CC#23: How to become an angel investor
Best practices, common mistakes and a rant from editor about the shortage of sophisticated capital for early stage founders in Florida.
If becoming an angel investor has crossed your mind at some point, here are some things you might want to consider.
Avichal Garg, the founder and managing partner at Electric Capital, started off the discussion “The reason I started was to learn how to do it and support friends. In the early days, your losses can be considered a form of “paying a tuition” to learn how to do it. Over the past decade my reason has evolved a lot. For first-time angel investors, theres a great article by Alex DanCo about accruing social capital that I highly recommend.”
He continued: “If you think you’re gonna make money, it’s like winning the lottery. Most people don’t make money. The reality is you probably won’t make money and even if you do, probably not for 10 years.”
Sriram Krishnan, not to be confused with the host of Good Time show and a partner at a16z, was an early Spotify employee and a current angel investor: “I started off because I thought it was really cool, and then I thought it was really fun. My first investments were sent to me by my good friends who were the co-founders/executives at Spotify. Eventually, it became so much fun working with the early founders. You really need to enjoy being in that early stage environment. Doing it for monetary reasons should be secondary.” For the purpose of this blog post, I will refer to him as Sriram 2.
Steven Sinofsky, a former executive at Microsoft and current partner at a16z, shared some of his thoughts: “If you think of the law of powers and pick your numbers, you’ll need 1/10, 1/50, 1/100, etc. to pay off; and all of the others are cash outlays that you won’t see any money back from at all. You need to find your theory. It’s impossible to only pick winners.”
Avichal: “There’s a lot that end up making money but it’s not significant. It’s important to understand how cap tables work so you can do the math. Having a portfolio company sell for $250m may sound like a big win, but when you break the numbers down, you’re not making much once you calculate your small share, account for your losses, pay the LPs, etc.”
Where do you start sourcing companies?
Sriram 2: “AngelList is how I started. You’re in for a multi-decade learning experience. You’re better off starting on one of these platforms because it will help you start to build some type of pattern recognition. If you’re in a tech hub, then it’s all about your network and staying up to date with who’s raising. Back in 2012, when I was at Spotify, I went on Linkedin and I added angel investor to my profile even though I had made 0 investments up to that point. Suddenly, founders began DMing me. You want to reach out to these folks, let them know you’re an angel and see how you can help them.”
Avichal: “I’d like to share Steven Sinofsky’s framework for excellence. Just be excellent at something, it makes things really easy. When you reach out to these founders it becomes very clear how you can help them. From a founders perspective, it’s a very efficient use of their cap-table if they have somebody who can give them money to be an advisor.”
Sriram 2: “It’s important to note that sometimes the skills you develop as an operator at larger companies doesn’t translate to startups. For example, if you’re a biz dev exec at a large corp, it may not necessarily be relevant to early stage companies. It’s on you to figure out what startup founders need at what stage and align yourself to be able to help them.”
Aarthi: “I like identifying “problem spaces” or particular problems that I would like to see solved. Whenever I come across a startup that has a product solving that problem, if I like the founder, I almost always invest. It’s quite literally the best way of “putting my money where my mouth is.” In regards to sourcing the companies, I think alumni demo days are great as well (Y-Combinator for example). It’s a whole process—you really just need to get involved and not expect anything in return and just be willing to help. Then one day you’ll start having founders reach out to you.”
Sriram 1 (Host / Partner at a16z): I just want to reiterate: expect to lose all your money.
Avichal: “Angel investing is a great way to make ideas come to life. Start putting your ideas out there through a blog/twitter and the right people will find you.”
Sriram 2: “The mere act of reaching out to founders and saying “hey I like your product and this is why I like it.” This is valuable for the founders and it may naturally create an opportunity for you to invest in the company.”
Sriram 1: Cold DMs Twitter/IG or cold emails, you’d be surprised how often it works.
Steven: It can’t be true that everyone is struggling to raise money and that everyone is fighting to invest. Everyone’s looking for that first check and that first set of connections. There’s always a lot of value at that very. Early stage.
You found the company, you’re going to meet with them. What do you do?
Sriram 2: “The first few things I’d do would be to look at the founders background to see if it maps onto what they’re trying to solve. I try to see who else is working on the company to understand how experienced the founders are and how big the team is. Here’s the first 2 things I try to figure out:
1. Which bucket does the company fit in: pre-product, post-product or a company with traction?
2. Is there “founder-market fit”, in other words, does this team have a background that makes them uniquely qualified to solve this problem?
Avichal: “In that first meeting, I’m trying to learn about this person. One of the things I’ve come to believe is that the most successful founders who stick with something for 10 years, have often times been thinking about this idea for a long time before even starting to work on it. So it’s important to understand where they come from and why they are doing this. The other thing is, if I walk out of a convo and somebody has taught me something counterintuitive, that’s a really good sign. If that happens in that first conversation, I usually give that founder money.”
Sriram 1: “Even though clubhouse seems like an overnight success, Paul was thinking about this and working in the space for a long time before they even founded the company. When thinking about founder-market fit, you really want to see if this person has solved the intellectual puzzle of what they are trying to build. The other thing is, do I want to go into business with this person. Would I want to introduce them to my network.”
What are some common mistakes you guys have made or have seen others make?
Steven: “If you have some experience in big companies, this can work against you. One of the things I often see is people coming to these meetings and forget that they’re talking to a pre-seed company. They might have no code and you go into the meeting and start talking to the founder as if they’re on the 8th iteration. Chances are very high that the person knows way more about this problem than you do. That’s part of what you’re looking for. It’s important to understand that there’s nothing but feature requests and customer problems in front of them. So telling them they should implement this feature and change that feature, it’s the opposite of help. It’s just proving that you’re going to be annoying and it probably won’t work out.”
Sriram: “You’re evaluating the founder, but also realize they’re judging you too. You should try to pitch yourself. Explain to them all the ways you can add value and why they’d want to talk to you in the middle of the night 5 years from now.”
Sriram 2: “One mistake I made was projecting my ideas and ideologies onto the founders. I thought they had the ingredients and with these ingredients they could make a potato salad, but they wanted to make a sandwich. I had to stop myself from telling them what I thought they should do, and understanding that they’re the ones who understand their market better than anyone else.”
What do you look for regarding early signs of PMF (product-market-fit)?
Avichal: “It’s evolved a lot. It used to be you had people come with a product, traction and data. Increasingly what you have is some people with nothing more than an idea. It’s become what market are they in and why is that an interesting market and do they have something different from whats out there. Then of course the timing question: Why now? Was there some new tech? Maybe a new distribution channel? A new business model?
Sriram: “Marc Andreessen had a blog post a long time ago where he said:
When a great team meets a lousy market, market wins.
When a lousy team meets a great market, market wins.
When a great team meets a great market, something special happens.
The timing of markets is so critical. Some of the most successful tech companies prove this point. Google was powered by the rise of the internet. YouTube came at the time that digital cameras were becoming increasingly available and popular.”
Avichal: “If it turns out a lot of smart people have arrived at the same conclusion, there’s probably some ground truth to it. Warren buffet has said the same exact thing that Marc Andreessen said in a different way.”
What metrics do you look for?
Sriram 2: “The two things I look for are:
Are people consistently using the product. If they’re in the consumer space, they may need people coming in 5-6 times per day to use product in order for the business model to work out. If consumers are highly engaged for a short period of time and then they leave, that may be ok for certain types of products (for example, a dating app). It’s crucial to understand churn and usage.
The founders’ ability to ship product and iterate very quickly. How quickly can they ship? If they can only ship once per month, that may not be enough. Being nimble and adapting quickly to user feedback is incredibly important.”
Avichal: “It depends on the market they’re in. If it’s an early stage SaaS startup, do they have some people who are willing to pay for it? If it’s early on and the product is not completely refined, are people still knocking on their door asking to use this product?”
Aarthi: “Talking to their first few customers and seeing if they’re obsessed with the product, or if they just kind of like it.”
Final thoughts and tips to new angel investors
Sriram: “If you want to get started you don’t need to give so much capital. Think about it as a way to have fun and learn.”
Sriram 2: “You have to think in long-term horizons. At an early stage decide what size checks you want to write and keep it consistent. Also some founders don’t need your help. They’ll typically make it very clear if they do need your help. In addition, in today’s world, some founders may expect you to do some amount of work.”
Aarthi: “Not all advice is equal. Make It very clear what areas you have expertise in and that you are available if they ever need help.”
Sriram: “Ultimately, you want to help the company grow. This becomes a source for new companies in that category.”
Avichal: “If you can email people and just offer help, that will help you in the future. I think there’s an angel problem. We have too many angels reaching out to founders and wasting their time.”
Rant from the editor
This topic is something I’m very passionate about because as I began hosting events for founders in 2017, I quickly realized there’s a huge lack of early stage capital here in the southeast US region, particularly in Florida where I’m based. This is why we’ve built an accelerator.
To clarify, it’s not that there’s not enough wealth in FL, there’s heaps of wealth. But a lot of this wealth was made in real estate, construction, healthcare and other fields that are very distinct from the tech/startup world. Therefore, there is a lack of sophisticated capital that really understands early stage investing.
Let me give an example, without naming any names. We’ve made introductions for founders who were raising a seed round to multiple “early-stage” VC firms, only to have them refuse a meeting (a simple 10-15 minute phone call) with the founders. Why? Some common responses are: Not enough revenue. We don’t do SAFEs. Unfortunately, we’ve got some incredibly talented founders in our region (and some in our accelerator). Yes I may be biased, but I know a great deal when I see one, and I only connect VCs to what I believe are great deals. This is crucial for our accelerator to build a strong brand and strong relationships with investors, to help more companies in the future get funded.
At OneSixOne Group, we have set out to level the playing field for founders in our region. In silicon valley, founders who are connected have more leverage than investors. In Florida, investors have all the leverage. This is not great for investors either. By trying to “de-risk” what many would describe as a “risky” asset class, they are significantly increasing their odds of missing out on the 1 or 2 companies that will generate 60-80% of the return for a particular fund. I’m curious to hear what others think about this?
I hope the clubhouse chronicles continues to connect me with more angels & VCs that have a deep understanding of early-stage venture investing and truly subscribe to the “Founders First” methodology. If you’d like to chat about this, or even reach out for any reason, feel free to email me - firstname.lastname@example.org
If you’re interested in reading a slightly longer, more detailed version of what I’m talking about here, check out this blog post I wrote back in October on why I’m all in on Florida’s tech ecosystem.