Category Archives: Angel investing

Why I dont invest in non tech startups #IIT #entrepreneurs

I was at the IIT Mumbai eCell event on Sunday and had a chance to meet students from various colleges all over India. The event was an eye-opener for me, given how many students were interested in entrepreneurship. This event had over 1200 people this year, and that was a 25% increase from the previous year. It is exciting to see the uptick in interest from students on becoming entrepreneurs in India.

I was on a panel with Suvir of Nexus Venture Partners and Bharat of Aditya Birla PE fund. A quick poll of the audience indicated that over 70% of the students were interested in starting their own venture and a similar percent were keen to build a non-software, or Internet / Mobile venture.

I clearly disappointed the audience when I said I would never invest in a non software / technology venture, and I had over 20 students come to me after the event to express their dismay. They were also very upset that I would be so categorical about my position both on a personal level and also as an investor at Microsoft Ventures. While they understood that Microsoft would not be interested in a non software company, they were curious as to why I would, on a personal basis, avoid these companies.

This post is primarily me addressing the question as a seed investor in the early stages of a company.

There are 3 parts to my answer.

1. Expertise: I dont have any knowledge, connections and value to add in a non-tech company. I invest primarily small amounts of money in an individual capacity so I can help the entrepreneur grow their business, besides just give them money. I dont have the background and intrinsic know-how of domains such as healthcare (if you want to run a specialty hospital) , education (if you want to start a school) or a restaurant.

2. Growth: My personal experience has been with about 30+ companies that I have invested in over the last 15+ years. I had invested in a Sports bar (restaurant) and also a real estate company. Both companies were started by entrepreneurs who I knew well for over 10 years. They both returned about 12% in interest each year for 3 years. Which is great, but does not move needle. Software and technology companies, grow much faster and in a short period of time. As an example if you look at the 39 companies that are “Unicorns” with over $1 Billion in valuation over the last few years, on average they have taken 5.7 years to achieve the $billion valuation. For non technology companies that have gone public over the same period and have a valuation over $billion, the time period has been 9.7 years. Almost twice the time.

3. Capital efficient in the early days: Do a simple analysis of the need for capital among the companies until year 3 and you will realize most of need very little money in the early (<1 year) and tend to be fairly capital efficient until year 3. After that they take a lot of money to get to $1 Billion. Since most of the companies end up failing, I’d rather put less money early in more companies than more in fewer ventures.

Are there too few seed/angel investors in India or is too much money chasing too few great companies?

This is a debate that I keep having with entrepreneurs and investors alike. When you talk to entrepreneurs they correctly point out the # of angel and seed deals done in India are very few. If you remove accelerators, the number of angel funded tech companies in India is about 60 (2013) and the number of Venture deals, which are about 50. Add the accelerators, which add another 60 companies and we have about 150 startups getting funded each year.

Given the number of entities that get started is about 1000 (2013), that seems like a small number. Entrepreneurs also point out the very investor friendly terms (drag along, liquidation preferences) that are given by angels in India and the fact that most angel funded companies give between 20 and 30% of their equity at the seed / angel round, which are common among technology startups.

On the other side, Venture and angel investors point out the relatively few exits (fewer than 10 in the technology sector) and the amount of time it takes to grow companies in India (over 10 years). They believe there is enough money for the right opportunities. I can point to 2 examples of companies we are trying to fund which have 3 competing term sheets at the angel investment stage to confirm that it happens, but is rare.

Which brings me to accelerators such as ours. There are about 30+ accelerators in India, but I am going to focus on the top 5. In discussions with other accelerators, the constant theme I get from most folks is the intense focus on the part of entrepreneurs to “get funded”. First the angel round, then the sapling round and then the series A. I know in our own case that is true.

So let me talk about our case in particular, although I have mentioned it before. We dont want to focus on funding. If that’s the biggest need of entrepreneurs then they should go elsewhere.

Unlike other accelerators which are not a corporate program, the key value to Microsoft from our program is startup engagement. We take pride in engaging with the startups and are extremely happy if they are successful, but the financial return from our investment is going to be largely negligible to us. Even if 1 of the 11 startups “makes it big” and we owned 6-10% of the company when it went IPO or got acquired, it would not be a significant dent to Microsoft by any means.

We had a chance to review about 800+ applicants this batch 4 for our accelerator. There were many great entrepreneurs and companies, but we could only support 10 – 15. If we were running a fund, similar to a venture investor, we would only select 2 or maybe 3. That’s consistent with our previous batches.

That we believe is a great disservice to the entrepreneur ecosystem. Many more companies could be small, non angel / VC funded businesses, and still do well. I do not like the term “lifestyle” businesses, but these companies do not warrant the money required by rapid growth, quick to scale companies.

So we do not put a lot of emphasis on our companies getting funded. We do help them get connected with angel investors and venture capitalists, but that’s it. In many cases we have worked behind the scenes to push investors we know to get deals done faster and at better terms, but that’s largely behind the scene. Our emphasis is to open doors and opportunities that help them get in front of other entrepreneurs, potential customers and partners and help them understand the discipline that it takes to be a great entrepreneur.

A few of our previous company entrepreneurs dont like that, and we don’t have a problem with that. Our goal is to help the ecosystem grow and allow more entrepreneurs to experience the journey. If they only wish to focus on funding, they are better off going elsewhere.

So, back to the question: Are is there too little risk capital in technology or too much money chasing too few deals?

Unfortunately the answer is clear only from the perspective that you are coming from. Neither entrepreneurs nor investors will be able to see the challenges the other side faces very easily so it is a question that quite possibly has no clear answer.

The best is to keep at the problem and have different parts of the puzzle try and fit themselves as they progress instead of force fitting more funding into companies or the other way around.

The other part of the question comes from the seed fund that we have as part of Microsoft Ventures. We have not invested in any company, in India, so far, but we have 2 in the pipeline. We get questions on why we dont fund all the companies from the accelerator.

The answer is fairly straightforward but very hard for entrepreneurs to swallow in India.

Microsoft Ventures fund is global. Which means we look at opportunities in the US, Israel, China and other locations. We have some fairly standard criteria for our funding – including, but not limited to the following:

1. We only have the authority to put money in a US or UK entity.

2. We can only use a convertible note instrument.

3. We need to have the company’s product’s well aligned with internal Microsoft teams / products and goals.

The accelerator, however, does not have the strict guidelines associated with these 3 criteria.

Finally since we fund all companies globally, the investment committee looks at all companies across multiple geographies and “looks” for traction, differentiation and other metrics and our companies are just not as strong as those in Israel or the US. They seem to need a lot more time, same amount of money, with potentially smaller exits. While that’s the nature of the maturity of our startups in India, that’s not a bad thing overall. We will get there eventually is my perspective.

Until then we have to fight battles on why we should fund a company from India, when the comparable company in the US is much further along.

The argument for China is simple – a US company just does not do as well in China as a Chinese company.

The arguments for a Israeli company are great as well – most of their companies are Delaware entities, have extremely strong technology (which is aided by government) and they have at least 100% more traction (customers, revenue) than comparable Indian companies.

What do you think? I’d love your perspective on what I am missing.

How to apply MapReduce() to your #startup #funding process

MapReduce comprises of 2 parts – Map() –  filtering and sorting and Reduce () performs a summary operation. The “MapReduce System” orchestrates by marshalling the distributed servers, running the various tasks in parallel. This speeds up the entire process dramatically.

I met with a startup founder who made the rookie mistake of “talking” to 3 angel investors, focusing his discussion on only 1 person, who was going to lead. He then realized after 6 months that the lead investor was in, but others had gone sideways and were not going to invest. He did not spend enough time with the other investors, assuming that the lead investor would corral them.

You will need a lead investor for your angel round. As the founder you will have to recruit, manage and keep the lead investor engaged. There are other investors who may not lead, but are going to be a part of that round.

Your first priority is to identify the lead. Then you have to soft circle and get the rest of the folks to pony up commitments.

Most founders talk to investors who are not leading in serial fashion, going after then one at a time. I would suggest you MapReduce the process.

I know that many folks recommend you have one person in your team responsible for fundraising. I would suggest you filter your investors and assign one person in your team -Map() – to keep other investors “in the loop” – emails, scheduled phone calls or in person briefings.

You (the person responsible to raise the round from investors) should be responsible for the collation and summary – Reduce ().

This reduces risk of waiting for 6 months to finally figure out that you need other co investors and also “involves” your co founders in your company to help with fund raising.

If you go about it in a serial fashion, (i.e. one investor at a time), the elapsed time to get investment done increases dramatically but your risk of closing the round is still the same.

What do you think? Anyone tried this yet?

Accelerators have supported twice the number of entrepreneurs to the Indian startup ecosystem

I have been researching the data from Thomson Reuters to understand the optics of the accelerator business in India. There are 37 accelerators we track, who give a little seed money and take a percentage of the company in return.

Based 2012 data, accelerators have funded 89 companies with their first check, compared to less than half that done by angels and VC’s in India.

Most accelerator funded companies take 6-8% of the company in exchange for 5-10 L ($10K to $25K) in India. That 6% dilutes to ~4% at series A (assuming 20% for angels and 30% for VC’s).

The first scenario for you, the entrepreneur, is to get funded directly by a VC. The chances of that happening in India are low – 1.4%. The other challenge is that those companies got relatively poor valuations (average about $1.4 Million pre money). Only 19 out of 1300 entities got funded last year to raise their series A through a VC directly. In this case you will possibly dilute 30-40% and still own >60% of the company. I have used 30% dilution in the chart below.

The second scenario is to get angel funding and then in 18 months get VC funding. The chances are better that you might go through this scenario (2X more – 43 companies got angel funded last year), and then venture funding. You will end up owning 56% of your company (by giving about 20% to the angel investors). The valuation challenge persists with angel investors as well, with the average valuation being less than $1 Million.

The third scenario is to get into an accelerator. The chances are twice as much (nearly 9%), but give up 6%, then get angel funding and finally a venture investment. You will end up owning 52% of the company now compared to 56% in the previous scenario. The 4% should get you a better valuation and it does for last year’s data (Average valuation was $2.3), nearly 60% higher.

See the chart below for the data.

Accelerator Metrics

Accelerator Data

The numbers on top of the boxes are the # of companies that got funded last year. The number in the parenthesis is the % of companies of the previous box.

The numbers at the bottom in percentage are the % of your company you will give up to that entity.

The circles at the far right are the % ownership of the company you will have post that path.

I’d love for you to let me know if there are any mistakes in this analysis.

This data will change as accelerators get older and have been around for some time, since most of the VC deal flow is still not through Accelerators or Angels. I suspect as companies from accelerators get more mature and the accelerators get better at running their programs, we will start to see a better benefit for entrepreneurs in India.

Thanks to Anand of Accel, Rahul of Canaan and Abhijeet of Bessemer Venture Partners for reading drafts and reviewing the information. Amaresh & Hanaan at Microsoft brainstormed this model.

All the data above is for Series A valuations and numbers from Thomson Reuters. Overall, there were  143 – 155 companies that reported receiving funding last year in India, and many of them were follow on financing (series B or later).

Why more non-technology investors will form the bigger pool of angels by 2020

It is only 7 years to 2020, and I’d like to speculate a bit and make a fool of myself by taking a stab at the future of tech angel investing. To do a good enough job of predicting the future (or a hopeless job of it) you have to know the current state well enough.

In the US there are about 250,000 angel investors across all sectors and about 25% of them are in the technology sector alone. The number of active technology angel investors is claimed to be about 40,000 – active being defined as someone who does at least 1 investment in a calendar year.

Of the 40K angel investors, fewer than 5,000 are classified as “lead investors”. These are folks that will take the pole position in funding a startup and get other investors to rally around them. In India, those corresponding numbers are 500 angel investors in technology and about 25 lead angel investors.

Currently word of mouth networks rule and tend to be the large part of deal flow for investors. Most lead investors get pitched by people they know first or have worked with, then via referrals and finally from random others. This means that typically angel investors tend to put money in things they (mostly) understand or people they know well. That makes logical sense, since they tend to want to add value, learn from and coach entrepreneurs instead of just providing the money and checking in once in a while.

The increasing need for speed to make decisions, means that most angel investors are forming affiliations with others who complement their skills and are beginning to pursue “expertise” in certain areas.

I am noticing another trend that’s starting to make waves in the angel investor ecosystem.

Non-technology angel investors are increasingly becoming due diligence experts in deals.

I spoke with 5 of the top investors in the US a few weeks ago in the technology space and their preferred co-investors were ALL non-tech. That’s amazing and bodes well for startups.

The example I was given is the work being done in agri-tech (intersection of Agriculture and technology). Most of the technology portions are relatively easy to understand for a technology expert, but the non-technology parts of soil testing, crop selection and cold-chain storage were all alien to most technology founders. So they enlisted the help of local (Seattle) farmers and food supply chain experts. In this case it was cheese processing.

In places such as India, where technology founders are a small part of the ultra-rich, this is a dramatic change and a great way to expand the angel investor ecosystem.

I can see how we can enlist more non-technology high-net-worth individual to form teams of investors to help get deals done faster. Since they have good working knowledge of the space and sectors, they are more likely to provide insights and connections that matter.

The irrational fear of missing out (FOMO) #startups

I know an entrepreneur who attends every event that happens in Bangalore. Provided its free. He also organizes many events. I used to wonder where he has the time to run his company or do his job. I have yet to ask him why he attends all these events.

I could hazard a guess. It could be the free food, or the chance to meet other people that might help his company or a chance to make serendipity happen.

Then I overheard a conversation he was having with his mind. Turns out he suffers from “Fear of Missing Out” syndrome, or FOMO.

To be fair, those “rare connections” do happen. That’s the whole point of serendipity. And also the point of never giving up. You just keep plugging away at it until you get to the promised land.

I am that person.

I realize that I have the irrational fear of missing out.

The trouble is , every time I meet an entrepreneur, I learn. I learn a small little thing that I did not know before. It always happens. Without fail.

I have learnt one trick about how to get more views per post with a single character added to my posts. I have learnt the perfect Subject line you can write to get a better open rate in your email newsletter.

So the question is always one of the value of the time spent. I fear that I might miss out on learning something, but at the same time I fear my time is worth a lot more than the lesson learnt.

It is the fear of missing out and it is an irrational fear, but I am curious as to how you overcome that fear. Thoughts welcome.

The step function of #changes that are happening in the #Indian #startup scene

Most everyone believes that startup growth happens in step functions. You work for ages on something and it seems like there is little progress, but as an entrepreneur you are plugging away at it and suddenly one day, the growth is dramatic. Then it plateaus for a while and grows again. That’s the same for startup ecosystems is my opinion (not researched).

Step Function Growth

Step Function Growth

I am starting to see the next step function of growth in the Indian technology startup scene. There are a lot of people (entrepreneurs, investors, etc.) contributing to this growth and its hard to point to why it happened except in hindsight.

First, what metrics should we track so we can really know if there’s a step function or no progress?

Here are a few that we track at the Accelerator.

1. # of startups: How many startups are getting formed, where are they getting started, etc.

2. # of funded startups: Time taken to fund startups, amount of investment into startups, stage the companies are in at the point of angel investment etc.

3. Pace of growth: How quickly are they signing customers, how quickly are they getting VC investment, how quickly is their revenue growing, etc.

The NASSCOM 10K startups initiative is one such forcing function contributing to the growth.

Yesterday in partnership with NextBigWhat they organized the first of several #startuproots event.

A big part of that event was the #sharktank, which had 4 companies out of 200 that applied, that were going to pitch to investors and they had to make a decision on the spot.

For those of you who are not familiar with the sharktank format, the startups get 5-10 minutes to pitch, the investors get 5-10 min to ask questions and 2-5 min to make an offer. The entrepreneurs can then take some time to make their decision and then make a counter offer.

All offers are binding, save for legal and financial due diligence. Which means if and investor gets cold feet later, they cannot back out.

Yesterday, 4 companies presented. I had heard about 2 of those companies before (but did not know they were chosen) and the other two companies were fresh and new.

There were 8 investors who were part of the sharktank, but only 6 were serious. The other 2 seemed more there to critique and provide theoretical knowledge about startups.

Pankaj Jain from 500 startups, Ravi Gururaj from HBS, Ranjan Anandan from Google, Anirudh Suri from India Internet Fund and RK Shah from HBS were on the investors side.

Tookitaki (ad-tech space), Moojic (retail music hardware), Credii (Mid-market IT decision support) and Lumos (solar panels for backpacks to charge your phone), were the presenting companies.

All four got funded at the end of the event. I personally thought 2 of them would definitely get funded, but all 4 getting offers was truly a step function change.

I was personally pleased that Lumos got funded. They are doing something new and innovative that most Indian entrepreneurs wont do – Working on a non-software, difficult to scale hardware business, because of their passion.

I have to call out a special mention to RK Shah. RK is not a technology entrepreneur, (he runs a textile unit) neither is he a professional institutional investor. He wrote 2 checks himself yesterday. We need more RK Shah’s in India.

Finally big kudos to Jaivir, Brijesh and the rest of the NASSCOM 10K startup team. In less than 1 week, they got 850 signups for the event, and 500+ people attending.

Why do investors use boilerplate emails instead of telling you the plain truth?

Most every day I get 2-3 requests to review companies for investment in the seed stage as an individual investor. Since I keep a fairly open network on both LinkedIn and Twitter, I get many folks sending me an email to review their plans. While I do read all of their emails, and send them a response, only 1 in 10 get me to open their plans.

It tends to be fairly easy to decided not to pursue based on their description of the problem or their background. Although I have put my criteria for investment on my blog, rarely do people read it.

I dont think entrepreneurs have internalized the changed landscape for funding of all types.

I do send a quick email to everyone of the people who I dont intend to invest in with a short 1-2 sentence reason. Either its because I dont like the market, the idea or dont believe it will work.

I used to be brutually honest initially (a few years ago) and have mellowed down over the last year. These days if I say I dont have time, it really is the truth. Its not because I dont like the plan or the entrepreneur or the idea. Its just because I dont have the time to evaluate the company.

The main reason I mellowed down was the feedback I heard from many entrepreneurs who had not developed a thick skin that my response was really disheartening and counter productive.

I read today, Paul Graham’s piece on VC boilerplate that Harj Taggar wrote and was amused initially, but the reality is most entrepreneurs prefer to read emails from investors that have some boiler plate stuff rather than the honest truth. I mention most, not all.

Its hard to find know which entrepreneurs prefer the straight up honest truth versus the ones that prefer to get a pat on the back with some encouragement to keep going.

Practically speaking the email from Harj, has 25 sentences too many. If all the email said was “it’s currently a little early for us to step in here.”, that would suffice. If there was more detail, i.e. the number of users, or too few customers, etc. it might help, but really it rarely does.

Why?

Primarily because you get into a shouting match about why the entrepreneur thinks you should be investing at this stage and why you are not an “angel investor” if you wait longer or that you (as an investor) are very risk averse. See comments on my post earlier on what you should have ready before you approach me to get a sense for that.

I invest in very few deals every year (most likely 2) and so do most VC’s. Like most of us we are all pressed for time. Short email responses with quick no should help, but realistically most entrepreneurs dont like that.

A field guide to being a technology angel investor

I am going to work in a series of posts over the next few months on angel investing. This guide will be based on my conversations with about 100+ US angel investors and over 50 in India. The goal is to encourage more high net worth individuals to fund new technology companies.

I have one request of you: If you are an entrepreneur, please promote this guide (it will be free, before you ask that question) among potential angel investors and those that are on the fence. I will try and make it into a downloadable single file in 2-3 months when I finish the guide. Here’s an excerpt.

From 2008 to 2013 there has been a 713% increase in angel investors1 who have funded technology startups the world over. Dramatically lower costs of starting companies, thanks to cloud computing and well formed distribution channels such as app stores has created a boom in entrepreneurs forming new digital ventures. This boom in supply coincided with significantly lower returns from several other asset classes worldwide including a steep drop in public markets, debt returns and also lower housing and real estate prices, which enabled these investors to seek better returns, offered by technology angel investing.

There are multiple reasons we are seeing an increase in angel investors including the anticipation of higher returns, the desire for fostering entrepreneurship among the youth, the need to give back in a more meaningful way to the community and the joy of mentoring. Many angel investors are also seeking a way to leverage their expertise, experience and connections built over the years into a meaningful venture. Whatever the reasons, the net result is that we now have a large set of experienced individuals interested in helping fund and grow innovative companies.

This guide is for potential and new investors, ones on the fence and those who are experienced at the art and math of investing at the early stages. The audience for this guide includes high net worth individuals and experienced entrepreneurs who are keen to help the next generation of entrepreneurs. This guide can help those who, after years of experience working at a large company are now looking to branch out and learn about new markets, new companies and technologies by nurturing and investing in game changing entrepreneurs and their ideas.

How to get to 1000 startups in India ever year

I will be on a panel with several others at the IAMAI conference next week for the India Digital Summit and the discussion is about how to make 1000 digital startups happen annually in India.

I thought I’d put some thoughts together and get some opinions before I present at the panel.

Currently there are less than half that number of product companies being started each year.

There are various issues across the funnel, but I’ll focus on the #1 issue, which I believe is at the top of the funnel.

Great product entrepreneurs starting great companies.

I wanted to pick a specific example from our accelerator: two of the most amazing hackers and geeks I have worked with – Melchi and Aditya co-founded Cloud Infra after 6 years at Google here in India, building high quality products.

I would fund them just given their background and the quality of hackers they are. Regardless of what they are developing.

Anyplace else (Valley) they would have been funded first and then they would have been asked questions. I worked with them for 4 months.They are amazing.

India needs more of them to increase the number of startups from 500 to 1000.

Unfortunately that’s not happening and is not going to happen.

I may get a lot of brickbats for this statement, but:

I believe the best product entrepreneurs should have built & shipped a world-class product before they start a company.

If you have worked in a services company it does not count. Period.

There are very few software product companies in India – in fact fewer than 20 are really good. Of those 20, many, including Google, are cutting back on hiring and investing in India.

That’s just awful.

Yahoo, Zoho & InMobi in particular have contributed a LOT to the product startup ecosystem in India, given how many good developers they have helped groom.

If you worked at any of these product software companies a few years ago, then you are a candidate for a high quality product startup in India.

Granted, a small number of these folks are actually starting companies, but that can be fixed.

The trouble is there are not too many of them in the first place.

And the bigger issue is that the Google’s and Facebook’s of the world are preferring to hire more folks in the valley.

In fact many of the top IIT graduates who get jobs at Google and Facebook are moving to the valley. 2 years ago they’d be working here in India.

To get 1000+ digital startups each year in India, we have to work on making sure world-class digital software companies hire more of our top people here in India.

I dont think tax breaks will provide them any more incentive to hire here.

I also believe there are enough quality folks here in India they can hire.

I’d love some ideas on what will make them hire more people of high caliber in India and keep them here. I’d love to see them not cut back on hiring in India.

What are your ideas on how we can get these companies to hire great engineering talent in India?