Babbling VC

Think Wisely About Your Business Angels

You often see advice on picking your VC. I've written often about this topic. Yet you hardly ever see much about angels. Sure, it's even harder to get angel money than it is venture capital. But nevertheless, you should always consider the consequences of raising money and the person who gives it to you. It may have longer lasting consequences than you ask for.

I've been noticing quite a few "spats" over the last couple of months, very often involving business angels or something having to do with them. I'm sure this is nothing new but it's become quite obvious as of late. Lots of angels are in a poor situation be it because of the recession or poor investment decisions in the past. Actually, it's probably both but some have it worse than others (kind of like the VC's). Those angels who pursued "spray & pray" strategies have a lot of investments which they will never realize a return on. This makes them quite nervous and also unpredictable in your decision making process. If nothing else, they are so busy firefighting that they simply won't have time for you. In general, very nervous or preoccupied investors never make for good support. Oftentimes, in-fighting breaks out which does nothing but deter your start-up from being successful. It also becomes an every man for himself situation and this obviously isn't optimal. Early on, you need all the focused help you can get.

Even worse is that lots of angels have been burned. For example, here in Germany you have at most a 10 year phase now of visible angel investing. There were angels before but these were mostly high net-worth individuals who dabbled here and there, usually within their industry (typically not tech if 10 to 15 years ago or earlier). In the late 90's though you had lots of folks making quick money on the bubble. Many of them went into angel investing thereafter. Actually, I hardly know of any entrepreneurs who exited back then who didn't do some form of angel investing after a successful exit. These weren't necessarily highly experienced managers. They were out to make a buck and didn't necessarily play fair. After what is now a fairly long period, many have already been weeded out. Yet, quite a few remain and due to their behavior they may be caustic to your fundraising process. You definitely need to avoid this as there is nothing worse than not getting meetings with investors simply because of whom you have in your investor syndicate. 

There are great angels out there. I am happy to have seen many of them establish themselves over the 10+ years I've been in venture specifically here in Germany and in general in Europe. These are the guys from whom I receive a majority of my dealflow. They are out there and if you talk to VC's, you should ask them who they know and like. I quite often steer really early stage guys to angels whom I respect. This is a win-win situation as they get a good deal and I know down the road, I may have a better chance of investing in that business. In general, business angels aren't necessarily the easiest people to find and approach. If you ever are planning on launching a business with angel money, start the process early of identifying them and finding out how they tick.

Your VC Must Really Suck

At least that is what you'd think was the case for most start-ups. The past couple of months I've been seeing quite an upswing in posts bashing VC's. Not only are the VC's themselves being abused, so is their performance. Fortunately, this reminds me of 2000. After the Internet bubble burst, VC's were the bad guys. They were the ones caught up in irrational exuberance. Their business model was broken and they were all finished.

Well, fast forward 9 years and let's take a look at what we have. The industry has significantly consolidated. Less new funds are being started and lots of the ones out there are running on fumes. Venture partnerships are structured over ten year periods hence the next couple of years are going to be brutal, especially for funds started in 2000 or later. Nevertheless, we are returning to normal.

The upswing in the number of funds was a one-time event back in the late 90's. There were so many funds out there in 2000 that it wasn't a sustainable level. Hence, the market is correcting and we are coming back to a normal number of funds in the market. You'll have far less funds in Europe when compared to the US but both geographies are seeing a significant decrease.

Back to my original thought. If your VC is still around, has 10+ years of track record and has raised multiple funds, they'll probably be around for a while longer. Yes, the industry is changing but players have established themselves in their respective markets. Those who survive do so because they deliver returns. Are there assholes out there who manage to somehow continue to survive? Yes, there sure are, as is the case in every industry. Is it to be believed that the majority of VC's out there though are crap and not worth taking money from? Well, that's up to you to decide if you're raising money. As I've written before, no one forces you to raise money from VC's. Should you believe all the bad press on venture capital? Well, take it with a grain of salt. Educate yourself and don't depend too much on the people whining online about how bad things have become. The best funds are still out there banging out good deals.

What Kind of Deals am I looking At

I've been asked the past couple of days where I see opportunity in terms of spaces to invest. Well, I wish I had an all-knowing crystal ball but I don't. So my best guess based on what I've seen the past 12 to 18 months and where I am focusing most of my attention is as follows:

I still believe the mobile sector in general is solid. We see that the growth of smartphones is continually speeding up and ever more people are accessing the internet via mobile. With flat data rates coming down in price and 3G networks expanding, you have a perfect opportunity for innovation. I am still bullish on this sector, although we've often seen ideas where we believe it may be too early. When it comes to innovation on the mobile, I am looking for things which solve large problem with simple solutions. Without giving up too much information, I have a couple deals in the pipe right now with cool ideas. In short, with the amount of time I see people around me daily playing around with their phones, I can't imagine some of the bigger exits not coming from this space.

I've said it before and I'll say it again. Customer service and customer retention are hot, whether someone is hyping it or not. I believe some of the best opportunities out there to innovate are around helping companies deal with their customers, deliver them the best possible service and make sure they don't leave. As examples, I love what Zappos does, I'm excited around the prospects for GetSatisfaction and I like the idea behind Spotfire software (owned by Tibco). Unfortunately, I am seeing too few exciting businesses in this space out of Europe at the moment.

Another space which I believe is improperly addressed to date is location based services. Once again, I may sound like a broken record on this one but I have faith. I want services delivered to me based on where I am. Unfortunately, I'm kind of tired of all these "see where your friends are" apps. They are interesting to an extent but there just isn't a business model. At the same time, I want a service that for example knows I'm at the train station or in the subway, which pushes information to me on routes and timetables based upon my previous travel activity. I'd love a service which tells me where people go to eat after having eaten at the restaurant I'm sitting at. Sense Networks are definitely on to something with their Citysense application. Track other peoples' activity, learn from it and fill me in. These are things I am willing to pay for.

There you have it. Hope this helps for those of you who asked. This is where I am focusing my search and am most excited about ideas coming out of these three areas. Nevertheless, I may be totally off on timing, hence I continue to track other areas opportunistically.

UPDATE. I did leave out one space which I was just asked about and that's cloud computing. Yes, in general I am looking at everything "cloud" but I find the segment too broad at the moment and can't say I've narrowed down where I'd place my bets. Further, I believe cloud encompasses so much of what's already out there. It reminds me a lot of cleantech a year or two ago. Everything and anything COULD be cleantech as long as it had a certain angle. I feel that is the case now for cloud computing. So, am I looking at it? Yes but with a very critical eye. Seems like a lot of repackaging is taking place at the moment.

Just One More: Customer

I'll keep this short since it's fairly simple. The rest of the world is not you, nor your family, friends or network. We tend to live in bubbles thinking that lots of other people think the way we do. They don't!

If you are launching a product or a service, make talking to potential customers your passion before launching. I so often see businesses where basically people tell me they are pretty sure they'll be able to find customers. They all too often can't provide proof for this though. Spend the time interviewing potential customers. Find those people who are farthest away from you in terms of their thinking and see if they're willing to spend money on what you have. After you've talked to all of them, go find one more person to talk to. It's always better to have just one more piece of information. Interviewing the people you know and a "couple others" just isn't enough. The process has to be structured to some extent and needs to give you a good market set.

Of course, you have to know when to stop and just go ahead and launch. This is the fine line we all have to walk when setting out with our own products or services. It's foolish though to not do you homework. If you "build it", they will not necessarily come. Do your best before going out and building it.

Would the Real VC & Entrepreneur Please Stand Up

There is often conversation about what makes a great VC. The typical buzz words surrounding value-add, network, recruiting and so forth usually pop up. The same goes for entrepreneurs and their companies with their own set of buzz words. Yet, the reality is a bit different and I'm going to define it quite digitally. Who do I think the best entrepreneurs are? The ones whose companies deliver the greatest returns on my investment. I don't really need to like them, nor be friends with them and so on. I just want to make sure that I get loads more money back than I've invested. The same goes for VC's. My LP's (the investors in our fund) don't really care much about me personally. Nor do they really care whether entrepreneurs like me or not. They simply do a calculation every time I come to raise additional money. If I'm not delivering a significant multiple on their invested capital, I'm out of luck.

Let me clarify one point. There are obviously characteristics for both VC's and companies which lead to one or the other being the best at what they do and they matter. If you're a total dick, eventually entrepreneurs are going to stop coming to you. Same goes for the entrepreneur. He or she won't be able to hire employees, no one will work with him and so forth. There are so many interlocked characteristics which lead to success and I am the biggest proponent of these characteristics. That is not the purpose of this post though.

Ultimately, what makes a great VC or a great company is a matter of perception and varies based on whom you ask. I laugh a bit when reading lists written by one or the other. Sure, you may be a great VC in the eyes of an entrepreneur but if you aren't delivering the necessary returns for you LP's, you just aren't good. Same goes for some companies. They are a joy to work with and you end up making friends, etc. Yet, if the company isn't delivering a VC-like return for you, it's just not good.

Be Prepared for Your Pitch

One thing to remember when pitching to a VC is that you have to be prepared. When I say prepared, I mean in regards to questions which are going to be thrown at you. Further, when I refer to questions, I mean the questions VC's are going to ask. Specifically, you will hear most of the following questions if you are very early stage and are trying to get me excited about your idea (obviously this is not an exhaustive list):

Customers:
1.  Who is your target customer?
2.  Why will this customer buy from you?
3.  Have you done market testing?
4.  How many potential customers were you able to test your product on?
5.  Will these customers be willing to pay for your product?
6.  Will they only pay once or continue paying?
7.  Do you already have paying customers and if so, how many?
8.  Are you talking to your customers regularly?
9.  Has customer feedback gone into tweaking the product?

Product:
1.  Who developed the product? In-house or contract developer?
2.  Is the product done and if not, what remains to be completed?
3.  What is the underlying technology?
4.  How easily could someone copy your product?
5.  Is there a competitive product in the market already?
6.  How long did it take to create/complete your product?
7.  Are you using the product yourself?
8.  What did development cost?
9.  How will you tweak the product in the future?

Market:
1.  How big is your market?
2.  Is your market Germany, EU, World?
3.  How much of this market do you want to win?
4.  How will you address your market?
5.  What is it going to cost?
6.  How well do you know your market, i.e. have you worked in the target market?

Employees:
1.  How many do you have.....full-time, part-time?
2.  Do they have options?
3.  What kind of salaries are you paying (going to be paying)?
4.  How long have they been on board?
5.  Has there already been churn and if so, why?
6.  Who are your future hires?
7.  Do you have specific people in mind when it comes to future hires or will you need a headhunter?

Management:
1.  How many of the managers are founders?
2.  How much of their own capital have founders/management invested?
3.  What are current and future (post-financing) salaries of management?
4.  What additional management hires are necessary?
5.  What are the weaknesses of current management?
6.  Do you have company cars (yes, I will ask this!)
7.  Is the complete management team in one location or separate offices?   
8.  How often does management meet as a group?
9.  How long has the management team worked together?
10. Has management had previous exit experience?
11. Has management been part of venture-backed companies previously?
12. Has management previously worked in start-ups?

Financing:
1.  How much are you raising and why?
2.  What will you initially spend the money on and how are you prioritizing this?
3.  How much time did you plan to complete fundraising?
4.  Are you looking for one or multiple investors?
5.  Do you have a valuation in mind? (Of course you do but is it negotiable?)
6.  Are you current investors participating in the round....pro-rata or more than that?
7.  If the current investors aren't participating, why is this the case?
8.  Are future rounds planned?
9.  Will an ESOP be part of the current round?
10. How long have you already been out fundraising?

Miscellaneous:
1.  Why are you talking to us? (Seems like a no-brainer but you'd be surprised how often people stumble on this one!)
2.  What do you expect from me outside of cash?
3.  Have you done any reference calls on us?
4.  Would you like me on your board?
5.  How much time do you expect me to invest as an investor?
6.  Have you ready my blog? (Yeah, I do ask this every now and again but only when I sense that some is prepared!)

Again, this is not an exhaustive list. I thought I'd just do a brain-dump of things that come to mind. I hope in some way this gives you a sense of the types of things we throw out when hearing a pitch. Maybe it's helpful when meeting with other VC's as we do tend to ask similar questions. Nevertheless, don't presume we've read all of this beforehand in your business plan and know it already if it's in there. We want to have a discussion with you and get your answer in person when you are pitching to us. The more questions I ask, the more interested I tend to be.