investment thesis?

We all know it's the right thing to do to invest in a portfolio of companies to avoid idiosyncratic risk--the kind of risk that is specific to a single investment. If you have a large enough portfolio--common wisdom is some 20-25 companies--of uncorrelated investments then you have pretty much minimized the unsystematic risk.

Related is the idea that since venture investing is a hit-based business, you need to have a lot of investments to have a good chance that one is a hit and returns your entire pool of capital several times over***. The number of investments to make it probable for this to happen has been estimated at between 20 and 150.

These numbers don't take a few things into account, and you should.

Getting rid of diversifiable risk makes sense: the risk that a portfolio CTO quits after six months, that Google unexpectedly launches the exact same product, that your platform decides to ban the way you make money. Sometimes you should know this is going to happen before you invest (I'll talk about due diligence in another post) but sometimes there's no way to know. Having many companies means that if a couple hit one of these deadends, you're not finished. But keep in mind that diversifiable risk presupposes a lack of correlation between investments. The risk that a CTO leaves one company is uncorrelated with the risk that the CTO of another company also leaves. On the other end of the spectrum, the risk that there's a financial crisis and every venture investor simultaneously decides to stop doing Series As is 100% correlated across all seed-stage companies: it's a market risk and you can't get rid of it through diversification.

But in the middle are the the kind of semi-correlated risks that are the bread and butter of every good venture investor, the risks that go with a particular sub-industry. The risk of Netscape changing third party cookie policy from opt-out to opt-in is correlated across most ad-tech companies but not many other internet companies. There are similar risks to any investor's thesis, be it Big Data, Social, Consumer Internet, whatever. But trying to entirely diversify away these risks means you can't really have any thesis at all. And that means you can't have any expertise. The market risk in finance is called β and is the best you can do in an efficient market--one where all information is available to all participants. But if you feel like you know something that not everyone knows, that you're an expert at something, then you can generate α, return in excess of risk taken. β is what asset allocators brag about. α is what investors brag about. We like α.

There are two strategies: create an index-fund like portfolio with 100+ relatively uncorrelated investments and try to get β, or create a 20+ portfolio of companies you actually know something about--less diversification but more α. The latter strategy is riskier: if what you believe about the market turns out to be untrue, that whole part of the portfolio goes bad. But if it's right, you do better than the market.

There's also, of course, an impact on how much money you spend and how you spend your time. Many founders don't want investors who are putting less than $25k or $50k into the company. You may find that you don't have enough money to get to a fully-diversified portfolio. You should think about this carefully. If you're not somewhat diversified, you are handicapping yourself relative to other investors and you face a pretty decent probability of actually losing all your money****.

And then there's how you spend your time. If you hope to help the companies you invest in grow by being active, you can't make 100 investments every few years unless you have some infrastructure to help you.

Fifth, what stage will you invest at?; sixth, swing for the fences or go for earners?

I assume that most angels invest at the seed stage. It's the only time when you can get an appreciable piece of the company for an angel-sized stake. But there's seed and there's seed. If you put in first money like I try to do, when it's two people and a pony, you're taking more risk and will need to hold the investment longer before exit. But you get to invest in the best people and the best ideas. If you invest after there's a minimum viable product and the company is looking for some money to start getting customers, then you have less risk--you can assess the strength of the team as a team and look at the MVP as a product and talk to potential customers about how burning their need for it is--but by then you're probably competing with many other investors to get a piece of the deal.

In my experience, if you invest at the very start of a company, you will end up holding that investment for some six to eight years. Some companies exit sooner (although it's rare for one to exit less than three years after inception) and some take longer (I was recently talking to the founder of a company I invested in thirteen years ago--and it was two years old when I invested--about starting to look for a buyer.) In any case, you should expect a substantial period of illiquidity.

The type of company you're investing in also makes a difference to holding period. The companies that are swinging for the fences usually take longer to mature. Simple, for instance, whose vision is to disrupt retail banking--one of the largest industries in the world--by actually treating their customers like customers took three years from idea to launch. Less ambitious companies can start, launch a product, and sell in less time.

Some investors prefer the less ambitious companies, the earners, hoping to build and flip in a short period of time. I don't. I tend to follow the old adage of shooting for the moon and landing on the roof. If you're trying to build a billion dollar company and fail, you might end up with a $50 million exit. If you're trying to build  $10 million company and fail, you end up with nothing. But that's personal style; there are prominent counterexamples.

Seventh, will you follow on?

Related is whether you follow-on or not. That is, having invested in the seed round, do you also invest in future rounds?***** I'll talk about whether this is a good idea or not in a later post, but if you decide you want to be able to follow on, you need to reserve money for it.

In my portfolio, the average amount raised has been about

    First round        $1.3 million
    Second round$4.7 million
    Third round$7.7 million

If you invested $50,000 in the first round at a $5 million post-money you would own 1%. Then you could expect that your pro-rata of the second round would be $47,000. Your pro-rata of the third round would be $77,000. Your $50,000 is now close to $180,000. I usually stop investing after the B. I reserve twice my original investment for follow-ons, assuming that some companies won't raise the A or the B.

Putting it Together

I ask my founders to build a financial model, even though it's inevitably wrong--"prediction is hard, especially about the future." But the act of building it means they need to think through tradeoffs, milestones, capital needed, etc. While the decisions they make because of this thought experiment should evolve as actual facts come in, the exercise of modeling allows them to know what their envelope of viability is. Answering the above questions should allow you to do the same.

NB: The undisputed master explainer of these types of issues is Roger Ehrenberg on his Information Arbitrage blog. His post on Portfolio Construction goes way more into depth than I have. Also read at least The Right Fund for the Mission.

Next: Modeling your fund [edit: not done yet, skip to The Signal and the Noise for now.]

Previous posts in this series
  1. Intro: Why I'm Not an Angel
  2. How to spend your time: The Work-Work Balance 
  3. Positioning: How to be Different When What you Sell is a Commodity

* Long ago a girlfriend brought me to a gathering of her friends. We joined a couple of other couples playing penny-ante poker. After I goaded the others into betting BIG (literally HUNDREDS of pennies) the gf walked away from the game. She chided me afterward: "Why were you being such a dick? We were just trying to have fun." I didn't get it. If it isn't painful when you lose, why even play?**

** Also, why I don't blog relationship advice.

*** The difference here is a bit confusing. Diversifying away unsystematic risk means that you actually increase the expected value of your portfolio for any given amount of risk. Making lots of bets in a hits-based business doesn't increase your expected value, it decreases the variability of your outcome.

Think about it this way. There are ten upside-down bowls. Under one of them is a $20 bill. You can 'buy' any bowl for $1. Since each bowl has a one in ten chance of having $20, your expected value of each bowl is $2. The smart thing to do is to buy all the bowls, spending $10 to get $20. Your expected value does not change (it's still 2:1), but the variability of your outcome has gone to zero: you always get the payout.

Of course, if you bet on a single bowl and won, you'd get a 20:1 payout. It's because you know nothing about the bowls that you're better off buying them all. If you have an inkling about which bowl is more likely to have the money under it then you're better off just buying that one. The idea that you should make 150 investments to lock in the average angel investing return presupposes that you have no idea which companies are better than the others. I've never met an investor who truly believed this. I consider myself pretty damn humbled by experience, but even I'm not that humble.

**** The astute reader will observe that if you follow the rule from question 1 and only invest what you're comfortable losing, you may put yourself in a position where you're more likely to lose it. You then have the choice of one of two mantras: 1) "The rich get richer, not me", or 2) "I am large, I contain multitudes."

***** If you decide you want to be able to follow-on, you need to negotiate pro-rata rights into your deal. I'll talk about this and other deal terms in a later post.

Monday, March 25, 2013

How to be Different When What you Sell is a Commodity (Angel Investing 3)

When I started a company my co-founders and I thought and discussed and argued about how we were different from our competitors, how there was a hole in the market, how we were going to win by going where no one had gone before. We got potential customers, suppliers, employees excited by talking about how we were different.

If an entrepreneur were to map venture funds on a traditional 2x2 competitive matrix, using their two most important value propositions as the axes, it would look like this*:

In the things entrepreneurs care about most--price and control--VCs don't seem all that different from each other. That's not going to change and you're not going to change it. Venture capital is already a business which is, at best, on the edge of being uneconomic**. In the times when VCs have been sucked as a group into competing on price, the whole sector has done badly.

In the product world, if you are really good at something, you compete on price to take more market share. In the services world, where your expertise isn't that scalable, when you're really good at something you raise your price. VC is a service business and I often see the VCs with the best reputations offering a deal that is slightly worse than average and still being chosen as the funder. Conversely, I have often seen lesser known VCs or financial backers from outside the VC world offering much richer deals in order to be chosen. If you want to have price discipline (and you do) then you need to offer something besides price, and it better be good.

Ask yourself: how do I distinguish myself from all the other sources of money out there?

This seems like a ridiculous question to some. You, after all, have the money; shouldn't you be the one doing the distinguishment? When you walk into Tiffanys with a Hefty bag stuffed full of large bills, the salesman doesn't ask "Why should I do business with you?" He sprints across the floor and asks "How can I help you?" Thinking this is how it works in angel investing is a classic rookie mistake. The founder who is willing to take your money regardless of anything else you bring to the table is the founder who can't get money from anyone else. This means one of two things:
  1. You are smarter than all of the other investors and see something they don't, or
  2. The company is not a great bet.
The first situation happens. I've done a few of those, as has any venture investor worth their salt. But the majority of great investees are good enough bets to have many interested investors. If you want to be in these you need to offer more than just money.

There are many ways to add real value through the process. I'll talk about that in detail in a few posts. For now you need to think about positioning in general, about what you have to offer, both so you can generate the right kind of deal flow and so you can plan your investing strategy.

Here's a potentially scurrilous example of positioning among early-stage VCs.

Each of these funds has been very successful at being chosen by great companies to be their lead investor and they've each staked out different investing strategies. The x-axis is the amount of team, product and market risk they are willing to take (less to more as you move right.) The y-axis is how much operational help they offer, from incubator or incubator-like at the bottom to hands off at the top. The z-axis is how deeply they know a specific industry or technology***.

In reality, none of these funds fits as well into their box as this graphic makes it look. And each offers something that this box doesn't capture (not least, among this group, attitude.) But you should have a sweet spot, you should be able to articulate it, and, more importantly, it should articulate itself through your actions and communication. Entrepreneurs will find you if they know you are what they are looking for.

Anywhere you choose in this cube has its tradeoffs. If you spend more time helping your entrepreneurs you have less time for other things. If you spend less time helping you are less valuable (assuming your help is valuable.) If you take less risk you either aim for lower returns or you face much more competition for investing in the deals. If you're more specialized you need to work harder on finding potential investees but you are better able to evaluate the ones you do see.

Where you fit depends on what you know, how much time you have and your personality. It will determine how you spend your time, how you generate dealflow, how you filter deals, and how much you can help.

Next: Investing Strategy  Portfolio Construction

Previous posts in this series
  1. Intro: Why I'm Not an Angel
  2. How to spend your time: The Work-Work Balance 
* For the VCs' real customers, the LPs, it probably looks more like this.
** In terms of risk-return.
*** The risk-return profile, all else being equal, gets better as you move from bottom right to top left. That's why most funds are in the top left box. Of course, If all else is equal, maybe you should go find some other business where you do have an unfair advantage. 

Thursday, March 21, 2013

The Work-Work Balance (Angel Investing, 2)

The first question every prospective angel (and all my relatives) ask me is "What do you do all day?"

It's sort of a funny question. For any job more varied than working on an assembly line, the answer is either going to be pretty long or pretty vague. Usually I go with vague. Today I'm going with long.

Venture capitalists

  • Find companies that need capital,
  • Figure out whether they should invest,
  • Convince those companies they should take investment from them,
  • Negotiate terms, create syndicates of investors, and invest,
  • Help build the company,
  • Manage and protect their investment,
  • Manage and protect their portfolio, and
  • Exit--sell or shut down companies.
Institutional VCs also spend a good deal of their time getting investors for their own funds and then keeping them informed, but we're not institutional VCs, so we don't have to worry about that.

I have 23 companies currently in my portfolio. I invest in four or five new companies a year. I sit on five boards that each meet monthly or every other month, so one board meeting a week. I talk to another six company founders every week or every other week. I talk to an additional five company CEOs at least once a month. The others are further along and I talk to them once a quarter or so. On average each of my companies has a follow-on financing every 12 months so I evaluate a follow-on opportunity twice a month.

Given all that, here's how I spend my time:
  • Two days a week generating deal flow,
  • One day a week filtering deals that I see,
  • One day a week doing due diligence/negotiating terms/reading contracts/building syndicates on deals I like,
  • One day a week at or preparing for a board meeting,
  • One day a week talking to other portfolio founders/CEOs to see how they're doing,
  • One day a week looking at material/giving advice/making introductions for the other portfolio CEOs,
  • One day a week networking with other VCs/corporate types/other innovation professionals and answering random email,
  • One day a week keeping on top of industry developments and emerging technologies,
  • Half a day a week looking at follow-on opportunities,
  • Half a day a week making sure the i's are dotted and t's are crossed.
That's ten days a week. That's why I haven't answered your email.

Ok, maybe that's what I should do. Here's more like what I actually do:
  • One day a week trying to make sure people don't forget I exist: blogging, emailing people I haven't seen in a while, tweeting, coding stuff I think is interesting and putting it on the web,
  • A few hours a night trying to figure out what the hell is going on and trying to continue learning new things: reading everything I can get my hands on,
  • One day a week going to board meetings and talking to my other portfolio companies,
  • Half a day a week filtering the inbound deal flow,
  • One day a week looking at companies I think are especially interesting,
  • Half a day a week evaluating follow-ons, reading legal docs, keeping track of the portfolio as a whole,
  • One day a week meeting new people--entrepreneurs, people in the industries I'm interested in, other investors, random people friends say I should talk to, etc.,
  • One day a week prepping for, teaching, or doing follow-up for my course on entrepreneurship at Columbia.
That's six days. And that list is still a bit aspirational. I never get everything done. Tradeoffs.

Institutional VCs have to make tradeoffs too. For them a little bit of the stuff in the first list can be delegated (making sure the Is are dotted and Ts are crossed, some of the initial filtering of deals, some of the due diligence, a little bit of the helping portfolio companies.) And some of the stuff is made easier when you work in a team (filtering deals, evaluating follow-on opportunities, keeping on top of industry developments, networking.) But there's a reason most of the best VC firms--and all of the best early-stage VC firms--are partner-based, not hierarchical: almost all of these activities for any given investee or prospective investee need to take place inside the same brain if the process is going to be high function.

Angel investors don't have the advantage of delegating. And working in a team is usually pretty ad-hoc (unless you're part of an angel group, which then adds some overhead of its own) so trade-offs become more important. Angels (and super-angels and very small seed funds) choose different trade-offs. Some focus entirely on generating deal-flow but making sure someone else leads the deal: they do less evaluating and more networking. Some focus on adding a ton of value by knowing the industry they invest in extremely well: they do less deal generation (deals in their field show up on their doorstep) and more helping. But most fall somewhere in the middle.

I've made tradeoffs: I try to know the industries I invest in and so do more work on understanding specific sectors and a bit less work on generating deal-flow; I tend to invest as early as possible, so do more work trying to understand the founders and less work trying to understand what the company has done to date; I try to co-invest with people I trust so do more work talking to other investors and less negotiating terms and iterating legal docs; I'm an engineer so I spend more time building tools to do my work so I can spend less time doing the work; I'm not much of a schmoozer so I need to earn my keep by sitting on boards and helping founders. Luckily, this then cuts back on the time I need to spend networking.

Even so, it's pretty all-consuming. But if you hope to build a portfolio that gives you a reasonable chance of making money, all of the tasks in the first list are needed. How you spend your time getting those tasks done depends on your personality and your expertise. Figuring out what tradeoffs work for you is probably the most critical decision you can make.


Next: Positioning How to be Different When What you Sell is a Commodity

Previous posts in this series
  1. Intro: Why I'm Not an Angel

Wednesday, March 20, 2013

Why I'm Not an Angel

If you bootstrap your business it's your prerogative to make any stupid decisions you want--so long as you don't run out of money. But if you decide you want your bootstrapped business to be as successful as possible, you probably make pretty much the same decisions a businessperson backed by outside capital does. The process you use to grow a successful business does not materially change because of how you are funded.

So why do angel investors invest so differently than institutionally funded venture capitalists? Angel has come to be a bit of a pejorative, connoting a certain hobbyist nature, an unseriousness, amateurism. When entrepreneurs tell me they don't want venture firms in their seed rounds, just angels, my antennae go up: what are they afraid of, competence? I stopped calling myself an angel investor some time ago; I try to think about myself as a bootstrapped venture fund, doing the same job with the same professionalism on a smaller scale.

Every would-be angel I've met takes pride in their day job, they would never settle for stupid or unprofessional in their work. Even in their hobbies they would not be satisfied with sloppy or half-done. They are serious, successful people who have made their way by putting in the work to do their jobs right. So why, when they think about angel investing, do they impatiently jump right in with only half-assed attempts at learning how to do it right? Why do people who would never sit at a high-stakes poker table with hard-eyed strangers unless they had spent countless hours at lesser tables put tens of thousands of dollars into a startup without bothering to learn the rules, the odds, the other players?

Venture investing looks so easy from the outside. The public faces of VC--Fred Wilson, Mark Suster, Chris Dixon--are encouraging and open, willing to give pithy advice on the dos and don'ts. People like to talk about what they've done right and how more of that needs to be done. They don't tell the stories much about bad times, hard decision and all the work they did to create the few bright spots they write about. They like to make it look easy. If you read the VC blogs, you must wonder how they manage to fill their days when all they do is wander Union Square bumping into top-notch entrepreneurs, writing them checks on the spot, and then flipping the companies to Google or eBay for hundreds of millions of dollars. Union Square Ventures only invests in a handful of new companies each year--with five investing partners. Each partner only does a deal or two per year? It must be like a tropical vacation. Right?

In the New Yorker's recent portrait of Bruce Springsteen the author makes this distinction: "Keith Richards works at seeming not to give a shit. He makes you wonder if it is harder to play the riffs for 'Street Fighting Man' or to dangle a cigarette from his lips by a single thread of spit. Springsteen is the opposite. He is all about flagrant exertion." Many VCs are trying hard to be cool as Keith Richards. And hey, why not? If you can convince people that you invested in a billion dollar outcome by ignoring the dismissal of all of your peers and the common wisdom and instead just trusting your gut, or that you found the next big thing just walking the floor of a tech company occasionally glancing over engineers' shoulders at their screens, well that's probably about as cool as you can pretend to be if you're a financial intermediary.

But playing the guitar like Richards actually takes a ton of work and an enormous amount of repetitive practice, whether he acknowledges it or not. I'm here to tell you that Springsteen is being more honest than Richards: VC swagger is pure BS. Writing a check is easy; creating a decent chance of getting a bigger one back down the road is hard, damn hard.

Prospective angels ask my advice all the time, as one of the few people on the east coast who has made a living as an independent venture investor lo these many years. I'm happy to answer their questions, but I don't think any of them has ever taken any of my advice. Ben Franklin said "wise men don't need advice, fools won't take it." But I'm an optimist, so advice will follow.

This will be several posts, broken up into bite-size chunks. I will do my best to suppress my usual rambling ranting. Nothing I write in any of these posts is new. If you did your homework, all this would be old hat. That's part of the point: I'm going to lay out a score of pages to convince you that to be a successful venture investor you don't have to be a super-genius, you just have to actually do the work. The main take-away should be that there are no shortcuts.

Some caveats. I'm talking about a specific type of venture investing here, the kind I engage in. Investing in people that can use some modicum of cash to attempt to build a world-class company in a fairly brief period of time. I'm not talking about funding your cousin's restaurant or your buddy's bar. Those worthy endeavors have a different logic.

I'm also talking about aiming for a positive return on your investment. If your primary goal is to help out friends, give back to the community, or support a worthy idea then you don't necessarily care about how much money you make. I'm not going to give advice on how to manage for a non-monetary outcome. I believe in positive returns, not least because if you run out of money you no longer have the wherewithal to fund worthy ideas.

How would professional venture capitalists invest in super-early companies with small amounts of money if they didn't have the huge amounts of cash potentially needed to single-handedly fund the company through to exit and didn't have gigantic well-known brands? Because that's what angel investing is.

Next: The Life of an Angel. The Work-Work Balance (Angel Investing 2)

Monday, March 4, 2013

On being an asshole

Here's something you didn't know about me: I'm vaguely claustrophobic. It doesn't mean much in practice, but when I was at the last TechStars demo day at Webster Hall, I watched the presenters from the same place I watched the Beastie Boys in 1985, the Mountain Goats in 2008 and every concert in between--the back left, right near the door, the stairs, and close enough to the outside to make it tolerable.

It's a little different in the back. Fred Wilson and Brad Feld are right up there in the front row representing, while us riff-raff are standing by the bar wishing it was open. I like the back row. My best friends from college are the ones I met sitting in the back row. When David Soloff came to talk to my class at Columbia, he paused a few minutes into his profanity-laced tirade about entrepreneurship to poll the class: who was uncomfortable with his swearing? Several hands in the front row went up. Who thought it added to the discussion? Several hands in the back row went up.

Some of the people in the back row are the studied cool. But some others are the actually unenthusiastic. The back of demo day was no different. On one side were people like Andy Weissman, Chris Wiggins and Taylor Davidson, all trading notes on which founders we found particularly awesome, who already had funds committed, the amazing amount of progress some teams had made during that session of Techstars, and, in general, gratefully soaking in the condensed learning of months of hard work by talented and smart people.

On the other side of me were a group of people loudly telling each other how ridiculous the ideas were, how the companies were going to crash and burn, how stupid and sheeplike the investors were for giving them money, etc. You know what they were saying, because our ecosystem is flooded with this type of talk. We see it every week in the tech press when some formerly high-flying company starts to falter. We see it every day in the comments on Hacker News. We hear it when we have coffee or drinks.

And it's not just envious wannabes saying these things. I've heard venture capitalists, big company executives, startup employees, lawyers, angel investors, students, and professors bash entrepreneurs. Every sort of person except other entrepreneurs.

Chris Dixon said there are two types of people in the world: people who have tried to build a company and people who have not. This ruffled the feathers of people I know in the innovation community who have never been an entrepreneur because it implies that those who haven't been entrepreneurs should just shut up and sit down. That's not exactly right, but it is true that people who have been through the process of trying to start a company do not, as a rule, engage in destructive and pointless criticism of other entrepreneurs. Not that non-entrepreneurs all do, just that entrepreneurs don't.

There's a difference between criticism and critique. One is destructive, the other constructive. Entrepreneurs who have been through the grinder, who have been "dismissed by arrogant investors who show up a half hour late... having pundits in the press and blogs who’ve never built anything criticize you and armchair quarterback your every mistake" (as Chris puts it) don't then turn around and do that same thing to other entrepreneurs. Because they know from experience that it's pointless and results in pointless pain.

The people who call entrepreneurs stupid, who bludgeon them with their mistakes and try to humiliate them in public rationalize it by saying "we're being direct, open and tough--just like the real world." They are egregiously wrong. That's not the form that either education or motivation takes in "the real world." Unless by real world you mean our schools or government where the highest goal is creating the conformity needed to staff middle management at our large industrial age corporations. Entrepreneurial zeal does not survive that.

I once asked a Swedish founder what the difference between starting a company in Sweden and in the US was. He said that in Sweden there is a saying: "the tallest poppies have their heads cut off." Those who are outstanding will be cut down so they no longer stand out. He believes this attitude prevents many Swedes from deciding to strike out on their own. I wish this were particular to Sweden (no offense)--or to any one place that wasn't here. But it isn't. It's not even a Swedish saying, it's a universal one. It's first recorded use is in some of the first recorded history, Herodotus. The context then was to enforce a more homogeneous community in order to better control it. This is still its use now. This attitude is the absolute antithesis of what we are trying to do in the entrepreneurial community. We are not cutting the heads of the tall poppies, we are letting a thousand flowers bloom, praying that one of them will be taller than all the rest so we can then plant its seeds and someday all the poppies will be tall.

If you've been through the pain of starting a company, you know that criticism is entirely useless. If you haven't, and you find yourself in the back of demo day wanting to cut down the people brave enough to have made it up onto the stage, you need to think hard about it. Think about the difference between criticism and critique. Think about the difference between extrinsic and intrinsic motivation and how entrepreneurship is predicated on the latter--the carrot, not the stick. Think most of all about whether what you are doing and saying is helping founders succeed, even if their success is not something you will be part of. Because if you don't believe that their success helps us all, no matter whether we are involved in it or not, then you are in the wrong room.

At least you're near the exit.