VentureSouth 2017 Summit - portfolio review

Third (back off our soapbox), we are dedicating most of our second day to hearing updates from our portfolio companies. An absolute key part of angel group management is keeping track of the portfolio.

At an elementary (and yet surprisingly complex) level, making sure the right investors own the right things, cash is in the right place at the right time, entities are formed and administered at the right time. That’s what members pay for.

But at a more strategic level, you can’t expect a positive return unless you know what’s happening in your investment portfolio. This is (relatively) easy for publicly traded companies that publish quarterly data that you can monitor in your brokerage platform. It’s much harder for private companies. But on the flipside, there is much more you can do to help early-stage companies.

The VentureSouth team is primarily paid through carry: we really get paid only if the investments are successful. We are therefore focused on helping portfolio companies succeed. And obviously investors are too: if you just put $10,000 into a startup, you’re probably happy to make a few calls to help see that $10,000 again.

This help can take many forms and is too long for a blog post. But suffice to say now that hearing in-person updates from companies on what has recently gone well, what hasn’t, what’s next, and how we can help is helpful. We’ll be hearing from nine companies this month – and quizzing them and finding ways to help.

VentureSouth 2017 Summit - the economic development

(2) Our second main workshop is “Angel Investing for Economic Development.” This session aims to tell more people about why angel investing is critical to local economic development efforts.

Why are we doing this workshop? VentureSouth’s primary goal is to make good investments and positive returns for investors. Our motto is “Make Money. Have Fun. Do Good” – in that order – for a reason. But we do believe in the “Do Good” part.

This is achieved in many ways, but an obvious one is that early stage entrepreneurial communities are of great value – and you can’t have one of those without people funding companies.

There are a lot of people in the Carolinas whose job is to promote economic development, from the Department of Commerce, to community foundations, to trade associations, to city council representatives. Many understand the importance of early-stage companies – though the headlines are always on the large manufacturing plant or the multinational company office opening.

Early stage capital providers don't do a great job of explaining the importance of both entrepreneurship and capital to these groups. When we’re introducing VentureSouth to a new audience, for example, we usually discuss job creation data. Did you know that all net new job growth in the US is from early stage companies? It’s true, but you wouldn’t know that from looking at our website. The chart below should, we hope, remedy that.

Job creation chart.jpg

So, we welcome anyone with an interest in economic development, entrepreneurial vitality, job creation, wealth creation, and making the Carolinas even greater to come along to learn about a critical but overlooked way of doing that.

VentureSouth 2017 Summit - the education

Second, connecting informed investors and educated entrepreneurs is key to our business model: if either group doesn’t know how to operate, good investments and successful high growth companies are pretty unlikely to result.

Education is therefore a big part of our collective effort at VentureSouth. We do this during our meetings, on our blog, and, most importantly, through Venture Carolina, our “sister” non-profit that provides educational programs for entrepreneurs and, uniquely?, investors across the Carolinas.

Our educational content at the Summit is deep. The workshops being run are not 30-minute superficial chats to scratch the surface of a trend. These are half-day or full-day "events," with curriculum created by leading educators, delivered by experts in their field, tied to learning outcomes, and valuable whether you are just starting out or having been an investor or entrepreneur for many years. Our goal is meaningful and impactful education, not (just) entertainment.

So what’s on the menu this year?

(1) Post-Investment & Boardroom workshop. This is an Angel Resource Institute workshop, which combines the expertise of angel investors and the entrepreneurial depth of the Kauffman Foundation. The workshop is for our members, and for anyone else, that invest in early stage companies, and for anyone who has taken, or plans to take, investment.

We’ll be learning about common issues that arise after investment.

For an investor, how do we match the right board members with this investment? How do I keep an eye on and assist my new “asset” – help guide them on the right path without interfering?

For an entrepreneur, how do I keep my investors content while creating a great business? How do we all keep everyone aligned and moving towards our mutual goal of a great company and a lucrative financial return?

This workshop aims to equip both investors and entrepreneurs with the knowledge and tools to answer these questions. $99 invested today could save A LOT of problems down the line.

We’ll cover more on education in the next post.

VentureSouth 2017 Summit - the format

First, a key selling point of our angel group is that we have so many members – 240 and counting – who can provide an unparalleled depth and breadth of experience when looking at possible investments.

Unlike big groups concentrated in one city, however, our members are spread out, over a five-hour drive if you went straight from VentureSouth Piedmont in Greensboro to Salt Marsh Angels in Hilton Head – so arguably the concentrated power gets diluted by distance.

We’re at our most powerful when our diverse crowd of members meet, know each other, trust each other’s judgment and diligence, and work together effectively. Having everyone come to the same meeting helps do that – and so we very much appreciate the efforts of our “out of town” members coming to Greenville.

And we don’t envy the presenter having to pitch to a ballroom full of investors at this session.

VentureSouth 2017 Summit - why?

Having finished our October angel group meetings and all our kids’ Halloween candy, we are preparing hard for our final group meeting of the year.

In November, though, we change our operating model from monthly meetings in every town to a single large meeting in Greenville, SC – the VentureSouth 2017 Summit.

First, a quick pitch: you can see all the content and logistics on our Summit page here. Several of the sessions are open to the public, most importantly our three educational workshops - How to Pitch, Post-Investment & Boardroom, and Angel Investing for Economic Development. If you see something interesting, sign up and we’ll look forward to seeing you there.

But rather than sales pitches, we try to limit our blog to educational content, so thought you might like to hear why we run our Summit as we do.

There are dozens of startup, entrepreneur, angel, VC, and general tech conferences around the southeast – CED, Dig South, 36|86, ATA workshops, demo days galore, and countless more. So why a “VentureSouth Summit”? The next couple of posts will discuss a few reasons.

Why we don't sign NDAs

Approximately once a week we’ll be asked something along the lines of: “Could I also ask if you would be willing to signed an NDA with [my company].”

And our answer is always “You can ask, but no.” Angel groups do not sign NDAs.

There are many good reasons – Tony Lettich outlined some of the reasons here; Wil Schroter added some others here – but the short reason is “because life’s too short.”

Why does this matter? No harm done in asking, is there? From the entrepreneur’s perspective: we asked, the investor said no, and we’re back to where we’re started.

Well, from our perspective: not quite. The fact of asking us to sign an NDA tells us a few things about this investment opportunity even before we’ve met you – and none of them good.

·        It tells us that you haven’t done your homework. You haven’t reviewed our process page; you haven’t entered “Angel group NDA” into a search engine; you haven’t done the basic research on a key partner on your entrepreneurial journey.  

·        Or perhaps you have – but think it doesn’t apply to you. This tells us you over-estimate the value of your idea or yourself, and in neither instance does that make us want to work with you.

·        It tell us you are not well versed in how to be a startup. If you’re a young first-time entrepreneur, how many more serious “rookie mistakes” are you going to make? Or perhaps you’re too used to the cushy mid-cap middle management world of NDAs, corporate general counsel, and established protocols to thrive in the entrepreneurial world of a startup?

That’s probably too much to read in an innocent question. But when we are evaluating startup companies, we don’t have much information to go on, so every data point you give us becomes crucial. If your first data point tells us you are going to be harder to work with than the next entrepreneur in our pipeline, we probably aren’t going to look for more data.

AngelList Syndicate: Why Back It?

3)     Why should we back your syndicate?

So why would we back your deals? Simply because we are one of the largest, most experienced, professionally-led, and proven angel groups in the United States!

Our full time team have done this for nearly a decade; our over 200 members provide an exceptional pool of brains to analyze companies – and help them grow once we invested; and we’ve sold companies and generated quick exits and positive returns for investors. 

Are there other syndicates looking at SE deals? Not really. We can only find one other syndicate based in a southeastern state (Pomp’s); there are none in SC, GA, TN, AL, WV, KY, and even FL and VA.

The ACA Halo report (pdf) tells us that 12% of angel deals are from the southeast. These are deals not being picked over by every syndicate already. Proprietary dealflow? Check.

And the same report tells us that average valuations for angel deals in the southeast are 20% below national averages - and 25% below New York. Reasonable prices? Check.

What about investments in specific deals? For each opportunity available to our syndicate, we provide a brief “investment thesis” covering what was most attractive about the company in the opinion of our members who chose to invest.

AngelList Syndicate: Why?

2)     Why is VentureSouth doing this?

Why are you doing it? We have several reasons for attempting to create our AngelList syndicate.

First, it’s an experiment to see if we can. There are very few syndicates outside of Silicon Valley and NYC. We’re hoping to prove that they can be a valuable structure in underserved markets like the Carolinas.

Second, everyone recognizes the perennial “lack of capital” problem in the Southeast. There are only so many people interested in angel investing, and only so many in-person angel groups that we can operate cost-effectively. This might be a way to increase the amount of capital available for startups without requiring new infrastructure (or government handouts).

Third, to help the portfolio companies in which we invest raise their profile in the funding communities outside of the Carolinas

Fourth, to expand VentureSouth’s reach to potential investors outside of our physical groups. We don’t have groups in smaller and larger markets that are uneconomical for us to reach … but now people in those places can access (some of) our deal opportunities if they like the look of them.

Lastly, for fun. This seems like something that we would enjoy doing.

Aren’t you a bit late to this party?  Yes. Brad Feld did his three years ago, and other syndicates have been around a while and proven to be interesting. However, we are treading new ground as there few syndicates looking at southeastern deals, and we are always interested in ways to make angel investing more accessible and lucrative for investors.

AngelList Syndicate: How It Works

This week, VentureSouth is launching our AngelList syndicate. You can learn more about it on AngelList, our website overview page, and in a series of blog posts explaining how it works, why we’re doing it, and why you should consider investing. 

1)     How it works

What is an AngelList syndicate?  It is an opportunity for investors – those that already use AngelList and those who might be interested in doing so – to coinvest alongside VentureSouth members in our portfolio companies.

How does it work?  Once you register with the platform, you can see the investment opportunities that we make available and, if you like what you read, invest in the company. You can invest as little as $2,000 in our syndicate. AngelList’s guide to syndicates is here, and there are many other sources to learn about the pros and cons.

Will you share every deal on the platform?  No. Not every company we invest in is suitable for a syndicate. In many cases, the rounds are fully funded from our in-person angel groups and funds; in other cases, VentureSouth members comprise a small part of a round led by another group, so it isn’t appropriate for us to help “lead” the company in raising money; in others cases, we might invest in a bridge round or later stage financing that doesn’t fit on AngelList.

So which deals will you put on?  Investments we are leading or co-leading in companies raising true “angel rounds” where there is a small but meaningful gap in funding that remains after we have invested. This is likely to apply particularly in companies where there are few specialist investors in the Southeast – consumer-related companies, ecommerce apps, or green/sustainability companies, for example.

What does it cost? It costs nothing to “back” the syndicate and stay informed about the deals available. If you choose to invest in a particular opportunity (for which the minimum investment is $2,500), you will share in the fee that AngelList charges to set up its investment vehicle. (How much you pay depends on your share of the total amount invested through the investment vehicle.) VentureSouth charges no fee for this.

If the deal pays off, you get your capital back and this fee refunded; you then pay a “carry” of 20% on the profits of the deal to AngelList and/or VentureSouth.

Sounds interesting. How can we back the syndicate? Follow this link, do your diligence, and sign up. We look forward to working with you!

Back to basics: valuations - how do you work it out?

Now you know what a valuation is, how do you figure out what your valuation is?

The short answer to this question is simply “whatever someone will pay.” It sounds trite, but it’s true.

There are plenty of online resources describing the various methods for estimating your valuation; lots of places to get differing opinions on what the valuation “should be”; companies galore offering to (charge you to) help you “determine” your valuation; and places you can go (like a workshop) to learn about the strategies and techniques more.

All of these are nice, but fundamentally investors don’t care what other people (especially those with no skin in the game) think. For our money, all that matters to us is what we think this company is worth. That’s the right valuation.

Back to basics: pre- vs. post- complications

Four, more complexity between “pre-money” and “post-money”

Imagine a company that has previously raised a $100,000 convertible note whose terms require it to convert into equity if the company raises $500,000 of equity capital. Now it raises $500,000 on a $2 million pre-money valuation. What is the post-money valuation?

Per the last post, one would imagine $2M pre-money + $500k of money = $2.5M post money valuation, with the new investors owning 20% of the company ($500k/$2.5M). Right? No.

When a deal is done, there is often more complexity than simply “new money”. In this case, the conversion of the convertible note into equity; other times, the creation of an option pool for future employees.

To account for these complications, we actually calculate as follows:

  • Pre-money valuation = current number of shares multiplied by proposed share price
  • Post-money valuation = post-transaction number of shares multiplied by proposed share price

Back to basics: pre- vs. post-money valuation

Third, the “pre-money” vs. “post-money” confusion

Angels speaking in terms of “pre-money valuations” can lead to some confusion. Entrepreneurs often think in terms of “share of the company sold” and the cost of that stake in the company. So, for example, they might say “we are selling 25% of the company for $500,000.”

Multiplying each side by four: 25% of the company => 100% of the company; $500,000=> $2 million. So my valuation is $2 million.

This math is right, but that is not the pre-money valuation. It’s the valuation of the company including the investment that has been made – because the shares are purchased and the money goes into the company. So once we’ve invested, the post-money valuation is $2 million in this scenario.

To get the pre-money valuation, we have to subtract “the money” – i.e. $500,000 from $2 million. In angel language, this is a deal with a $1.5 million (pre-money) valuation.

Got it? Good – because this mistake appears quite a lot.

Consider this TechCrunch article from early March: on Dragons’ Den (Shark Tank with posher accents) M14 industries negotiated “a deal £80,000 for 20 percent equity, giving the young startup a £400,000 pre-money valuation.” No it didn’t.

Or a pitch we recently saw from an otherwise compelling company: “raising $350k for 10% equity, a $3.5M pre-money valuation.” No it isn’t.

 

Back to basics: what is valuation?

Continuing our “back to basics” snippets (see here on basic deal types and here on the types of angel groups), we are going to have a few posts about the “economic” terms of angel investments.

First up, what is “valuation” all about?

Most people get the basic idea about buying stocks. Apple’s share price is $139. There are a lot of Apple shares, so that if you would buy them all at $139 per share the total cost would be $730 billion. That’s Apple’s market cap, its valuation.

Angel deals work the same way. We buy shares in a company. When we speak about “valuation,” we mean the share price multiplied by the number of shares, to give a total valuation.

So, for example, we might invest in a company at a $2 million valuation.  This means we buy shares at a price that means if we bought all the shares in a company it would cost us $2 million.

This doesn’t mean we’re investing $2 million, or that our shares are worth $2 million, or that the company is receiving $2 million.

Other myths

Here are a couple more misconceptions and myths.

I don’t have time to be an angel investor. False. Members of our group attend a 2-hour meeting 10 times a year. (Obviously many do more than that serving on diligence teams or reviewing their findings, being active mentors, advisers, or board members to portfolio companies , etc. – but none is required.) Investors in our funds like the VentureSouth Angel Fund II as entirely passive – no time commitment required.

This is just for men. False. Nationally, around 25% of angel investors are women. Some funds, like our coinvestment partner The Jump Fund, are women-led and focused on female entrepreneurs. Every VentureSouth group has a strong showing from female members, and all meetings are open to spouses. All are welcome.

What else have we missed?

Myth #8: There aren’t enough unicorns in the southeast

This “myth” is true – there aren’t many unicorns in the south east, and none in the Carolinas. There are also virtually no IPOs in the south east – perhaps six in North Carolina and one in South Carolina each year.

Certainly if your investment thesis is to find the next unicorn, Greenville SC is not the best place to do it. But that is not what we are looking for.

We do have a couple of companies where an IPO is a reported goal or a feasible exit. Proterra, for example, just raised $140MM from VCs and has incredible momentum – and an IPO is an obvious possibility.

But those are the exceptions not the goals. As I outlined in “Stand-up comedian entrepreneurs in America,” we aim for companies whose goal is be acquired for $20 million to $50 million (and perhaps more if things go very well). If we can turn an investment at a $2 million pre-money valuation into a $20 million exit, investors are very pleased with their 10x return.

This is absolutely feasible in the southeast. The Carolinas are good at business formation: for example, NC is ranked #8 and SC #14 for startup formation by the Kauffman Foundation, and entrepreneurs (and everyone!) are moving to the Carolinas from everywhere else. We pride ourselves on a tradition of lighter regulation (SC ranks #14 for lightness of small business regulation according to Pacific Research) – though perhaps more than we deserve (NC ranks in the worst half). So there are plenty of candidates and a business climate supportive of growth.

And on exits the regime is also good. “Small cap” M&A (deals of, say, $25 million or less) generally doesn’t make headlines, but it happens often. According to Watermark Advisors’s December 2016 “Watermark Wire” report, the median deal size in South Carolina in 2016 was $31 million and in North Carolina, $27 million – that is, most deals are done at values of $30 million or less.

And there are a lot of them. Watermark tracked $900 million-worth of M&A where information was disclosed. By number of deals these were around 25% of the volume, so the total acquisition activity in SC alone could be $3 billion a year. For North Carolina, it was multiples of that.

This is the exit process for our companies. Acquisitions for $35 million, undisclosed amounts of similar sizes in private transactions that do not make TechCrunch headlines but do generate positive investment returns.

Myth #7: It takes too long to reach exits

This is too often, unfortunately, true. Startup companies take a long time to mature into middle market businesses that large companies are interested in acquiring. Everything takes longer in a startup – from building up a base of engage clients to replacing your laptop when it breaks down.

VentureSouth has several portfolio companies in its portfolio that are past the “3-5 years” that is our target “hold period.” Other nearby funds are still working on companies they invested in during the early 2000s. (This is not necessarily bad. The “home run” multiples in the angel returns studies take a long time to come to fruition!) But no-one has infinite patience, and we have to prove that returns can occur before the investments are inherited by our children.

And we have done that. The average investment time for the successful exits from the VentureSouth portfolio is 1.6 years. Our shortest was 3x our investment in 3 months (a 2800% IRR). So if you set out to invest in companies with a 3-5 year plan and the capacity for an “early exit,” get management and investors aligned towards that, and give companies the tools, processes, and advice to execute them, you can get capital returns in a reasonable time frame.

Myth #6: It costs too much to be an investor

Finding deals yourself; conducting your own diligence; negotiating a deal; paying attorneys to create a suite of transaction documents; paying accountants for tax returns each year; chasing management teams to provide the information to monitor your investments; finding ways to assist your companies to grow; and figuring out how to get your investment back again. The cost of that in terms of time and capital is high. So, yes, it can be expensive to be an angel investor.

In VentureSouth, we do all this centrally, and define the price for it. The time commitment from members then becomes a couple of hours a month for meetings (for active members) or zero (for passive fund investors). The cost is the annual membership fee or fund management fee (for the deal flow, diligence, negotiation, and administration) and carried interest (for monitoring, assistance, and exit). You can learn more about our costs here, here, and here.

Doing this for over 200 people leads to significant economies of scale, as you can guess. (One deal for 60 people is obviously much less cost than 60 separate deals would be.)

Is it expensive? It depends on your perspective. Consider our most recent fund, the VentureSouth Angel Fund II. The management fee is 2% of capital per year – not dissimilar from an actively managed ETF expense ratio, and identical to the typical private equity or venture capital fund’s management fee. (The “2” in the “2/20” structure.) The carry is 10% - half the usual “20%”.  

Then factor on top the value from being part of a group - the networking from being part of a group of business and community leaders, the intellectual challenge of evaluating companies, the satisfaction from helping entrepreneurs realize their dreams, education opportunities, and free food at meetings – and the membership fee seems pretty reasonable.

Myth #5: Angel investing is for philanthropy or fun, not making money

Angel investing is about making money. VentureSouth itself is a private business (a SC LLC), not a government entity and not funded with public dollars. (Venture Carolina is a separate 501c3 non-profit that provides education for entrepreneurs and investors, funded by private donations.)

We get paid primarily from carried interest – that is, we take a share of the capital gains investors make from good investments. (A much smaller share than the IRS already takes incidentally; and aside from Trump coming after us “paper pushers…getting away with murder”.) We don’t get paid if investments lose money.

But aside from business structure and incentives, members know that the primary focus of our groups is attractive financial returns. Our motto is “Make Money. Have Fun. Do Good” – in that order.

Is that true more widely? Do angel investors make money from angel investing, or is their activity simply (even if inadvertently) philanthropic?

Certainly returns on deals vary; they vary over time, geography, investment strategy, and level of good luck. But there are studies that suggest that, done properly, angel investing is a legitimate “asset class” capable of generating positive returns. Our series of posts last year (starting here, then with more analysis here, here, here, and here) we outlined the overall conclusion that angel investing as an overall asset class beats public market investing by 3x.

Investors in our groups have made money investing locally too: overall, the 11 investment rounds that we have exited successfully have generated a 60% annual rate of return.

Myth #4: You need to be an expert

Nope. Most people (nearly two-thirds) that join VentureSouth tell us that they are becoming angel investors for the first time.

This is not deliberate: we are not seeking out people that do not know what angel investing is. Finding them, educating them, and then helping them navigate how to be an effective angel is not the most efficient operational model!

But it is necessary, because in the Carolinas there is not a long history of angel investment. In New York, it’s hard to move without bumping into an angel investor; in Anderson, it’s quite a bit easier. Our operating model is to find people that could be interested in becoming an angel investor, and then give them the tools they need to decide.

These tools include:

Educational events. Taking a look at our events page will give you a flavor of the educational events available to members. We start with a new member orientation session and instruction packet, to help new members understand the basics. We have online webinars and in-person educational sessions on specific topics pertinent to angel investing – from “intro to deal terms,” to “valuations of early stage companies,” to “executing exits” – covering the whole range from investing to realization. We also provide access to the Angel Capital Association’s suite of educational topics. If we had a bigger budget, we would love to do more of these activities.

In house expertise. The VentureSouth team do this, and nothing else, full time – and we are beginning to know what we’re doing. We unashamedly steal the best practices from across the US – in part thanks to Matt’s presence on the ACA’s board of directors.

Established processes. We screen, evaluate, and invest in a standardized way. This month’s deal is compared to all the others we have considered, so a new member can quickly and easily “calibrate” this opportunity against earlier ones – even if they hadn’t seen those ones.

Support from our sponsors. Banking services, legal documents, accounting and tax returns – headaches that a startup entrepreneur (or us!) cannot afford the time or capital to learn about on their own. Thanks to Wells Fargo, Nelson Mullins, Bauknight Pietras & Stormer, and many others, we have the resources to tackle all the technicalities of angel investing; new angels are in safe hands.