Startup Ecosystem Ranking 2015

Global Startup Ecosystem Ranking, 2015 #Seattle and #Bangalore

The global startup ecosystem rankings at out. Since we had a chance to partner with the team putting together this research I had a chance to learn the methodology a lot more this time. There are three observations I have regarding he overall report and a follow up to an early comparison of the 2 startup ecosystems I have the most experience with – Seattle and Bangalore.

First, the two ecosystems are not that different in many aspects – the criteria used by compass were:

1. Performance (exits, valuations, etc).

2. Funding access

3. Market reach

4. Talent

5. Startup experience

and finally Growth index.

1. Growth: Bangalore is growing dramatically, at 2.5 times Tel Aviv’s growth and more than 3 times Seattle. It will be a matter of time before the total number of startups from Bangalore will be more than that of Tel Aviv or Seattle combined. Likely in 2018.

2. Spread: Seattle’s ecosystem of startups is more broad based – a few eCommerce (Zulilly, Expedia and Amazon), some cloud and a few SaaS companies. Bangalore’s ecosystem of startups is fairly shallow – eCommerce rules, followed by a few in Ad tech and B2B.

3. China: I am shocked that Beijing and China were out of the top 10, much less not even on this report. My first hand knowledge of Seattle and Bangalore and secondary knowledge of China, indicates that they will be #2 even higher than where LA is.

I would agree that market access / reach and startup experience,  expertise will put Bangalore slightly behind Seattle, but that’s more than made up for with Bangalore’s better funding availability and overall acquisition track record.

Here is my unofficial top ecosystems ranking, which I believe will reflect a more accurate ranking of the top ecosystems for startups.

1. Silicon Valley (Separate the valley and SF and you will have the #1 and #2 positions)

2. Beijing

3. New York

4. Los Angeles

5. Boston

6. Tel Aviv

7. Seoul

8. Chicago

9. Seattle

10. Bangalore

11. London

12. Austin

13 Sydney

14. Moscow

15. Toronto

The rest of the ecosystems dont matter. Either market access, funding or performance in terms of acquisitions.

The other parts of the ecosystem that should be measured include news and media involvement, hackathons, events, training and education – early indicators of where the ecosystem is headed and I think those will show a few other cities – Tokyo and a few middle eastern countries as well.

Startup Ecosystem Ranking 2015

Startup Ecosystem Ranking 2015

Being Capital Efficient

How your investor “Story” differs from your customer “story?

I dont subscribe to the meme that says you have only one “story” as a startup. I think you need different stories based on your audience. I want to talk about one particular case based on a real world example and share how the stories might differ, the messages might change, and the positioning might be different as well.

I had a friend who is building a hardware company. Or, so he thought. The hardware unit would sit in a car and monitor driving behavior. Since it was focused on a niche (but large) use case, he was able to confidently show a large market (over $1 B) in a bottoms up market research study.

He had also done some initial customer development and spoken to over 50 of his target customers who were all willing to buy and pay for the solution, talked to 5 potential distributors who were willing to stock and sell the product and also had talked to manufacturers who could build at scale. Armed with this information, he felt he could raise a $500K round, since he had a strong team of 3 folks with him.

Being Capital Efficient

Being Capital Efficient

To build the hardware he estimated 3 resources for 6 months, so he felt $500K would give him enough cushion to tide a few mistakes.

After 3 months of trying to raise money and talking to over 12 potential targeted investors in his list, he found out that the appetite for  hardware was just not there.

Well, there was appetite for a hardware company, but only at “scale”. Not in the initial phases, meaning the target investors,  who were “early, seed and angel investors” wanted to see upwards of 500 to in one case, over 5000 units, before they were willing to to give the angel terms – $500K at $2M valuation. My friend felt he was being low-balled, but he had no other options.

Most investors he approached were unwilling to fund his hardware company.

This is not about hardware though, the same “investors unwilling to fund” anything outside known or proven models exist in other areas as well. Markets get in and out of favor. The flavors of the month are big data, anything marketplace (consumer) and most all things SaaS, etc. and cloud (B2B).

So, when he reached out to me, my initial reaction was the same as other investors. Having burned my hand in hardware companies, I was unwilling to fund anything close to hardware. Over the last 9 months we have funded 10 hardware companies and 30+ software. Except for one hardware company, the rest still have not shipped product (nearly 3-12 months after they promised to do so) and most have been unable to raise a follow on round of funding.

On the other hand, 50% the software companies have been able to secure follow on funding. I understand funding is no measure of success, but it is a key milestone.

Instead I asked him to position his product as a “Insurance and driver data as a service” – DIDDaaS (forgive me) platform and get the version 1 out with software alone, instead of hardware. Turns out that worked. After 3 weeks of meeting the same investors he did before, with a software only, asset light play he was able to get $250K committed to start.

Trends point to the fact that even software companies are forgoing being capital efficient, but if your story depends on raising a lot of capital to be competitive, I’d say change the story to appeal to the capital efficient investor, EVEN if you end up raising a lot of capital.

Angel List Database of Investors

What percent of active angel investors are on #AngelList?

Every week, I get about 2-3 emails from entrepreneurs asking me to introduce them to angel investors who might be interested in a startup.

Besides this, I get about 3-5 introduction requests to specific investors.

Looking at my reports from Conspire, I end up helping more than 70% of the specific requests and only introduce 25% of the folks from the generic requests to “connect” to investors.

I’d love to help a lot more, but I unfortunately dont have the time. For the entrepreneurs who want connections, I end up saying – Can you please check on #angelList. Which is what I would do if I were in their position.

I usually get a note from the entrepreneur who say most of the investors on Angel List are “fake”. I think they are confusing getting “lead investors”, who are on Angel List versus, getting the entire round done, with investors who are not on Angel List.

Somehow, many of them come back telling me that there are a host of “other investors” who are actively investing, but are not on angel List.

That lead me to the topic of this blog post.

“What percent of active angel investors are on #AngelList?”

Angel List Database of Investors

Angel List Database of Investors

Most entrepreneurs believe that like the iceberg featured above there are a lot more actual investors than the # on any database. Or that there is opacity in the identification of angel investors.

I am not sure of the data, but I wanted to do some quick and dirty data checking.

Here are the assumptions I am making about the startup.

1. I assumed that I was looking to raise money in Bangalore, India or Mountain View, California.

2. I am starting a company in the SaaS (Software as a Service) space.

3. I am looking to raise $500K from angel investors

4. I have early product and some customers (none of them are paying, or a few are paying too little).

5. I dont have a large network of investors and I am not from Facebook, Google, LinkedIn or a “hot company” on my resume.

I then looked at Angel List with these assumptions and got about 35 “individual investors” in India and 512 investors in Silicon Valley. There are actually a lot more, but I weeded out the ones who have done only 1 investment over 2 years ago and those that are not SaaS specialists.

I also then looked at the recent 9 SaaS investments (last 2 years) in India, and 14 SaaS investments in SaaS in the Bay area. I got this list from Owler and Crunchbase and also looked at data from 5 accelerators – YC, 500, Alchemist, Angel Pad and StartX. I wanted to check who are the investors in these startups.

The data on some of the investors is available but most of the startups that recently got funded have 3-5 investors who are public and rest (similar number) who are “behind the scenes”.

The quick and dirty research suggests that close to 40%-50% of angel investors are not on Angel List.

The reason I was able to determine that only 20%-50% of the investors were publicly identifiable was by speaking to 7 of the Indian startups and 9 of the US ones.

The most common 3 reasons why not all investors were listed on the company’s Angel List page were:

1. The angel investor was not on Angel List.

2. The other angel investors did not want to be identified or preferred to keep a low profile.

3. The angel investors were part of the syndicate, which was led by one of the well identified investors already on Angel List.

I spoke to 5 of the “lead investors” and 3 of the “not on Angel List” as well.

There are 3 takeaways for entrepreneurs from my research.

1. To get an angel round done, you need a lead angel investor who is very likely on Angel List and is pretty active (you need a lead for other rounds as well, BTW, so no surprises here).

2. If an “angel investor” is not on Angel List, it is highly unlikely they will lead the round or help you close the round.

3. Most of the “other investors”, not on Angel List purely work on recommendations from their trusted “Angel investors” NOT from other entrepreneurs. This is different from professional investors (such as Micro VC’s or VC’s) who get most of their recommendations from other entrepreneurs.

So, my recommendation is start on Angel List, get your lead investor and then use other sources (LinkedIn is the better source than Angel List for this) to find investors who are connected to your lead on that platform, but are not on Angel List. Also use recommendations from your lead investor to help you get to other investors who invest with your lead.

5 strategic items to consider before you get acqui-hired #napkinStage

In the last 3 years at Microsoft Ventures, 7 teams have been “acqui-hired”. 2 were from India, 5 in the US. I had a chance to be up close and see the action, the challenges, the frustration, the joy and the sigh of relief that the entrepreneurs face with these deals.

Acqui-hires fall into 2 buckets – those that save face and those that are incrementally progressive.

While many of the acqui-hires seem like a face-saving opportunity for the founders, they are pretty traumatic for the employees and almost always a poor deal for the angel investors, with exceptions.

The incrementally-progressive ones land the early employees great jobs in the new entity, provide a small return for the investors and allow the founders to get a small win under their belt.

I think about acqui-hires with the focus on the 3 main constituents – the early employees, the advisers and investors and finally the founders.

 

Acquihire Model and Strategy

Acquihire Model and Strategy

You could debate who comes first and who should be considered later, so this is only one model for thinking about this.

1. Return on Risk (ROR) for early employees. Most of your employees (if you hired great folks who were already in other great companies) have taken some form of risk to come and join your startup. Assuming that many left opportunities that were considered less risky than yours, I suspect they would expect a sufficient return on the risk taken. Most good employees, will get an offer from your acquirer, which, I think is the main reason why they are acquiring your company in the first place. The best way to give them a return on risk is to help them “true up” on their salaries they forwent.

2. Return on Time (ROT) for the first few hires. In most acqui-hires, I have seen that the acquiring company does not value the product / service that has been built, but instead likes the team. Building a new team who work well together takes time and energy, which is why they chose to acquire a team instead. A good way to help your early employees a return on their time spent (and you as well to hire, recruit and build the team) is typically via a “sign on bonus” for the entire team.

3. Return on Investment (ROI) for your early investors: If you take money, it should your responsibility to return it if you make some money. While many founders feel that angel investors fully know the risk they undertake when they invest in startups, the responsibility to return money does not go away when things dont work out. What I have found is that most founders will end up going back to being founders again and if you leave a trail of destruction or burn bridges when you do your first startup, it will get much harder to raise money for the next one. If you can help investors get as much money back or return their invested capital, then you will go a long way in terms of building credibility for your next venture.

4. Return on Equity (ROE) for advisers. Early advisers dont invest money, but typically their time. While you might feel less responsible towards them since “they did not lose money”, they did give you time, some connections, advice and mentorship, I think you should try and get some for of return for their Sweat Equity. I have seen one or two founders, taking a portion of their “earn out” to buy out the adviser shares that have been vested. You dont have to do this, but it does help.

5. Return on Opportunity (ROO) for founders. While most founders are relieved just with any exit (given that many acqui-hires were to save certain closure) I do think that founder return is important. If you do get an opportunity to get a good package of stock options and sign on bonus from your acquiring company, I’d highly recommend you negotiate for that.

I have found that in 4 of the 7 deals that happened, the acquiring company would have gladly paid an extra $100K – $250K just so the various parties involved would be “made whole”. In many cases the founders just did not ask since they were desperate to get the deal done.

My only suggestion to you as a founder is to ask if you can. If there is a good alignment with the acquiring company and they wish to keep all the employees for a longer time, they would gladly negotiate some more money to help make the deal more attractive to all parties.

The reason for the $100K to $250K number is simple. If your team is 3-5 people, the cost of hiring a team alone will be covered at those numbers. So, in most cases, it will be a win-win for the company.

Lessons from the Greek debt crisis for entrepreneurs

Here is a hypothetical “real” situation. Lets say you raise  some angel money from a few friends (IMF) and a few rich individuals (Germany and French banks). The money you raised is $250K, in a convertible note (loan).

The intention was to get product to market (stabilize your economy) with that money and hire 2 others besides pay for you and your cofounder. You detail that the money will last 5 months at $10K per month per person, plus expenses.

Greek Debt Crisis

Greek Debt Crisis

The angel investors are not happy that you and your cofounder are taking $10K in salary per month, which they feel is a lot (yes I know that it seems like a small amount in SF, or Bangalore as well), but really want in your deal (because they believe you will build a good business).

Then after 5 months, the product is not quite there and will likely take 5 months more to bring to market. You go back to your investors and let them know the situation. While not happy, they are still ready to back you and now are willing to put $25K for the next 6 months, and ask both you and your cofounder to forgo your salary (austerity) until product is shipped.

You and your cofounder realize there’s no choice but to accept the austerity measures and give in to better terms as well and think that the pain (no salary) will be short term so it would be worth it.

6 months pass and you need to raise more money. You have some early customers, the product is in the market. The money is needed to scale, grow and also to provide some relief to the founders in terms of getting paid.

The new investors though, are not giving you the valuation that will give you any relief and are not willing to pay for the “accrued” salaries of the founders. They also think that to grow the business, some of the loans from the angel investors needs to be “written off”. The previous investors will take a “haircut” on their debt.

Previous investors are unwilling to take the haircut, so your funding, goals and priorities are at am impasse. Neither side is willing to give up.

You now have 3 choices.

1. Exiting investors take a haircut on their debt, and their “investment” of $75K, is going to be valued at $25K instead, but they will be part of any growth going forward.

2. New investors are willing to value the previous investment at $100K (which includes the $25K in accrued salaries to founders for the last 6 months) and are willing to fund the company enough to pay salaries and support growth.

3. The founders are willing to take a haircut on their ownership (and give it to previous angel investors) and forgo their salary for the last 6 months as well.

That’s the Greek debt crisis and the options in a nutshell, with the players changed and the situation more complicated (Euro, Social programs, etc.)than I explained it.

The reality of the go-forward plan is that there will be compromises that need to be made all around. Founders, previous angel investors and likely the new investors will all have to find a solution to keep the company going.

Who’s the most vested – the founders (or Greeks) who have spent 12 months of their life trying to bring product and idea to market.

Who’s the least vested – the new investors, who are not going to invest unless they see upside.

Who’s taken a lot risk – the existing angel investors, who put money in expecting a return, but knew fully well that it was risky.

Asking the existing investors alone to take a haircut wont be right, neither will it be fair to have the founders take all the burden of the new investment.

Ideally if you can “carve” out a portion of the future potential for both founders and previous investors, it would be fair.

I have seen though too many cases where new investors “Cram Down” previous investors and in many cases dilute the founders way too much to have meaningful value going forward, which is why terms and provisions in the convertible notes are getting more difficult and involved.

What’s the best solution you think to the above problem? Who (all) gets the haircut?

If you are #napkinStage what is the 1 thing to focus on to get traction with investors?

I was at the Seattle Founders Institute graduation event last night with 40 others who gathered to see the 3 newly minted entrepreneurs from the program. From the over 100’s of applicants, there were 30+ who signed up for the program, and yesterday 3 folks graduated.

Seattle Founders Institute

Seattle Founders Institute

TeaBook is a monthly tea subscription. The founder has spent a lot of time in China to source and obtain unique tea’s that will be mailed to your home every day. The tea market is over $25 Billion and growing at 7% annually. They had a great story and compelling market presence. I personally felt the monthly subscription commerce business has many players, and I suspect in the next few years there will be much consolidation. The tea market itself has many competitors as well including TeaLet, teabox, Chahoney and LizzyKate. They have some early indication of traction, with some trials and some passionate customers already willing to sign up for the service.

American Giving – was focused on ending poverty in the US, with a researched philanthropy website. They founder was looking to create a indegogo style site, where philanthropists could research, back and support giving to Americans better. The potential to unlock over a $ Trillion in well researched giving would be large and they were looking to take a 15% admission fee on all giving.

MeltingSpot, has a 2 sided marketplace for helping consumers looking to meet “folks they like” near them. Think of “Tinder meets FourSquare”. They Melting Spot could be a bar, or a restaurant, who wants to “sponsor” a spot where people only interested in “animals” would be able to meet others. There are many dating sites and apps, and many social networks, but their focus was on helping folks in their local region. They would make money by charging bars to sponsor a “melting spot” – initial suggested retail price was $30/month.

All 3 entrepreneurs had great stories and did an excellent job showcasing the market (which was large) and spoke to their personal backgrounds as well. None of them had a working website or prototype (some mockups), but they had financial projections. They were all non developer or technical founders, looking for their CTO, but had the sales and marketing background and expertise.

All of them were looking to raise some money – from early seed (>$100K) to seed ($2 Million – teabook).

As an investor, the biggest challenge I faced was I was not sure how many more pivots were going to happen before they get Product Market fit. I suspect a lot more, because none of them had product shipping yet.

Which leads me believe that Kickstarter or Indegogo is the best way to show social proof, customer validation and early traction.

If you have an idea and you want to progress on the journey towards investment, the launch page with social proof, early orders on your crowd funding campaign, product prototype and having a well rounded team are a must have for #napkinStage companies. Those would be the things to focus on, more than distribution channels,

The rise of the Micro VC fund and the future of seed stage funding – 5 questions for @SamirKaji

Samir Kaji at First Republic has been following seed stage investing for a while now. I have written before about the rise in Micro VC funds, which are typically <$100 Million funds run by a solo General partner or two partners. Many angel funds are in the sub $25 Million range, as well.

Samir Kaji First Republic

Samir Kaji First Republic

Over the last 10 years (since Jeff started Soft Tech Venture Capital) there are over 250 Micro VC firms that have been started. I had a chance to talk to Samir yesterday and asked him 5 questions to explain and understand this phenomena. Here is an edited version of our conference call.

1. What are Micro VC funds and why are they a thing now?

As the cost of the software startup drops, the amount of money required at the early stage has reduced as well. At the same time the number of startups has increased and so has the number of angel investors. Micro VC funds are deploying smaller capital at the earlier stages than traditional Venture firms. Typically 10 years ago, the VC fund would be $100 – $200 Million and invest in 20-30 companies, between $2 Million to $20 Million per company. Now the larger funds are deploying $5 Million to $50 Million as their fund sizes have increased to $500M to $1 Billion.

2. How many of these Micro VC funds are there are where are they located?

Close to 40% of the 250+ Micro VC funds are in the Silicon Valley said Samir. 25% of them, or about 60 are in Asia and Latin America. About 30 are in Europe (largely London and Germany) and the rest in Chicago, Boston and New York.

3. What value does a Micro VC provide besides cash?

Depending on the Micro VC, expertise and connections are the most important things they provide besides cash. A good Micro VC is already thinking about your next round and has built a good network of connections to help you with follow on funding. Since most Micro-VC funds are small by nature, many often cannot exercise their full pro-rata in follow on financing rounds, and almost certainly do not have the ability to serve as a lead in the next round of capital. Instead, they have a well curated list of investors who they have worked with before to help introduce startups to their network. Expertise varies by investor, but most will be able to help you hire good people and also help you with Go To Market, Pitch preparation and some early business development.

4. When and how should entrepreneurs approach Micro VC?

Typically after you have a little traction is when most Micro VC’s will be interested is what I learned. Most want to see some validation of your startup. Some of them do work with Accelerator programs, but I have seen many of them working their network of entrepreneurs to get introductions to other potential entrepreneurs.

5. Will there be more or fewer Micro VC’s in a few years? Where is this headed?

Micro VC’s are here to stay, said Samir. In fact, he sees more of them will emerge in the next few years. The main reasons are that there are enough entrepreneurs who have had some modicum of success and dont want to do a startup again, but want to use their expertise, connections and network to help diversify their risk and give back by helping other entrepreneurs. So, they will in fact continue to exist. He did say that the Micro VC’s with more tenure will likely move “up market” and start to raise larger funds and become the next generation VC funds, while newer, smaller GP’s will start to become Micro VC funds.