Thursday, April 25, 2013
Andy Weissman on entrepreneurship, product development and the future of the Internet
Andy Weissman is a partner at Union Square Ventures and one of my favorite people in the startup world. He was a co-founder of Betaworks and was previously at Dawntreader and AOL. His easygoingness belies the fact that he's one of the most thoughtful investors in the business.
Andy came up to talk to my entrepreneurship class at Columbia University's engineering school. I have people from the startup world in class every week. The point is not to have them teach, but to have a conversation with the class about what it's like to be an entrepreneur and to be part of the innovation economy. If the three turnings of the wheel are learning, knowing, and enlightenment, the speakers bring about the second: not what we do in the innovation economy, but what we are. Andy's talk is a great example.
Andy talks about what an entrepreneurial environment looks like--even in a company that's no longer a startup, how Betaworks did product development, where he sees business on the internet going, and what USV looks for in a startup. Andy's a really approachable and engaging speaker and I wish I could have had him talk twice as long.
Some marks:
0:00 - Intro, Andy's early career, at AOL
7:17 - Starting Betaworks
11:52 - Joining Union Square Ventures
13:47 - AOL diaspora
14:49 - Background of entrepreneurs
19:14 - Entrepreneurial environments--autonomy and empowerment
21:34 - Life after an acquisition
22:30 - Ideation and product development at Betaworks
30:55 - Evolution of internet business
33:20 - Next stage in internet business evolution
40:21 - NYC's internet ecosystem
44:39 - Is there a 'New Tool' now?
45:56 - Future of the internet
48:16 - What is USV looking for in a startup?
53:06 - Balancing data and gut feel in evaluating your startup idea
55:54 - Regrets?
56:32 - Most intriguing company he hasn't invested in.
If my fourteen-year old got her hands on this video it would have jump cuts and pan zooms and a swelling soundtrack and lots of duck-faces. Instead you get what you get: occasional bursts of static and a weird pan to the previous class' blackboard notes. And no, I have no idea what those equations mean.
Monday, April 15, 2013
A Tool for Open VC Data
A week ago I posted an idea for VCs to share their investments in machine readable form from their own websites. This is the simplest possible way to open up that data without relying on an intermediary that might either become a middleman or a bottleneck.
The first pushback on the idea was that VCs valued being obscure and so wouldn't cooperate. I wrote something in Forbes yesterday in response. The subtext is that some VCs won't share data but there's nothing you can really do about it except recognize that the ones who do share are probably better partners for entrepreneurs.
The other criticism came from Greg Yardley who emailed me to tell me that the sample investments file I put up had a syntax error. I had missed a bracket. Javascript is fiddly. To help me out he put up a tool with a user-friendly front end to create the portfolio objects. This should help you out too if you're going to put one up on your site.
He also improved the spec. He renamed the file from portfolio.js to investments.js--a more accurate description--and added things to the spec that real computer people have, like a version number. The new spec is here.
The tool is at VCDelta.org. It does several things:
- You can create a new investments.js file. This also has the very cool feature of being able to import your existing Crunchbase data to use as a starting point. Huge time saver.
- You can edit an existing investments.js file, the site copies the data from your website.
- Copy-paste it using a text editor or some-such,
- Save it on your computer as "investments.js",
- Upload it to your site using an FTP client, then
- Let me know! Email me, tweet me (@ganeumann), tweet to @VCdelta, comment on this post or whatever and I will put you on the list of known investments.js files.
Thank you Greg!
Monday, April 8, 2013
A Mechanism for VC Deal Transparency
[Edit: Greg Yardley has built a tool to implement this. I talk about it here.]
There was a bit of a brou-ha-ha last Friday over VCs not publicizing their investments. I was dubious: I've never met a VC who didn't want the world to know about every investment they make. It's a crowded market and letting entrepreneurs know you're making investments lets them know, well, that you're making investments. All of us investors need to let the world know we continue to exist because if we don't, we soon cease to exist. Publicity around deals is by far the easiest way to do that.
But over the past few days I was challenged by entrepreneurs to provide more information. "Through what mechanism?" I asked. There was no good answer. Crunchbase, great for what it is, is not a good mechanism. Perhaps the entrepreneurs don't realize this (or perhaps I'm doing it wrong) but even though CB is wiki-like, I can't edit the "Investments" section of my page; I think only CB admins can. Because I'm never sure what the process is, I have neglected it. But there should be a mechanism to update our portfolios and it needs to be Internet-y: simple, end-to-end, machine readable.
It's okay if a VC does not want to share information. Those that share information get more attention, more love from entrepreneurs, and better deal flow. At least that's what I believe. And I've had many VCs bring themselves to my attention so they can be added to VCdelta's scrape. I do what I can.
But here's the rub: I don't like being a bottleneck. I'm providing a service and it's automated so it doesn't take much time*. But being a scraper, it breaks. And then some firms decide to use technologies that are more viewer friendly that VCdelta is not set up to handle, like AJAX or Flash. Some firms use images on their portfolio page that have no company name associated with them. I don't have time to make it better. And, in my own opinion, it pretty well sucks right now. Firms like Intel Capital have never been included. First Round Capital broke after they moved to an AJAX portfolio page. Etc. These are important firms, and I don't have time to get them back into the program.
So I have a proposal. If investors want to publicize their deals in a usable way while not relying on a third-party gate-keeper, then we need some common language and setup to communicate. It should be simple, hosted on the VC website, and machine readable. Something like this, my investments**.
It's a Javascript object. It's machine readable. E.g. in python:
import urllib2, simplejson as json
portfolio = json.loads(urllib2.urlopen("http://neuvc.com/investments.js").read())
The object is formatted like this:
[{"company":"companyname1",
"url": "http://www.companyurl1.com",
"rounds":[ {"Series": "Seed", "date":"06/2009"},
{"Series": "A", "date":"04/2010"}, ...]},
{"company":"companyname2",
"rounds":[ {"Series": "Seed", "date":"08/2008"}, ...],
"events":[ {"event":"Sale to BigCo", "date":"10/2012"}, ...]},...]
My proposal is that investors put this type of file up on their homepage and keep it updated. If we roughly agree on a format and location third-parties can easily find out what we are doing. This is not my standard, it is a proposal for a community standard. I disclaim any ownership of it. If someone wants to publish a similar format for funds raised and fund personnel, please do. I'm a one-person, bootstrapped operation so don't feel my opinion is of much weight for those.
If you decide to use it, let me know. I will have @VCdelta tweet any firms that adopt it.
You may or may not believe that investors are being transparent enough, but some of our customers believe we are not. This is a mechanism to address that, if enough people choose to adopt it.
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* Normally I would publish the code, but it was built accretively so it's spaghetti and I'm embarrassed to have anyone else see it. I have had on my list to rebuild it from the ground up, but it's been on my list for 18 months.
** There is one investment not on the list because the entrepreneur has asked me not to disclose yet. The wishes of my entrepreneurs trump your need to know. Sorry.
Thursday, April 4, 2013
The Signal and the Noise (Angel Investing 6)
[Note: Post Number 5, on modelling your portfolio, was supposed to be next. Then I asked my friend Chris Wiggins a naive question about power law distributions. In return he sent me this paper. And this software. And this syllabus. And this paper. And this video. And also this talk he gave, which was above my pay-grade. And then I read the papers and watched the video and I was enlightened. And then I ran the software and it told me that the returns in the AIPP data were not power law distributed, that it was far more likely they were log-normal distributed. And I knew there would be a whole 'nother set of papers and videos and online coursework. And so I threw up my hands and wrote this post instead. I'll get back to the other one when my brain recovers.]
A long-time VC at a top tier firm said to me the other day: "we used to talk about proprietary deal flow, but that doesn't exist anymore. Good ideas can get in front of anyone and good founders make sure they do." Mahendra Ramsinghani* makes the same point yesterday on PEHub. It's true.
There was a time, say three years ago, when you could see great deals that no one else saw. That time is gone. Great deals are seen by plenty of people. Anyone can easily invest alongside me, or David Lee of SV Angel, or Founder's Fund, or almost any other great investor.
But this does not mean that you will automatically see great deals. Deals don't just suddenly start landing on your desk the day you decide to start investing. You need to make yourself known, then you need to make yourself wanted, then you need to make yourself needed. That takes some work.
And then, as soon as you start generating signal, you have to deal with the noise.
As an investor you will see a lot of potential investments for each one you make. Venture capitalists say they see 100 plans for every company they fund. There are a few reasons for this:
- Most businesses should be friends-and-family funded, or bootstrapped**, not venture funded;
- Most startups that should be funded should not be funded by you; you should invest in what you know: the people, the market, the types of activities the firm will need to excel at to thrive;
- You may see several companies solving the same problem at the same time, but you probably don't want to have too much bet on a single problem;
- Related, you will need to say no to good companies because they are too similar to companies you've already invested in;
- You won't know which are the best new companies unless you are seeing a lot of them***, you won't know where the market is pricing companies if you aren't talking to a bunch of them, you won't know what problems companies in that industry are facing, you won't know which other investors are actively in the market, etc.
Once you open the door to any and all deals, you're drinking from a firehose. You can't look at everything. You need a mechanism to filter for the deals that fit your criteria, and you need to do it in a time-effective way. That may be the harder part of deal flow: not quantity, and not quality exactly, but finding the needle in the haystack.
Ramsinghani correctly chides the VCs he's invested in to no longer consider proprietary deal flow a competitive advantage. But I don't think it means what he thinks it means. VC investing has become democratized. But the result is not that everyone now has the same advantages, it means that everyone now has the same problems. Established VCs have processes to separate the signal from the noise. You need them too.
Next: Generating deal flow
Previous posts in this series
- Intro: Why I'm Not an Angel
- How to spend your time: The Work-Work Balance
- Positioning: How to be Different When What you Sell is a Commodity
- Portfolio Construction: Transcending Hobbyism
- Data sidebar: AIPP data summary
- Data sidebar: AIPP exit data
- Portfolio Modelling: TBA
* Who, btw, wrote the book on venture capital as a profession: The Business of Venture Capital
** For many reasons--the return needed to compensate for the risk around a raw startup, the need to get to a cash exit (not just a sustainable business), the principal-agent risk, etc.--most startups should be self-funded or backed by friends and family or supported by the founders starting the company on the side. The National Venture Capital Association says that in 2011, only 973 startups received their initial venture capital funding. CB Insights has said closer to 2000. In comparison, the Bureau of Labor Statistics says that in March 2011, there were 536,445 establishments less than a year old. These numbers are not apples-to-apples, but the point is that far fewer than 1% of new businesses take venture money.
*** Saying this may rub some entrepreneurs the wrong way, they don't want their time wasted responding to fishing expeditions. I agree. Do not waste entrepreneurs' time. Be honest. As soon as I decide I'm not investing, I tell the entrepreneur. If that's before the pitch I also often tell them that I would be happy to sit down and hear their pitch anyway. Many times they take me up on it. In return, I try to be helpful: constructively critiquing their plan, offering to make intros to portfolio companies or other potential partners, etc. My existing portfolio companies always come first, but in almost all cases in the startup world, the competition is not other startups, but established companies. I like helping startups, and if I can help without disadvantaging the companies I've already made a commitment to, I will.
Monday, April 1, 2013
AIPP Data Modeling (Angel Investing, Sidebar 2)
More from the Angel Investor Performance Project data.
Much of the financial activity at early stage companies happens around investment rounds. Acquisitions, failures, and fire-sales tend to happen when it's time for the company to raise more money. So it doesn't make sense to look at rates of failure or exits divorced from the fund-raising process.
Here's a look at the AIPP data from the last post. Company exits and the sale multiples by years held. A zero multiple means the company failed.
| Sale Multiple | ||||||||||||
| Year | 0 | 0-1 | 1-2 | 2-4 | 4-8 | 8-16 | 16-32 | 32-64 | 64-128 | 128-256 | 256-512 | >512 |
| 0 | 5 | 3 | 0 | 1 | 0 | 0 | 0 | 0 | 0 | 1 | 0 | 0 |
| 1 | 22 | 8 | 3 | 35 | 1 | 2 | 1 | 0 | 0 | 0 | 0 | 0 |
| 2 | 36 | 24 | 6 | 5 | 3 | 1 | 1 | 1 | 0 | 0 | 0 | 0 |
| 3 | 25 | 6 | 6 | 8 | 21 | 1 | 1 | 1 | 1 | 0 | 0 | 0 |
| 4 | 29 | 8 | 3 | 39 | 1 | 1 | 1 | 1 | 0 | 0 | 0 | 0 |
| 5 | 14 | 23 | 7 | 6 | 1 | 0 | 0 | 0 | 0 | 0 | 1 | 0 |
| 6 | 2 | 2 | 1 | 1 | 1 | 1 | 1 | 2 | 0 | 0 | 0 | 1 |
| 7 | 1 | 5 | 6 | 0 | 0 | 1 | 0 | 0 | 0 | 0 | 0 | 0 |
| 8 | 1 | 2 | 1 | 1 | 2 | 1 | 0 | 2 | 0 | 0 | 0 | 0 |
| 9 | 0 | 0 | 0 | 0 | 0 | 2 | 0 | 0 | 0 | 0 | 0 | 1 |
| 10 | 1 | 0 | 1 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 |
| >10 | 11 | 0 | 0 | 0 | 2 | 1 | 1 | 1 | 0 | 0 | 0 | 1 |
Note the oddly large numbers in the 0-1 multiple range in years 2 and 5. My hypothesis is that these were companies that could not raise their next round (the A and the B, I assume) and went through a fire-sale, resulting in some money to the investors but not a gain.
What would Markov do?
This, I think, more closely corresponds to reality than the continuous assumptions most analyses take. Note that this roughly agrees with the common wisdom that 1/3 of venture-backed companies fail (here, 34% overall), 1/3 return capital (here, 19% overall are fire-sales so return >0x and <1x, but some bleed-over into slightly more than 1x returns could be attributed to the 1/3 "return capital") and the rest make money for the fund.
The AIPP dataset is not large enough to be able to make good predictions about sale multiples at each round. But if we assume that
- Venture investments as a whole make 25% p.a.;
- Venture funds end up returning 2x cash on cash on average;
- Seed is in year 0, any A would be in year 1, any B would be in year 3; and
- A sale after the B would be in year 6.
Full follow-on:
- 1.6 for pre-A sales,
- 4.4 for pre-B sales, and
- 4.7 for post-B sales;
- 1.6 for pre-A sales,
- 6.4 for pre-B sales, and
- 10.2 for post-B sales.
Actual multiples would follow a power law probability distribution, as noted in the first sidebar, with these as the means.
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* I doubt this is a unique result. In configuring the model behind these this seemed most reasonable to me given my experience.
** If you follow on, then you invest money in the A and B at a higher valuation, so your eventual multiple is lower, albeit on a larger investment.
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*.
| Multiple | |||||
| 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 | |
| Follow-on | |||||
| 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%) | |
| All | |||||
| 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 | |
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.
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* 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
- Intro: Why I'm Not an Angel
- How to spend your time: The Work-Work Balance
- Positioning: How to be Different When What you Sell is a Commodity
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* 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.
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