Thursday, November 20, 2008

The view from on high- New York Angels meeting

Yesterday, I attended the monthly meeting of the New York Angels, a group of 75+ Metro New York investors that fill the gap between friends/family and venture capital financing. Members include Esther Dyson, Gideon Gartner, Josh Kopelman, Scott Kurnit and Chris Anderson. (I have been a board member for 3 years). As background, over the past 4 years the group has invested more than $20mm in 50+ young companies. The companies mirror the Metro NY landscape with many investments in the internet arena, a smattering of retail, and a respectable share of medical oriented firms.

David S. Rose, the Chair is well plugged into the Angel investing activity around the country, through his investment in Angelsoft and he began the session with a perspective of the way Angel investors seem to be reacting to the market downturn. He sees Angels taking a 'new approach to investing' whereas, despite continued innovation, follow-on rounds for seed investors will be mostly problematic as the venture community is hoarding capital to support their existing portfolio companies; leaving diminished resources for new investments.

From a deal overview, he sees valuations plunging in the 40% range to a pre-money in the $1mm range for seed investments. Moreover, the business objectives for stakeholders will place a premium on getting to self-sustainability, at the expense of growth. This shift is directly tied to his perspective that scant resources will be available from professional investors, so it's better to own a grape than to throw out a rotten watermelon (my words, not his).

One of the beauties of Angel organizations is the diversity of backgrounds, thought, and opinion; sort of like going to the in-laws for Thanksgiving. As such, let me share why I disagree with some of the sentiment expressed by David:

1. I don't think professional investors are interested in small companies that have reached break-even and 'with fresh capital' have the potential, but not the record of seeking break-out growth. The environment is littered with firms that have great potential, but limited growth that a VC simply does not have the time to filter all the coal dust to find the diamond. The math for early stage venture investing success dictates that each portfolio of an early stage investor should have at least one 10x that returns most of the fund. Each investment ought to have that potential.

2. I don't see a plunge in seed stage valuations. Depending on which side of the field you are sitting on, it's a shame (or a virtue) that investors can't own more than 100% of a Company. Realistically, the market dictates a healthy balance between greed and avarice whereas early investors, post-investment, ought to leave a healthy amount of equity in the entrepreneur's pocket. After all, these are the folk whose passion will drive them to 24/7 company commitment, who will face multiple rounds of later dilution and are the glue that will make your investment more valuable. Owning too much, too early is a Faustian bargain.

Instead of a plummeting prices (ok, there will be some moderation), I see a 'right shift', whereas seed investors who put money behind ideas, will now look for a finished product. Those seeking a finished product, will look for some measure of market acceptance. And each will invest at their historic valuation levels for an investment that has now been measurably de-risked.

Entrepreneurs seeking seed capital will revert to cold garages. Prudent investors will have wonderful opportunities to participate in a changed risk/reward environment. One, whose later returns, will depend upon participating in investments that are showing signs of attaining, or have reached market leadership.

1 comment:

  1. Perhaps surprisingly, I don't disagree with Charlie to a large extent. It's just that he left out one part of my discussion, and we didn't discuss another.

    While getting to break-even on existing dollars is, to my mind the current market standard (and I've now heard this from virtually EVERY angel and EVERY VC with whom I've spoken in the past month), break-even alone won't cut it (and never has, as Charlie points out.) The trick (and the point I made on Wednesday) is getting to break-even WHILE AT THE SAME TIME CREATING LONG-TERM, UNDERLYING ASSET VALUE. That is, you still have to create what will eventually be the Next Big Thing, but we're willing to trade off Year 1 revenue growth for year 1 break-even...provided you can prove to our satisfaction that time is working to your advantage because the underlying enterprise value is getting bigger and bigger.

    As for the valuations, if Charlie doesn't see rapidly dropping numbers, all of you entrepreneurs should run, not walk, to Charlie's door, because he's must be the only high-priced game in town [grin]. He makes an excellent point about retaining incentives for founders and management, but what he neglects to say is what invariably turns out to be the case (at least in my experience): management is crucial to a company's future; first round investors are not. Time and again (and again and again), what happens is that the company's option pool is refreshed back up to 15-20% with each new round, and much of that goes to management to make sure that they stick around with their full energy. And for those now-deprecated angel investors, do you think anyone cares if they get diluted? Hah!

    As for the last point, Charlie's 'right shift', yup, that's happening. Business plans alone are simply not getting funded. By anyone, anywhere. These days we want to see product, traction and outside validation.