Several months ago, we began the process of meeting with various local angels, an investment bank, a couple of local VCs, a VC fund focused on Texas ETF companies, as well as numerous startups looking for funding. Our thesis was that the funding industry had changed over the last few years so that the amount of money needed per startup was much less than previously required. (An assertion made by David Rose at the Austin Entrepreneurs Network Funding Forum in April 2009). Based on our observations of the Austin market and at various funding meetings, we extrapolated from David’s keynote that traditional angels had made themselves uncompetitive in the funding market as they moved closer to traditional VCs in becoming more “organized”, and requiring the startup to show customers, revenue, and traction before they would invest. This process was classified as “risk reduction.” It was obvious that the pendulum had moved to the far side of the arc. Traditional angels are known as notoriously poor early stage investors, as evidenced by their poor returns (Angel clubs typically screen over 600 deals per year, and only only 15 to fund. Of those only 2 are profitably sold) – so organizing into groups and reducing the amount invested per angel was a logical risk reduction strategy. Membership to these “exclusive” clubs was also evidence of your high net worth status, and provided an opportunity to access “startup lottery tickets.”
We concluded that the main implication of these circumstances (smaller amounts needed for a startup and angels becoming uncompetitive) was that startups would need to bootstrap their operation for as long as they could, gain some customers, revenue, and market validation, and then sell the technology/company quickly so they could move onto building their next idea.
In other words, the frequency of liquidity events and exits for the startup would significantly increase. Since the monies needed to show market validation and then business model validation was lower, the valuation needed at exit would be lower. This meant that a company could entertain a liquidity event much sooner, and an IPO was completely unnecessary. Moreover, the impact of the Great Recession strengthened the “hand” of the larger tech companies that were very cash rich. The result would be that these cash rich tech companies would acquire smaller companies and technologies, and more importantly, acquire groups/teams of engineers (who “played well together”) at a “good” price.
The thesis of frequent exits and acquisitions was the conclusion of Super Angel, Dave McClure, in a piece he published this weekend, called “Money Ball for Startups.” He should have called it “Powerball for Startups”, as it would have more appropriately articulated the concept that a quick and profitable exit for any startup would be the equivalent of holding a winning lottery ticket.
The other point advanced by Dave was something we first heard from Mike Maples Jr., namely, that angles needed to make investments in startups earlier in the process. Mike Jr. called this becoming a Super Angel. The main implication is that angels needed to move back to their traditional location in the center of the funding spectrum, and take on more risk – something that they had been moving away from. Dave is absolutely correct in his assertion that the largest majority of VCs won’t know the impact of your product/service, and won’t know how to validate it. Super Angels Marc Andreesen and Ben Horowitz have made a similar point. If you’ve ever spent time “educating” a VC about your product/market/space, even when you can show a large number of customers and a nice revenue ramp, you will immediately appreciate the comment. Therefore, the trend to smaller startups with faster liquidity events would have an enormous positive impact on the entrepreneurial activity by all sorts of entrepreneurs/dreamers that have an idea for a product/service.
Dave also put some numbers to the business creation, validation process.
1) Product: Amount invested: $0 – $100K. 3-6 months to develop a basic Minimum Viable Product (MVP) that’s functional and useful for at least a few customers.
2) Market: Amount invested: $100K – $2M. 6-12 months to test marketing and distribution channels, understand scalability & customer acquisition cost, conversion to some non-zero revenue event.
3) Revenue: Amount invested: $1-$5M. 6-24 months to optimize product/market fit and get to cash-flow positive.
We don’t think that the amounts needed to invest as large as indicated above, but there is obviously a lot of wiggle room depending on the team/market/product/service. As a result, there is an enormous opportunity for angels, who can validate an operating team and/or technology, and provides them with an opportunity to invest earlier in the company formation process, and look for a quicker exit. We’ve met with a few local companies that have made some very nice progress and could definitely consider that quick and profitable exit.
Think of this as the next “Entrepreneurial Gold Rush.”
The real question to the angel community: Do you know what you are doing, and hence, have the confidence to invest early?
By Richard Piotrowski CFA is the Managing Partner of Outram Research LLC, which focuses on assisting startups to improve their funding pitches to the Angel and VC investors. You can follow Richard on Twitter: @Angelpitchdoc. He can be reached at email@example.com, or at his blog: angelpitchdoc.wordpress.com. Also check out our website: www.outramresearch.com