Moneyball: A Quantitative Approach to Angel Investing (Atlanta - Oct 2012)

500.co/challenge #m4s

IT’S NOT SPRAY AND PRAY. IT’S A PROCESS.

MONEYBALL STARTUPS+

PAUL SINGH

500 Startups

@paulsingh・paul@500startups.com・resultsjunkies.com/blog

500 STARTUPSGETTING TO KNOW

BECAUSE WE’RE KIND OF A BIG DEAL

PAUL SINGH

API TO VENTURE CAPITAL & FUNCTIONAL EXPERTISE

THE BIG OPPORTUNITY IN EARLY STAGE TECH INVESTING:

(FOR FOUNDERS. FOR INVESTORS. FOR GOVERNMENT.)

BUILD SOMETHING PEOPLE WANT

FOUNDERS:

WRITE CHECKS AND ADD VALUE

INVESTORS:

MAKE LIFE EASY FOR INVESTORS & FOUNDERS

GOVERNMENT:

VENTURE CAPITAL IS OPEN TO ATTACK BY DISRUPTIVE NEW BUSINESS MODELS AND TECHNOLOGY.

-- NAVAL RAVIKANT (@naval)

(R)EVOLUTION IN THINKING

EARLY STAGE STARTUPS

HAVE CHANGED

STARTUP COSTS LOWER THAN EVER

BUT SCALING STILL COSTS MONEY

CLOUD, OPEN SOURCE AND ONLINE DISTRIBUTION DRIVING

WEB GETS BIGGER.WORLD GETS SMALLER.

TRACTION IS THE NEW INTELLECTUAL PROPERTYPLATFORMS (SEARCH, SOCIAL & MOBILE) PRIMARILY DRIVING THE CHANGE.

NO LONGER “GOOD ENOUGH” TO DEPEND ON TECH DIFFERENTIATION.

CAPITAL INCREASINGLY COMMODITIZED

RISE OF THE ANGELS, YO!

NEW REALITY: MONEY FOLLOWS

FOUNDERS

SIGNALS ARE EVERYWHERE

BIG DATA + OPEN SOURCE ANALYTICS = NEW TECHNIQUES FOR VC

WALL STREET BEAT US TO IT

UBS PROPRIETARY SATELLITE PARKING LOT FILL RATE ANALYSIS POINTS TO AN INTERESTING CADENCE INTRA-QUARTER AND POTENTIAL UPSIDE TO OUR VIEW.

TWICE A WEEK A SMALL HELICOPTER CIRCLES OVER CUSHING’S TANK FARMS ON AN OIL INDUSTRY SPYING MISSION.

WALL STREET ISN’T ALONE

THESE TECHNIQUES ALREADY USED TO UNDERWRITE IN-VITRO FERTILIZATION LENDING, PAYDAY LOANS, SUBPRIME AUTO LENDING, HOME/PERSONAL/AUTO INSURANCE AND MORE.

WE CAN DO IT, TOOSURPRISE!

IT TURNS OUT,

+ “GUT” + TRUSTED MENTORS + MUCH, MUCH MORE DATA.

SENTIMENT ANALYSIS

WHAT IS THE TEAM THINKING? WHAT DOES THE MARKET THINK? WHAT DO MY PEERS/MENTORS THINK?

NEEDLE IN THEHAYSTACK

REAL USE CASES: SIGNS THAT A FUNDING ROUND IS ABOUT TO OCCUR AND/OR SIGNS THAT A PRODUCT IS ABOUT TO EXPLODE.

VERY HARD TO DO ACCURATELY BUT PAYOFF IS BIG & FAST.

FASTER PORTFOLIO TRENDS

CURRENT SYSTEMS OF QUARTERLY/AD-HOC REPORTING IS BROKEN -- SELF REPORTED DATA IS OFTEN BIASED.

THE RAW DATA IS THERE, THE SYSTEMS TO COLLECT IT AND THE ALGORITHMS TO ANALYZE IT ARE MISSING.

CURIOSITY

500 CHECKLISTProduct solves a problem for a specific target customer

Capital-efficient businesses - operational @ <$1M funding

Primarily internet-based distribution - search, social, mobile, local

Simple revenue models - transactions, subscriptions or affiliate

Functional prototype before investment (or previous success)

Small but measurable usage - some customers, early revenue

Small but cross-functional team - engineer, design/UX, marketing

EARLY STAGE VCIS CHANGINGHAS CHANGED

STATE OF THE ART IN EARLY STAGE INVESTING IS NOT

VERY SOPHISTICATEDTRUST REFERRALS. MOVE FAST. KEEP LEGAL/FINANCE SIMPLE.

BUILD RELATIONSHIPS WITH OTHER INVESTORS, SYNDICATE EVERYTHING.

MONEYBALLIT’S NOT SPRAY AND PRAY. IT’S A PROCESS.

BUY WINSMY PRIMARY GOAL IS TO

NOT NECESSARILY BUYING INTO THE HOTTEST DEALS.

FOCUS ON TEAM, EXECUTION, TRACTION & DATA.(STICK AROUND... I’M GOING TO SHOW YOU HOW)

INITIAL BET DESIGNED TO GIVE US MORE DATA FOR

SUBSEQUENT BETS

QUANTITATIVEPORTFOLIO APPROACH

BENEFITS: CONTROLLED RISK + OUTSIZED RETURN POTENTIAL

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30

Monte Carlo Simulation of Angel Investing

# of Deals

mean median std dev

RISK MITIGATION THROUGH

DIVERSIFICATION

MODERN PORTFOLIO THEORY:

HIGH VOLUME INVESTING ALLOWS

FOR HIGH ERROR RATE

TRACK IRR & VALUATIONS WITHIN

YOUR PORTFOLIOAT LEAST YEARLY. RECOMMEND QUARTERLY.

CONTROLLED RISK:OUTSIZED RETURN

POTENTIAL

PORTFOLIO IRR QUICKLY POSITIVE

(WITH SMALLER EARLY EXITS AND PROMISING DEALS GETTING FUNDED)

EVEN “SMALLER” EXITS CAN MOVE

THE NEEDLEDON’T FORGET: YOU CAN SELL POSITIONS TO DOWNSTREAM OR SECONDARY BUYERS TOO.

LAW OF LARGE NUMBERS FTW!

INDIVIDUAL BETS ARE SMALL

MUCH EASIER TO RUN AN EXPERIMENT ON A $50K INITIAL CHECK INSTEAD OF $250K+

BAD BETSFAIL FAST

SMALLER CHECK SIZES FORCE COMPANIES TO PROVE THEORIES FASTER. ALLOWING INVESTORS TO QUICKLY ITERATE OUR FORECASTING/FUNDING

MODEL. FEWER “LIVING DEAD” AND QUICKER RETURN ON RESULTS.

FAILURE RATESARE HIGH

DIVERSITY OF HIGH VOLUME INVESTING ALLOWS FOR HIGH ERROR RATE. FUND IRR QUICKLY POSITIVE WITH SMALLER, EARLY EXITS AND PROMISING

DEALS GETTING FUNDED.

DILIGENCE HAPPENS IN THE REAR VIEW MIRROR, NOT THE CRYSTAL BALL.

ALLOCATE FOR FOLLOW-ONS

(...OR “HOW TO AVOID GETTING SQUASHED”)

30% Capital - Initial Betstarget 10-20 deals

70% Capital - Follow Onfilter out failures, follow-on the top 20%

DEAL TERMSSO YOU FOUND A STARTUP YOU LOVE?

DEBT VS EQUITY

CONVERTIBLE NOTES ARE OK (REALLY!)

LOWER LEGAL FEES, LESS DOCS, QUICKER TO EXECUTE. WHEN CAPPED, THEY FUNCTION SIMILAR TO PRICED ROUNDS.

STANDARD DOCS ARE YOUR FRIENDS

WHEN IN DOUBT, DO NOT INNOVATE IN FINANCE OR LEGAL

PRO RATA & INFO RIGHTS

ALWAYS. ALWAYS. ALWAYS. ALWAYS. ALWAYS. (GET IT?)

FOCUS ON VALUATION & MULTIPLES

OWNERSHIP % MATTERS MUCH LESS. FOCUS ON REQUIRED EXIT SIZE RATHER THAN SOME MYTHICAL OWNERSHIP TARGET.

IT’S HARD TO MAKE MONEY ON

VALUATIONS > $5M(PRO TIP: CONSIDER MIN. RETURN REQUIREMENTS FOR DOWNSIDE SCENARIOS)

LET FOUNDERS GET BACK TO WORK

YOUR PRIMARY GOAL

THIS IS A LONG GAME: AVOID LOSING YOUR REPUTATION OVER 1%. WHEN IN DOUBT, LEAN TOWARDS THE ENTREPRENEUR.

AVOID BOARD SEATS

MOST BOARDS PROVIDE MINIMAL

VALUE-ADD

BEST DEALS USUALLY REQUIRE LIMITED BOARD SUPPORTSPEND YOUR TIME SOURCING NEW DEALS. LIMIT TIME ON SIDEWAYS DEALS. LET THE WINNERS KEEP ON WINNING (AND ANSWER YOUR PHONE WHEN THEY NEED YOU).

DO NOT INNOVATE IN FINANCE OR LEGAL

INVESTINGIS A PROCESS

DABBLING IN INVESTING IS (AT BEST) GAMBLING. BETTER TO WALK AWAY OR PURSUE INVESTING NEARLY FULL TIME OR

FIND SOMEONE TO MANAGE YOUR MONEY

BE AN ACTIVE INVESTOR

PORTFOLIO EFFECTS & THE LEAN STARTUP MOVEMENT ARE YOUR FRIENDS

YOU CAN EXPECT FAVORABLE WITH 10 DEALS BUT IT TAKES 20+ TO BE SAFE

BE A SMART INVESTOR

FOCUS ON INFORMATION ASYMMETRY & PRICE/MULTIPLES.

BY ITS NATURE, THE INTERNET UNDERMINES ANYONE WHOSE STATUS DEPENDS ON PRIVILEGED ACCESS TO INFORMATION.

-- MICHAEL LEWIS

API TO VENTURE CAPITAL & FUNCTIONAL EXPERTISE

THE BIG OPPORTUNITY IN EARLY STAGE TECH INVESTING:

(FOR FOUNDERS. FOR INVESTORS. FOR GOVERNMENT.)

500.co/challenge

IT’S NOT SPRAY AND PRAY. IT’S A PROCESS.

MONEYBALL STARTUPS+

PAUL SINGH

500 Startups

Moneyball: A Quantitative Approach to Angel Investing (Atlanta - Oct 2012)

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