Investment Failure as an Angel

Last week I was catching up with a friend and he said he could never be an angel investor as he’s too worried the investment would fail and be worthless. I offered up that most angel investments fail and it’s better viewed as charity that helps entrepreneurs. Thinking more about it, investment failure doesn’t bother me for several reasons:

  • What Could Be – Investing is a leap of faith that there’s an opportunity to build a great company.
  • Opportunity to Learn – Every deal is different. Every market is different. Every entrepreneur is different. There’s so much learning with each investment.
  • Paying it Forward – Helping entrepreneurs is a core value for me. It’s what I enjoy doing.
  • Upside > Downside – If we succeed, the return could be 10x or 100x the original investment. If we lose, the downside is only the original investment.

Investment failure as an angel is never fun but the enjoyment and potential upside outweighs the risks.

What else? What are some more thoughts on investment failure as an angel?

Another Publicly-Traded SaaS Company Going Private

Earlier today Vista Equity Partners announced they were acquiring Xactly Corp (NYSE:XTLY) and taking it private for $564 million. Vista has already bought several public SaaS companies including Marketo for $1.8 billion and Cvent for $1.65 billion, among other acquisitions. Public markets are supposed to price in all known information, yet Benjamin Graham’s famous quote still rings true today:

In the short run, the market is a voting machine but in the long run, it is a weighing machine.

The idea is that opinions on public companies fluctuate, along with their corresponding stock price, on a regular basis. Only, over an extended period of time, their value is based on the underlying substance.

Let’s look at info on Xactly Corp from Google Finance:

  • Xactly Corporation is a provider of cloud-based incentive compensation solutions for employee and sales performance management.
  • 450 employees
  • Current annualized run rate $97.2 million
  • Annualized year-over-year growth rate of ~20% (hence slightly less than a 6x exit valuation on run rate not including cash on hand and debt)

For more information on Xactly, read the notes from the S-1 IPO filing.

For Vista Equity Partners, they must believe they can generate annualized double-digit returns on the investment. Here are a few ideas how they might do it:

  • Substantially Increase the growth rate through new strategies or direction
  • Roll up a number of smaller SaaS companies in the sales performance market grow much faster through an in-organic approach
  • Do nothing and believe that the momentum and potential for SaaS over the next 10 years is greater than what the public markets believe

My guess is that it’s a general bet on SaaS and better long term potential than markets price in. I’m interested to see how it plays out over the next 5-7 years.

What else? What are some more thoughts on another publicly-traded SaaS company going private?

Fast Growth and a Big Market to Raise Money

As a follow up to Common Investor Questions at The Atlanta Tech Village, one of the questions I received was why do investors have a hard time finding investment opportunities. There are a number of excellent startups with customers, management teams, and decent growth. Only, they can’t raise any money. What gives?

Just because the startup is making progress, without fast growth and a big market, most investors will pass. Fast growth is an indicator of product/market fit and latent demand for the product. Big markets present an opportunity to build a major business and generate out-sized returns. Investors often require both be present.

Most startups aren’t growing fast (> 100% year-over-year), even though they are a growth-oriented company (see the definition of a startup). They want to grow fast but haven’t achieved their goal. Most markets aren’t big enough to generate venture-like returns. Entrepreneurs pitch that their product serves a big market, but most of the time it’s a much smaller slice of the market.

Investors want fast growth and a big market. Startups that don’t have both rarely raise money.

What else? What are some more thoughts on fast growth and big markets as requirements to raise money?

Common Investor Questions at The Atlanta Tech Village

Several times a month I meet with investors from out of town that are interested in the Atlanta market and startups at the Atlanta Tech Village. With so much capital that needs to be put to work, investors are eager to find startups that have the beginning of a big business and the potential for strong unit economics.

Here are some of the common questions investors ask:

  • What startups should we be paying attention to in the building?
  • Any entrepreneurs we should meet with the next time we’re in town?
  • Do you have any startups doing X, Y, or Z (e.g. specific areas of interest like machine learning, health IT, marketing SaaS, etc.)?
  • Any startups growing fast with X to Y range of revenue (e.g. $1 – $2 million in recurring revenue)?
  • What events or programs should we consider for future visits (e.g. Atlanta Startup Village)?
  • Anything we can help with?

As expected, the questions from investors are fairly consistent as they’re looking for startups that meet their criteria and the opportunity to invest. Surprisingly, investors don’t have enough strong startups to invest in.

What else? What are some more questions investors should be asking?

Encouraging Institutional Investors to Buy 10% of the Angel Investor Equity

In last month’s post Why Not More Startup Success Stories, reader Jeff offered an interesting idea where institutional investors would be encouraged to buy 10% of the equity from the angel investors, assuming they’d be interested in selling. For most startup communities, there are very few exits resulting in long/indefinite delays before angel investors receive a return on their money and thus the rate at which returns are recycled back into the community is limited. If institutional investors more routinely bought a small stake from the angel investors — say 10% — that’d generate angel returns faster and allow institutional investors to buy a larger piece of the startup.

Here’s how it might look:

  • Angel investor buy 10% of the startup for $150,000 resulting in a $1.5 million post-money valuation
  • Startup achieves strong traction and raises a $3 million Series A at a $7 million pre-money ($10 million post-money)
  • Institutional investor that’s buying ~30% of the company (less the pro-rata from any existing investors that want to invest more) is willing to increase their investment up to $3.14 million such that the existing investor that owns 10% before the financing round can sell up to 20% of their stake which represents up to 2% of the company (10% ownership of the $7 million pre-money represents $70,000 for one percent) for $140,000 thus nearly recouping their initial investment while still having 8% of the company remaining (pre Series A investment)
  • Post Series A investment, and after selling 20%, the angel investor now has 5.6% of the company (8% diluted by 30%, not counting a potential increase in option pool)

The institutional investor would want the angel’s equity reclassified as the same type of equity as the Series A otherwise there might be a discount.

By encouraging institutional investors to buy a small piece of the existing equity held by the angel investors, angels are more likely to invest in other startups and capital will be recycled faster in the community. Entrepreneurs should consider asking institutional investors about this when raising capital.

What else? What are some more thoughts on the idea of encouraging institutional investors to buy a small amount of equity from existing angel investors?

Due Diligence for an Angel Investment

When raising money from angel investors, they often require a fair amount of due diligence to ensure the startup is what the entrepreneurs say it is and that it has proper record keeping. If the startup raises money from Institutional investors, like venture capitalists, the amount of due diligence increases substantially. Here are a few commonly requested items as part of due diligence from angel investors:

  • Operating agreement
  • Founder legal agreements like non-compete, non-solicitation, etc.
  • Cap table with any equity grants, stock sales, etc.
  • Customer contracts
  • Employee IP assignments
  • Financial forecasts
  • Financial statements
  • Recent bank statements

Entrepreneurs would do well to keep their legal and financial affairs in order generally, but especially so when close to the term sheet phase of the fundraising process.

What else? What are some more thoughts on due diligence when raising money from angel investors?

Raising Money as Forcing Function to Drive Towards an Exit

Recently I was talking to an entrepreneur that was working on raising money for his startup. After asking the normal questions including “why do you want to raise money”, he volunteered something I don’t hear too often: I want to raise money to bring on a partner that will position the business for an exit in a few years. The idea is that raising money will act as a forcing function to drive towards an exit.

Here are a few questions to think through:

  • Why not sell now? What additional value will be gained raising money?
  • What specifically is desired in a capital partner?
  • What’s the ideal timeline? What milestones need to be hit?
  • Are there any market dynamics at work that might improve or decline over the next few years?
  • How many more rounds of capital, and dilution, will be required to achieve the desired exit?

Planning for an exit in a timeframe is never really doable unless the business is profitable with enough scale to know that there’s an exit based on an EBITDA multiple to a private equity firm or other financial buyer. Most startups want a buyer that pays up based on growth potential, and those are nearly impossible to plan for confidently. Raising money does create more pressure to eventually find an exit, but isn’t a guarantee.

What else? What are some more thoughts on raising money as a forcing function to drive towards an exit?