I came across this post today http://bit.ly/cOeX66 that attempts to map the density of startups by geography. Interesting and I like the data visualization. Top zip code for MA? 02412 – Cambridge around the Kendall Square area.
I recently caught up with Andy Payne to chat about what we are seeing in the internet startup world around Boston. Andy has been around the Boston scene for a long time – being one of the co-founders of Open Market, Revenio, and FanSnap. He is an adviser to Care.com and Kayak, and on the board of HubSpot. A great guy with deep experience on consumer Internet companies.
Some highlights:
In all, a great session even if Andy trashed my white board 
Its been a great, if not extremely busy first week of June.
The Angel Boot Camp was a success by all accounts and CommonAngels was delighted to be a sponsor. Congratulations to Jon Pierce for all his hard work organizing the event. I enjoyed being part of the panel discussion on the “angel ecosystem” and you can check out some of the day including pitches here.
The next day started with our quarterly angel group syndication day at Microsoft NERD. Four strong companies presented that already have some level of angel group sponsorship.
That evening the 10 TechStars Boston teams put on their demo pitches. I’m a mentor in the program and for the second year running was amazed at the transition that took place with all teams from where they started 3 months ago. I thought everyone did a fantastic job and have heard consistent good comments from many other angel investors. I look forward to investing and working with several of the companies. Wade Roush from Xconomy has a very good write-up on the 10 companies.
The next day I joined Shawn Broderick, David Aronoff, Dave Barrett, Matt Fates, Peter Dougherty, Mike Grandinetti, and many others as a mentor for the 5 finalist in the IBM SmartCamp initiative. Congratulations to Sproxil for winning!
Busy first week and it looks like the rest of June is shaping up much the same…….
At CommonAngels our focus is on capital efficient seed/early stage opportunities. Everyone talks about capital efficiency, but what do we really mean?
I like to segment capital efficiency for IT startups into two stages: Initial capital required and end to end capital required
Initial capital required. This refers to how much capital is reasonably needed to test the idea and add value. What has changed significantly over the last decade is (a) that the cost for testing many ideas has come down significantly (for reasons well documented) and (b) the vast majority of exists are by M&A not IPO, and often < $100M.
As an angel investor and manager of a micro cap venture fund, this suits us. Our capital, both individual and fund is matched to many of the IT opportunities, particularly Internet enabled businesses. For < $2M, we can test a wide set of hypothesis on the opportunity over a period of 12 – 18 months. And by keeping the capital in low and at the appropriate price, the founding team has the benefit of what is referred to as “optionality”.
Optionality simply means that we have various options on growth, capital, and exit. Perhaps the team wants to exit at $20M after 18 months – great, we are all happy doing that. Perhaps, after 12 months of operations, its become clearer what the real market opportunity is and how best to become the market leader – and we can look to raise significant capital at a good step up in value. Perhaps the market is not growing as fast as we initially thought – no need to over capitalize the business, but instead lets look at a plan to get to cash flow break-even. I think you get the idea.
If I look at the seed/early stage IT investments we have made over the last few years, the distribution of the amount initially raised is:
$500k to $1M 3
$1M to $1.5M 6
$1.5M to $2M 3
With the average raise being $1.4 million. These financings provided runway between 6 to 18 months.
Contrast this approach with raising say $6M initially (a traditional VC approach, which typically gets syndicated between a couple of firms). It may be nice to have all that money in the bank, but it often takes optionality off the table. From day one, the team is embarking on a plan that involves higher headcount, burn, and expectations around growth. The problem with this approach is that expenses get way ahead of revenue, liquidation preferences pile on, and the post money valuation gets way ahead of where it should be unless everything falls into place as planned.
What is the right approach? It depends. Putting aside the question of whether it’s even possible to raise capital at a reasonable price in either scenario, factors that I would look at for an IT company include:
Product development. Building a new chip, database, infrastructure software, or security software requires a decent size engineering team. These are complex engineering problems to tackle, and it’s fairly hard to develop a functioning V1.0 product on small amounts of capital. It may be possible to invest a small amount to prove that a very difficult part of the technology (a) can be built and (b) produce the performance expected under a limited set of use cases. But in general, its probably going to take a few million dollars to build v1.0
Nature of the market and competition. If you’re in a new, nascent market you can only grow as fast as the market grows. Faced with this type of market, I’d lean towards raising smaller amounts of capital, building the product, establishing early distribution and beachhead positions, and be ready to raise larger amounts when the market starts to take off. Over capitalizing a startup in the early stage of an emerging market can be deadly.
End to end capital. This refers to how much total capital is needed to build a substantial, category leading company. It will vary of course by the nature of the business – traditional tech vs viral, web based business – however, in both cases it’s likely to require reasonable amounts of capital that will be tranched in stages, including raising capital from growth equity providers.
As an investor who has limited capital, this is fine as long as each additional capital raise is done at good step-ups in value. The dilution is offset by the increase in value. The danger of course is that many companies trip — value creation is rarely linear or exponential – and at that point significant dilution is suffered for the early investors and the liquidation preference stack becomes a heavy burden.
This does not mean we don’t like to invest in big IT ideas that have category leading potential – I in fact love these opportunities. The trick is to find opportunities that can be tested in a very capital efficient manner and only step on the gas at the “right time”.
I was recently asked by a couple of early stage entrepreneurs to talk about angel investing in Boston. The angel market around town has always been fairly active and cuts across many sectors, e.g. software, hardware, networking, internet, life sciences, optics, robotics, medical devices, cleantech, retail, industrial products, etc. There has been discussion lately about the lack of active angel investors in Web-based businesses – and the concerns are legitimate. But the truth is that there is a wide diversity of Boston-area angel investors, each with diverse interests.
For this post, I’ll focus on the market that I invest in and know best – early stage information technology. I’ve broken this into two parts: Finding angel investors to help get the venture started, and getting angel support for the go-to-market phase.
First step: Looking for those first angels to get started
The initial company creation phase involves building a product/service and testing some of your hypotheses about the business. This is the pre-seed or seed stage, or as one of my members puts it, going “from nothing to something.” For this stage many startups need anywhere from $10k to a few hundred thousand dollars, depending on the type of business (see my earlier post on case studies for this phase).
Around Boston, as in most geographies, there is a shortage of this type of funding – there are always too many startups and seed stage ideas looking for seed capital. I would say, though, that the gap “feels” a bit more acute at the moment for IT startups, in particular Web-based startups, as a result of three factors. First, the financial mess that hit us in 2008, and what it did to our investment portfolios – we are 1/2 to 2/3 climbing back, but it’s left a “psychological” mark in the short term. Second, more innovation, particularly around B2B and B2C Web-based businesses, meaning there’s more competition for seed capital in these sectors. Third, the lack of recent or sizeable IT exits that in turn creates a bench of wealthy high tech entrepreneurs to invest in the next set of entrepreneurs.
Most of the initial investment I see for this stage comes from:
Angel groups will invest at this level, although I’d say most tend to look at the next major funding gap – the early go-to-market stage. Venture firms are less likely to invest at this stage. It’s not that they don’t do seed investing, it’s just not their “bread and butter,” as one general partner put it to me recently. And for some VC firms, seed stage investing means funding an entrepreneur they know well who has made them money before.
Aside from money, I cannot underscore how important mentorship and learning from role models are in these early company creation phases. I loudly applaud David Cancel’s efforts to bring modern day mentors to Boston to help young local entrepreneurs. And at TechStars (where I am a mentor) the effort at energizing a terrific mentor base in Boston has been amazing.
Next stage: early go to market
Okay, product built (alpha, beta). Consumer, SMB, enterprise app launched. Founding team in place. You might have some early customers (paying or not paying).
At this point, many IT companies, particularly Web-based startups, will still be in an experimentation phase that can be financed in an efficient manner. And by efficient, I mean with somewhere between $250k to $3M (typically $500k – $1.5M), not $5M or $6M (I’ll post at another time about capital efficiency). Your challenges and goals at this point are:
There isn’t necessarily a clear transition point between stages one and two – as with most issues in company creation, the lines are blurred. But if you have found yourself looking to raise more angel money as you move into the go-to-market phase, your options become wider (but not easier, unfortunately).
1. Individual angels. At this stage you’re still probably looking at your close network, perhaps extended by one or two degrees. There are lots of individual IT angel investors around town – some very prolific, such as Joe Caruso, John Landry, Jean Hammond, and Ed Roberts – who are well known and terrific investors/mentors. There are also a lot of mentors who, while not necessarily likely to invest, can be very helpful on both business and financing advice, and making the necessary investor connections.
As noted, the extent of your personal network again is very important. Network heavily; leverage the law firms around town who are in the “deal flow” and know angel investors. Ask fellow entrepreneurs. You will find that angel investors come in many flavors:
As you pull your round together, a good piece of advice is to find a sophisticated lead angel or angels who can help you craft the deal and lead the round.
2. Angel groups. Groups are very active in New England. You can find a list of groups at Angel Capital Association and Xconomy also has a good list here.
Angel groups in New England vary in size and focus. Check out their websites to get a feel for the membership, types of investments, criteria, and process. Then network around town – find someone from the group you are interested in and talk to them to better understand their process and whether your startup might be a good fit for them.
As a general observation, I’d say the groups are filling an important capital gap – financings between $250k and $1 to $2M. These are financings around “go to market” and typically provide runway for 6 to 18 months. I’ll blog at another time on angel groups, but my rough back-of-the-envelope calculation is that Boston area angel groups have probably invested around $30M + in local startups over the last five or so years.
Going to a group may seem intimidating, but they offer the benefit of a centralized process and provide momentum to get a deal done. In contrast, talking to individual angels one at a time means you need to build your “sales funnel,” keep replenishing the leads, figure out closure rates (i.e. I need to talk to 6 angels to close one) – all of which takes time and effort.
With groups, you will find the initial screening is based on whether there are members who know your space. For example, at CommonAngels, if it’s a startup in cloud computing I’ll pull in John Landry; for online display advertising, I’ll ask Jay Habegger (CEO OwnerIQ); for digital media; Steve Woit (publisher of Xconomy); for lead gen, Dan Kaplan, (founder of Lowermybills.com); for energy IT, Martin Flusberg (CEO of Powerhouse dynamics); etc.
Raising capital in either stage can be challenging. The good news is that there are active, enthusiastic, experienced angel investors in Boston who are willing to help local IT startups, with their time and advice if not always with their money.
I attended a two day Techstars event in Seattle a couple of weeks ago. I love what Techstars is doing around the country and am a big fan of the concept. As part of the event, I had the pleasure of being on a panel with some outstanding investors and mentors — Shawn Broderick (serial entrepreneur and runs Techstars Boston), Steve Hall (Vulcan Capital), Greg Gottesman (Madrona Venture Group), David Cohen (runs Techstars Boulder), Andy Sack (runs Founder’s Co-op) and Brad Feld (Foundry Group).
Gregg Huang from Xconomy did a terrific write up.
Jeff Bussgang (Flybridge Ventures) also has a great blog post on what makes Boston start-up scene special.
I recently gave a presentation to the 128 Innovation Capital Group on raising money from angel investors. A copy of the slides is below and the video can be found here.
My key messages:
• Most of the angel market is made up of individuals investing on their own. A small yet important segment of the angel market is angel groups, of which there are over 150 in the US, representing over 7,000 investors
• The trade association for angel groups is the Angel Capital Association. You can find a geographic listing of groups on the site
• New England has seen the rise of many groups in the last 5 years. This is a good trend. Groups have different membership base, styles, investment focus, and processes. Its important to ask and understand how each group works
• There is a good deal of collaboration between groups. In New England, groups get together 3 to 4 times a year to syndicate interesting opportunities.
Practical tips:
1. Manage the process like a sales campaign
2. What should go into a pitch deck (see my earlier blog post)
3. Network extensively; build a pipeline
4. Use an experienced attorney
5. Understand angel group process
6. Convertible notes or equity?
7. Term sheet & valuation comments
(note – this is an update from a post I did back in August 2007)
I see hundreds of early stage pitches every year. While some are very good, many could be improved with better structure and content. Series A or seed stage pitches have a different emphasis than pitches for later rounds. In early rounds, you need to convince investors that there is an attractive market opportunity when there is often very little real world validation around your business. You also need to convince investors that the team can execute in what is often the most difficult (or rephrased risky) time of trying to build a company.
If you search the web, you will find lots of resources on what to include in a pitch – however, here are some of the basics that I like to see (these need to be adjusted as appropriate for your type of business and industry):
1. Team: The #1 focus for early stage investors. Do they have right skills, experience and credibility?
2. The market opportunity: the market should be described in such a way that it makes it interesting for the group of investors you are targeting. Sometimes it’s about bringing a disruptive innovation to a large established market (think Dell in PCs) or an emergent market that’s showing explosive growth (think YouTube in online video). All investors focus on the size of the market – basically the bigger the potential market, the more attractive it will be, but that does not mean you should throw out wild estimates (that has the affect of questioning your credibility which will hurt you more with investors than any small market size estimates).
Markets are more complex than just size (think segmentation, growth rates, etc) and are ultimately made up of individual customers (see 4 (a) below).
3. Your solution: the product/solution should flow naturally from your analysis on the market i.e. it meets a critical need in the market; customers will want to buy (as opposed to you needing to convince them that they need this); and for business customers, the economic value is real and quantifiable.
You may want to include the competitive overview here or later in the slides.
4. The business model: this section comprises various subsections around how you will architect your business. It won’t be set in stone – early stage company building is about proving your initial assumptions and you will make many adjustments to your business model.
a. Customers and market entry: as a seed/Series A round its unlikely that you have many customers (if any). This is a very tough place for new startups and one of the major areas of risk for investors. You need to show investors you understand who your initial target customers are, their buying process, and how they will likely use the product (note: consumer web applications are different — its about the user experience rather than ROI, although this does lead to a deeper discussion on “who pays”). If you don’t know these or at least have some well grounded, working assumptions around them, then its like sailing in a fog. Based on these assumptions flow your target customers, channels, sales models, and product roadmap. The product direction and market focus is likely to change (almost always does) as the company grows and the market shakes out, but you need a starting point in which to rally the team and allocate your scarce resources.
b. Revenue and economics: There are many different revenue models – enterprise license, maintenance, subscription, service, freemium, sponsorship, advertising, etc. You will also want to work out, particularly for consumer oriented businesses, lifetime customer value and cost of acquisition.
c. Sales model: ok you’ve identified an attractive set of customers, you’ve outlined a compelling value proposition to them, you’ve sketched out assumptions on how the revenue and economics work for the business – now how the heck do you sell to this group, particularly when you’re an unknown (and risky) startup? This is where the rubber meets the road, so to speak.
There is a whole host of choices around the sales/channel strategy: direct, OEM, telesales, web, to name just a few. Sometimes the models are clear and over time, the challenge will be to build a sales and marketing machine. At other times, the sales/channels will be unclear and you will need to experiment with several approaches to figure out where the low hanging fruit is before even contemplating building the machine.
5. Funding plan and milestones: how much, how big, and how quickly are all questions that investors will ask around your financials. This is actually more complicated in practice than one might think. There are many ways to finance a business in the early days (I’m not talking about the practical issue of raising the money, just different theoretical approaches that balance risk/reward/dilution). For example, a business might have 3 approaches – raise $500k to build a demo but not a complete product, raise $2m to take the product to market, raise $6M to build product, take it to market, and figure out the distribution model. For CommonAngels, we specialize in capital efficient businesses, so the first two fit our strategy; the later really doesn’t (I’m talking about the initial round; many businesses need capital to scale quickly, but we are not focusing on that phase in the seed/SeriesA round).
In addition, what milestones will you achieve with the money you want to raise? Also some investors like to see an exit discussion; I find this is very individual taste. For me, I’m more interested in understanding where are the points of strategic value that are being built into a business and whether it can be done in a capital efficient manner.
Now that you have the key points, organize them in a way that logically tells the story. Your audience’s attention is at its highest level at the start, so look for an opening that hooks them in to the story you are about to tell! If a summary slide makes sense use one. Avoid clichés and buzzwords.
To help get you started, click here for a tongue in cheek sample template.
Good luck!
The Life Cycle of the Entrepreneur in Today’s Economy. This is the title of a four part series currently being run by the law firm Foley Lardner and wealth management firm BNY Mellon. I had the honor of being on the panel for the kick off session that focused on starting your company. We covered such issues as: characteristics of entrepreneurs, how do you know if it is a good idea, how do you identify a great opportunity, what to look for in team building, and financing options.
As part of the discussion (and to help me prep for the panel), I decided to look back at some of the startups I am involved in to better understand what entrepreneurs had done to start and get their company off the ground, beginning with the initial creative spark for the idea. And I wanted to look at what they had done to go from this initial idea in their mind to “something”, which was the point that CommonAngels had invested.
I’ve posted the slides below. For each company, I looked at what each had accomplished in 5 areas – the team, the idea, market/need, the product, financing – and how long it had taken to move the project along from idea stage to “something”. On the right hand side of each slide is a high level view on what attracted us to each opportunity along with what we all agreed we were trying to achieve with the financing.
Each company of course has its own unique story, and maybe I will blog in more depth on one or two later. I did though want to highlight some interesting points:
• Ideas – in all cases the original spark and creativity for the innovation arose from founders personal experiences – some degree of pain or frustration experienced in either their business or personal life. For example, verifying the design of a complex FPGA chip was a real pain with existing tools and methodologies – so the founder invented a very clever and elegant technical approach to solving this problem. In another case, the founder’s daughter lost all her data on her PC and in looking at consumer backup solutions, he found that there was nothing on the market that was a simple and cost effective solution
• Taking this initial spark and starting to shape a business opportunity around it was an iterative, non-linear process. Experimentation, research, creativity, brainstorming, networking, and team building underlined much of this phase. And moving from idea stage to the point where CommonAngels invested took anywhere from 6 to 18 months.
• During this time, and in a very capital efficient manner, each had started to validate the very high level customer assumptions around the core premises for the business (termed de-risking in the VC industry). For example:
- Alpha code testing with a couple of potential prospects – would the novel approach work? Was there buying interest? How much better than the existing ways of solving the problem? How would a new tool fit into the existing workflow?
- Consumer surveys to better understand buying intent and behavior towards online backup – was it perceived as a problem? How was it currently solved? What features were perceived as important/not important? What price points were attractive/not attractive?
- Pre –sold several sponsorships to validate demand for a yet to be launched hyper local news site (this was huge validation that businesses would part with real money for the concept)
- Built a very cheap online web site and spent a small amount on search engine marketing to validate that there was indeed an online audience looking for product information. And from this established some parameters around the potential size of that audience and baseline measures for the cost to acquire. Often enterprise value for online media companies revolves around being able to acquire a defensible and sizeable audience at a price significantly cheaper than can be monetized. In todays web environment and using such acquisition channels as Google Adwords, Yahoo! Search Marketing, Facebook, etc its possible to run cheap experiments to test these assumptions
• In all cases, there was a “team”, meaning more than one founder when we invested. In one case we helped recruit another founder as the CEO to complement a strong technical founder. Founding teams varied from 2 people to 5. Some had worked together before; some were new teams. Two were first time CEOs.
• Side note: As one of my members, Dharmesh Shah, blogged a while back, the optimum number of founders is 2.09 which in turn came from a back of the envelope analysis done by Chan Chaiyochlarb titled “if you are going to launch a startup how many friends do you need?”
• Financing to cover this initial period typically came from three sources: the founder’s (along with no salary), sometimes family, and sometimes friends. The friends category is really individual angel investors who had a personal connection to one or more of the founders.
In sum, these could all be categorized as “seed” stage financings with – at the time — lots still to be proven around the concept and business (I will blog more on what I think about in capital efficient first round financings), but we were extremely impressed along all dimensions – quality of the idea/innovation, quality of the team, and the potential market opportunity. And all entrepreneurs had exhibited a frugal and effective approach to testing some key business assumptions with customers and partners.