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Marc Andreessen, besides having one of the best Twitter streams @pmarca, and an incredible blog, has a stellar track record as both an entrepreneur and investor. In this video of the week from the Stanford Graduate School of Business, Marc covers a number of excellent topics and provides a genuinely optimistic view of the continued disruption by technology.

From YouTube: Marc Andreessen, Co-Founder & Partner at Andreessen Horowitz, discusses his philosophy on investing in technical founders and the role of technology in today’s startups. Andreessen also addresses the kind of entrepreneurs and ideas his venture capital firm look for: “Big breakthrough ideas often seem nuts the first time you see them.”

Tucker Max has a new piece up titled Why I Stopped Angel Investing (And You Should Never Start) outlining some of his theories and lessons learned as a successful angel investor. With so much excitement and exuberance in the tech startup world, especially for angel investing, it’s important to understand some of the counter points.

Here are a few notes from the article against angel investing:

• 2 reasons he stopped angel investing:
  • There aren’t enough good people to invest in (and too much money is already chasing bad deals)
    • Poor education on going from tested idea to scalable company
    • Young and inexperienced founders thinking they know everything
  • Angel investing is a poor use of time
    • Majority of time should be spent on the best and highest use of skills, with everything else delegated or outsourced
• The biggest thrill in angel investing is that people flatter you and beg for your resources, and that makes you feel powerful and respected
• The entrepreneur is doing the important work, not the investor
• 2 reasons no one should be an angel investor:
  • The economics of angel investing work against all but a select few
  • The structure of angel investing works against all but a select few
• If you have to be an angel investor, do it as a syndicate on AngelList

I agree that most people should approach angel investing as a way to help entrepreneurs and to stay engaged or learn something new. As a way to make money, most people are better off staying away from direct angel investments and instead syndicating through a successful investor.

What else? What are some other reasons against being an angel investor?

After yesterday’s post Investment Strategy for a $20 Million Fund, several people reached out and said it was crazy to limit the fund to only eight total investments. After pointing out that if the desired ownership percentage is 20%, and the expected post-money valuation is in the $5 million range, mathematically there’s only room for eight investments. The general consensus was that the fund needs to invest in many more companies to get better diversification and an increased chance of finding a few winners where the capital reserves can be used to participate in future rounds. So, either the target ownership percentage or target post-money valuation needs to go down to increase the number of investments.

Here’s a potential second investment strategy for a $20 million fund:

• Allocate 40% of the fund ($8 million) for new investments and reserve 60% for follow-on investments ($12 million in reserves)
• Invest an average of $500,000 per company with a target ownership percentage of 10% for a total of 16 investments with an average post-money valuation of $5 million
• Of the 16 investments, take the top four companies and participate heavily in the follow-on rounds using the reserves
• To achieve $70 million of exit value, the majority of the returns come from the top four investments (e.g. ~$60 million in returns at an average of ownership stake of 10% for a total aggregate exit value of $600 million) and the remaining investments deliver more modest returns (e.g. ~$10 million in returns at an average ownership stake of 5% for a total aggregate exit value of $200 million)

This approach casts a much wider net and then goes deeper with a handful of portfolio companies. It still requires substantial exits but has more opportunities to find winners.

What else? What are some more thoughts on this second investment strategy for a $20 million fund?

Urvaksh broke the news about Valor Ventures last week with his article New Atlanta VC Fund Will Invest in Women’s Companies. I’m an investor in the fund and excited about helping female founders build large companies. Thinking about a $20 million venture fund, here’s a common investment strategy:

• Allocate 40% of the fund ($8 million) for new investments and reserve 60% for follow-on investments
• Invest an average of $1 million per company with a target ownership of 20% (results in an average post-money valuation of $5 million) and eight total investments
• After dilution in subsequent rounds, and participating pro rata in the “winners”, own an average of 10% across the eight investments
• To achieve a 17% IRR (needed to be top quartile), the fund needs to return 3x cash on cash, which is ~$70 million of cash (inclusive of management fees)
• Owning an average of 10% of eight companies means the portfolio of investments needs to have an aggregate exit value of $700 million

The venture model is predicated on finding startups that have the opportunity to become large, meaningful companies. Picking great entrepreneurs in great markets is the key to any successful fund.

What else? What are some other thoughts on the common investment strategy for a $20 million fund?

Recently I heard about a new investor strategy that I hadn’t seen before: as part of the term sheet, they asked for more pro rata rights than their ownership percentage. Pro rata rights mean that whatever percentage ownership initially purchased — say 10% — can be maintained when the startup raises more money in the future, assuming additional capital is invested to reflect the new percentage.

Here’s how it might work:

• An angel investor offers to put in $200,000 at a $4 million post-money valuation, to own 5% of the company but requires pro rata rights for 10% of the business
• Startup later raises $2 million at a $10 million post-money valuation, and the original angel that put in $200,000 now has the option, but not the requirement, to put in up to $600,000 (original 5% diluted to 4% by the new round but then 6% of the new business is purchased for $600,000) more money in the business and have 10% of the business, even though they had 5% after the previous round
• Startup now has a $10 million valuation and the original angel has put in a total of $800,000 for 10% of the business

The benefit for the angel investor is that they essentially get an option to increase their stake at a later time in the event the startup is doing well and decides to raise more money. In terms of downsides, the only challenge is that the entrepreneur now potentially has to sell more of their business in the second round of financing as many venture investors require a minimum ownership percentage for their initial investment (e.g. 15-25%) such that the entrepreneur might end up selling 35% or more of the business between the seed round and Series A (which isn’t uncommon). It’ll be interesting to see if this catches on for lead angel investors to ask for more pro rata rights than the original ownership percentage.

What else? What are some additional thoughts on more pro rata rights than ownership percentage?

Recently, I was reading the limited partner quarterly updates for a fund where I’m an investor. In the update, the author highlighted that the fund had reviewed 1,000 potential deals last year and invested in four companies. At a ratio of 250:1, it’s clear that there are many more startups trying to raise a Series A than there are Series A investments (see the Series A crunch talked about four years ago).

Here’s how the investment process might work at a venture fund:

• 250 deals reviewed
• 25 one-on-one pitches (where the entrepreneur pitches a single partner)
• 5 full partner pitches (where all the partners hear the pitch)
• 2 term sheets
• 1 investment

Raising money is much harder than most entrepreneurs expect. With funds seeing so many opportunities, but only being able to invest in 1-2 companies per year per investor, it’s clear that most entrepreneurs will feel rejected when out raising money.

What else? What are some more thoughts on the ratio of deals reviewed to investments made?