Founder Magic and Angel Investments
by Farid Haque
Let’s assume that we are new at “Angel Investing” or are exploring the opportunity of putting some hard earned money into a highly volatile and risky asset class and start with a few definitions.
An angel is an individual, often a wealthy individual, potentially a sophisticated investor who is able to part with personal cash to invest in a company in exchange for equity (shares), a position in the business, typically on the board, sometimes even operationally in the business. The cash provided by the Angel may even be used to provide debt to the start-up or, to make things more complicated, convertible debt (which may turn into equity at a certain point provided certain conditions have been met). In all cases, the angel intends to add value to the business by providing risk capital. The jackpot for start-ups, of course, is the angel that can provide so much more than just the risk capital. The ‘so much more’ often comes by way of contacts through networks, access to decision makers at large corporates, introductions to other angels, people and businesses, of significance to the start-ups, such as subject matter experts, or the holy grail… a celebrity that can inject instant interest in the business. I will come back to the Ashton Kutcher effect another time.
So why is it called Risk Capital? Well because the Capital is at Risk. And what most Angels don’t get very early on is that not only is the capital at Risk but it is also about to become VERY illiquid (hard to get their hands on and use elsewhere). It’s illiquid because it is very rare for an early stage investment into a start-up to experience a liquidity event i.e. some sort of sale or exit where the investor, the angel, is able to realise a return (and sometimes for the not so lucky a loss) on their money (no matter how big or small). There are always exceptions to the rule. There are cases where start-ups have been sold just a few months out of an accelerator or an incubator (in the case of Magic Pony sale to Twitter for $150m past being created at Entrepreneur First the deep technology incubator in London) or perhaps the investor has been bought out by a later stage investor (some love this outcome and strive for it especially when a trade sale seems years out). Perhaps a strategic investor (some large corporate) thought the opportunity was just too good to be true and wanted to saddle up that Unicorn early. It is also rare that start-up shares are ever traded on a secondary market, though there are some exciting things happening in this space also that may see private company shares exchange hands earlier on platforms, like SecondMarket (which was gobbled up in 2015 by NASDAQ).
Ok, let me slow down a little, so about that Unicorn…the mythical beast title is conferred on the elite few that are brewed into multi-billion dollar companies like Airbnb, Uber, and so many more. You may also hear the term Zebra bandied around, which is supposed to represent a business that ‘Exits’ (Sale of the start-up or in some cases the GrownUp) not in the tune of $1bn or more but rather to the tune of a couple of hundred million instead. I see it becoming fashionable for entrepreneurs to position themselves as ‘realistically’ building businesses that may be more likely to be Zebras than Unicorns. Let’s take a pause from the menagerie.
I also used the term accelerator or incubator. Well, here I am going to make sure that I share my thoughts on the matter. Having participated in 2 myself(Techstars and Mundi Labs), I consider myself a resident expert on the space. An incubator is as the name suggests an organisation set up to support very early stage ideas, and yes, many may literally be a figment in the founder’s imagination or a drawing on the back of a napkin with some merit, given the ambition and enthusiasm that the founder brings to the table. These organisations are essential in providing an early place, a safe place, for ideas to germinate. To grow under a warm lamp of support from those that are vested in the success of the idea and the team. Many a time, the ideas in incubators may not even have a complete team around them and are building as they go. This also happens to be the riskiest point at which an angel can invest. Not least because the technology is not yet built but also because the people mechanics have not been bedded down and many times there is a chance that human interactions are more likely the cause of the business breaking down than the business running out of money. A start-up coming out of an incubator has just jumped through its first hurdle. These programmes are not trivial and what they demand out of teams is a significant injection of time and energy. There are a number of new entrants in the incubator space that have now proven their mettle, like Entrepreneur First (EF) and have attracted a number of incredible Venture Partners like the founders of OneFineStay and Space Ape Games. Venture Partners add some technical and business prowess to the funds overall sheen and their battle scars help attract startups and Limited Partners (investors in the Fund that do not operate the fund) that value the experience their exits and journeys bring to the Startup game.
The Accelerator industry is a different beast, this is a mature multi-million dollar stage today. Filled with its share of limited partners, strategic investors, politics, financing and often a bevy of professional providers,like lawyers and accountants, all trying to get a piece of the action. The industry today has evolved into Tier 1, 2, 3 and, perhaps, lower tiered players. In Tier 1, to name a few would be the global stalwarts like Y-Combinator or Techstars. Tier 2 include the likes of Start-upbootcamp, Founders Factory and Wayra, jostling and working hard to develop world class programmes, often in concert with the support and investment of strategic corporates that come from the world of Financial Services, Telecommunications, Publishing, to name but a few. My description of Tierage is not that important, what is important is that start- ups that are able to complete these programmes successfully are able to position themselves in the market thanks, in part, to the media circus that surrounds them but also because of the ‘badge of honour’, the brand association that delivers the equivalent of an Oxbridge education or an Ivy League reputation for its alumni. This is a good thing. The start-ups win and so do the investors as the programmes quite literally push the teams hard enough to almost break them but yet allowing the very best to prove their hypothesis and build ‘real businesses’. So, do look out for those start-ups, as they have often survived these 90-day pressure cooker environments and built up massive networks that help them take flight.
The blog post was titled ‘Founder Magic’, so I should probably come on to that now. Many Angels go to Angel Networks, demo days and sit around with their networks comparing notes on their deal flow (the start-ups that come to them for funding) and very often the thing that gets them in the end is ‘founder magic’. It is very difficult to place bets at very early stages of a start-up’s life. However, very often that bet is being placed on the founder’s grit, their drive, ambition, passion and energy, all melded into what I call Founder Magic. Amongst the founders there are Wizards, those that have exited before and have the ability to command a crowd with their visions of what the next exit could look like for them. And then there are the Sorcerers (for the sake of being politically correct please extend this reference in the blog into all gender terms possible) who have loved and lost but learnt how to woo the early stage investor because they know what the investor wants to hear. And of course you have the magicians that have truly started to create real businesses through early product market fit and finally the apprentice that is hard at work trying to realise their magic. In all cases, the magic varies but, as an Angel, one thing that is for certain is that by putting yourself in the dragon’s arm chair you are putting yourself out there. Out into the open for them to cast their nets wide and hope that a little magic dust does, in fact, fall over your eyes. Regardless of what one can relate to or aspire to become all of the above are attracted to the lure of the Startup promise. The promise to exit and return vast sums of cash that provide a times “x” return on their investments. That promise must be understood to be frequently broken given the survival rates amongst early stage businesses. One big step therefore that an angel can take is perhaps exploring the range of stages that they invest at. Very early, early, past Product fit, late and yes perhaps even very late. A mix of the above. All this depends on so many variables that it is hard to generalise but angels do tend to be heavily over-indexed in the early years given that this is where “institutional-esque” capital is rarely seen to play (though that too is changing in Europe with funds coming into the fray earlier).
There are some in the market that are rarely tipped by founder magic and are referred to as Super Angels, that are more like Ferry Liners (these are sophisticated individuals that have been operators and investors that have already enjoyed considerable financial success in the world of early stage investments). These investors have an almost institutional approach to investment in early stage businesses, some having thematic portfolios and others being opportunistic but creating powerful syndicates online on platforms like AngelList (like my guru Tim Jackson from Walking Ventures previously known as Lean Investments).
In the next blog, I will talk a little about how a few friends I know have built shadow portfolios in the world of angel investments without putting much capital at risk and enjoyed some of the same kicks that come with the magic.
Disclaimer: Please remember that none of this is investment advice and your capital is always at risk when it comes to early stage investments.
This blog was written by Farid Haque, cofounder of AssetVault.co and first published on the Toucan website. The content is copyright of Haque & Company. This blog may not be reprinted without written permission from the author and mention of the author’s name.