I had a delightful conversation with Ritu Kant Ojha on his ‘Real Conversations’ podcast recently and we spoke on an array of topics including Angel Investing, Silicon Valley startups, exit opportunities for internet founders, capital efficiency and the ‘Burn Multiple’, IQ vs EQ and much, much more. You can listen to the complete podcast here.
Below is a summary:
Accidental Angel Investor - My journey into this exhilarating world of Angel Investing happened almost by chance sometime in 2014. After a long stint in the corporate world, I had turned an entrepreneur and was working on establishing a B2B Workplace Food business. While all my energies were focused on it, out of the blue came a not to be missed once in a lifetime project. It was in the new and exciting world of Insulin Biosimilars, a global business opportunity and was brought to us by a team of talented and experienced scientists. A band of close friends soon cobbled together an informal angel group, agreed on a business plan, set up a company, and funded the team of scientists who were tasked to deliver on the agreed objectives. While I understood little about the technicalities of the complex business, there were others in the group who had successfully built and exited pharmaceutical businesses and I ran along with their conviction. That’s it, unknowingly I became an Angel Investor. GeneSys Biologics has since evolved from its humble origins at an incubator at BITS Pilani to now having its own huge campus in Genome Valley, Hyderabad and attracting global attention. Most of my work experience up to that point was in legacy industries; Advertising and Financial Services and I realized that I had missed the entire technology and internet revolution. This set the ball rolling, post which I began actively exploring other opportunities which has led me to where I am today.
Exit opportunities for internet Founders and trends in the M&A space - M&A as conducted by investment bankers today is usually a long and frustrating experience, full of stops and starts, hard-nosed negotiation, and emotional flareups. I’ve had my fair share of experiences working with the Big 4 over the last few years and a normal transaction takes anywhere between 8-12 months if one is lucky. Fortunately, there are a new breed of VC firms that are using Warren Buffett's methodology to acquire profitable internet companies. They promise a term sheet in a week and a deal closure in a month. No renegotiation and grinding you on terms. These aren't your typical VC's that acquire and try to flip businesses in 3-5 years, they hold it for the long term. While Berkshire focused on railroads and fast food chains, these VC’s want to buy simple, profitable internet businesses.
The ideal target company should have a 3-5+ years of operating history, a minimum $500k/year in annual profit and a high-quality team in place. They look for simple internet businesses that have high margins, don't require tons of people or complex technology, and have a competitive moat. They run a quick 30 days process, simple structure with full or partial cash out, founders can stay or go, post which the VC's will hold and run the company for the long term. Technology founders may identify with the below situations:
Bootstrapped the business and scaled it with real customers and revenue and looking at handing the reins to someone else or partnering for the next phase.
Raised money and built a good business but haven't been able to achieve venture scale and investors need a soft landing.
Have early employees, investors or a co-founder who wants to leave/ cash out and you want to swap them for a friendly new face who can add value.
The above is very pertinent to the Indian market as liquidity in startups is a big concern. I’m working with a few VC’s in this space and more than happy to help internet founders get the ‘simple M&A’ done.
Silicon Valley vs Indian startups ecosystem – This is a controversial topic and is a hot topic of discussion on social media these days. There are two ways to look at it and both the arguments hold merit. Definitely Silicon Valley startups are innovative, have first rate Founders, address a global market and are baked in the best startup ecosystem in the world. Indian startups largely are thought to be ‘copycat’ products and address a limited Indian market. However, the biggest reason why startups fail is due to not achieving product market fit. By disrupting legacy businesses, they are actually creating new business models and discovering new customers and markets. So, if someone is trying to do a copycat product say in China or India, at least they don’t have to struggle to create product market fit (biggest risk) and therefore the chances of failure diminish considerably. They only have to focus on execution albeit in a smaller market, but at least their chances of success go up considerably. So, the argument cuts both ways and depends on your investment objectives. Also, to invest in US startups, one needs to qualify as an ‘accredited investor’ also known as a ‘sophisticated investor’ which is a income and net worth criterion as defined by the SEC.
Advice for new Angel Investors – People often carry misconceptions about angel investing. Firstly, one shouldn’t look to invest more than 5% of their net worth in startups because they are high risk investments and illiquid. Most startups will fail, so therefore only invest what you can afford to lose. Secondly it is important to understand the life cycle of building a business. I’ve been on both sides of the fence and can say with conviction that it takes nearly 8-10 years to build a start-up, scale it with strong fundamentals and set it up on its path to profitability. If investors are not willing to wait this long, then they are setting wrong expectations for themselves. Finally look to build a diversified portfolio and avoid concentration only in a few startups how much ever you like them. If one sticks to the above principles, startups investing could be an enjoyable experience. Book recommendation: Angel by Jason Calacanis.
Capital efficiency in COVID times and the ‘Burn Multiple’ – This is the hottest topic of discussion in startup board rooms across the world. Recently David Sacks of Craft Ventures wrote an article on how startups should think about capital efficiency in COVID-19 times. Sacks introduces the concept of the “Burn Multiple,” which correlates a company’s burn rate to its ability to add new annual recurring revenue. The lower your burn multiple, the more efficient your company is, he says. Here’s the formula:
Burn Multiple = Net Burn / Net New ARR.
For example, in the Q2 just ended, say a startup reports that it burned $2M while adding $1M to its ARR. That’s a 2x Burn Multiple which is reasonable for an early-stage startup. On the other hand, if the company burned $5M in Q2 to add $1M of net new ARR, that’s a terrible Burn Multiple (5x). Not just growth, but the efficiency of that growth will be increasingly seen as a key indicator of startups performance in the days ahead. Over the past 12 years, startups experienced an unprecedented boom in funding due to a deluge in the number of funds, which were raised relatively easily with low cost of capital and excess liquidity. Those days of overcapitalisation are truly over and eventually Darwin’s ‘survival of the fittest’ will come to fruition, and only the nimble and fittest will survive.
Intelligence Quotient vs Emotional Quotient – People often disregard EQ for IQ. While the Intelligence Quotient is very important in conducting business, it is often highly over rated. Most forget that startups are run by real people and if human interactions are not right between founders and employees and between investors and founders, it will lead to a lot of dissonance which could be detrimental for the business. Startup founders compared to corporate professional’s work in extremely high-pressure environments, with no support systems and these COVID times could be stressful for them. Investors should therefore bring in the right kind of Emotional Quotient in their interactions with founders in reviews and board meetings and help founders sail through in these tough times. Undue pressure on them could be detrimental to the startup as these are the guys who will get the startup out of this rut post the pandemic. EQ is needed now more than at any time before.