Guide to Angel Investing

I’ve been dabbling in startup investing for a few years now. Nothing extraordinary, and I’ve definitely not made it a career, but I have developed a guide of sorts that I follow when making the final decision of whether or not to invest.

This is written from the viewpoint of a single angel investor. Here it is:

  1. Risk: Understand the high risk in angel investing. Mentally, assume you’ll write off all investments as soon as you make them. Invest only what you can afford to lose.
  1. Avoid life-support investing: If a company comes for funding, where the founder says/implies something to the extent of: “fund us or we’re going out of business” – usually gravitate to not investing. Life support investing is a bad idea (not to mention stressful!).

Lean towards companies that will survive regardless of whether or not you invest in them.

  1. Three companies come in for funding:

A – Entrepreneur has the best idea ever! They need funds to build the product.

B – Entrepreneur has the best product ever! They need funds to market.

C – Entrepreneur has a product which shows great traction. They need funds to                    scale.

Everything else equal, investing in C has the most promise.

  1. Follow-up investor: For the new investor, prefer being a follow up investor rather than leading rounds.
  1. Investment hierarchy: First invest in companies with great traction. If that does not exist in the options, then invest in those with great people, followed by those with a great product.
  1. Bet on people rather than product: Early stages, funding is a bet on people rather than product. Products can change more easily than people.
  1. Never invest in something you don’t understand: Doesn’t matter what it is, who is involved, who has invested or how well the market is going.
  1. Entrepreneurial grit matters: Invest in entrepreneurs who show they’ll simply never give up on the company – no matter what. Perseverance is crucial. When things get hard (and in startups they will!), you want someone who has the grit to stick through it to figure a way out.
  1. Scaling: Always think about how the company can scale. If scaling is expensive or hard, lean towards not investing.
  1. Avoid niches: Niche markets are starting points – but that’s it. The ultimate market cannot remain in a niche space. Successful companies need to scale.
  1. Viable business or science project?: Is the company capable of being a business or will it remain a technology/project? Not all technologies can become businesses.
  1. The Fence: If you’re on the fence about a company for a long time – defer the investment.
  1. Entrepreneur’s knowledge: The entrepreneur needs to know more about the space than you. If you seem to know more about his own space – that’s a red flag.
  1. First versions will suck: Products require several iterations of trials and failure to become great. The key is if the entrepreneur/team is unfazed by failure to keep at it despite the obstacles.
  1. What if Google/FB does it?: Assume the incumbent is always going to copy the entrepreneur if he does well. What is his strategy?
  1. Does the product create delight?: Do you feel delighted when you use the entrepreneur’s product or service? If not, at least do the customers absolutely love the product? Defer the investment until that is true.
  1. Simple enough for your mother: Can your mother use the entrepreneur’s product or service? Simplicity is key for widespread adoption.
  1. Failure is a learning process: Past failures > No failures.
  1. Return time period: Expect returns no less than 5-7 years.
  1. Differentiate between the decision and outcome: Decisions must be taken using all information available to you at that time. You can’t predict the future and hindsight is always 20/20. A bad outcome does not necessarily mean a bad decision and vice versa. Don’t beat yourself up too much over a bad outcome, and then again don’t let a good outcome go to your head.

Good luck! And as always, if you do discover the next Google or Facebook, do let me know! 😉

With that said, here is the obligatory legal disclaimer that goes with any investment advice – Please invest at your own risk! 

“I could have built that in 2 weeks!”

Yes but did you? That’s the point. You’ll often hear an over zealous programmer or engineer exclaim that they could have built [insert hot startup] in no time so what was the fuss about?

The key that they’re missing out on is that it’s simple to clone, but extremely difficult to innovate.

It’s a decision tree. Every node represents a set of decisions available to you with all the possible permutations as below.

decision tree

What is visible to everyone is the path travelled, not the paths forgone. Once you know your destination, tracing the tree back to the root is relatively simple. However, starting from the root without knowledge of your destination is where true innovation happens. That is a process filled with trial, error, failure, and course-correction over and over again till you reach your final destination.

Conceptually speaking there are several startups that are in the same space – most fail but some do better than others, with one becoming a market leader. Path, Instagram, Oink, etc are all relatively similar, but you’ve heard of some and not the others. Why? They’ve all taken different paths in the tree which has enabled some greater success than the others.

First mover advantage is real. Reaching first on the scene with a product that scales gives you a distinct advantage to becoming the market leader no matter who you’re competing against. Take the case for Facebook, a company with near infinite resources and the top destination for the web. They were late to the ephemeral photo space behind Snapchat. Facebook released a Snapchat clone called Slingshot in an attempt to beat them. Despite Facebook’s resources behind Slingshot, which one do you have on your phone? They also released a Flipboard clone with Facebook News (yes they had/have a separate news app), an Instagram clone with Facebook Camera (before acquiring the former), and a Foursquare clone with Facebook places (now defunct) amongst others. They failed in every one of those cases for the exact same reason that they succeeded in out-competing Google+: they were there first.

Switching costs in networks ensure that network effects are always in play. If a user is on a hot app with his friends, he’s not going to switch to a clone that does the same thing and also convince his friends to switch, even if the second one is slightly better. The only way to convince the user to overcome the switching cost is to offer something that is 10x or an  order of magnitude better than what he is using.

Success always looks easy from a distance. That’s because it’s only the path travelled that is visible, not the entirety of the tree. The next time someone says “I could have built that in 2 weeks” simply ask “then why didn’t you get there first?”.

 

 

 

Solving a user problem vs a technical problem: the difference between creating value and wasting your time

What is the kind of problem you are working tirelessly to solve? Are you actually working to create value or simply wasting your time? The difference is in the end goal of what solving the problem accomplishes. Some very big user problems have fairly simple technical solutions. They are easy to use, solve an actual need and fairly simple to interact with. On the other hand, some very big technical problems really don’t end up doing much for the end user. The former gives you something that people want, while the latter gives you an extremely beautiful piece of crap.

Engineers are particularly susceptible to this. It is natural to fall into the trap of believing that just because something is challenging from a technical perspective, it must be a valuable problem to solve. From a user’s perspective, all that’s important is that the product does what it is meant to. “How” really doesn’t matter. If you are selling mousetraps, does it get rid of the mice better than everyone else? If yes, that’s great. Users aren’t going to care much of what happens within the product as long as it works. You can spend all your time trying to create a very advanced, state of the art, nuclear powered mousetrap that creates mini fission explosions to obliterate the mice, but at the end if it doesn’t get rid of the mice, is unwieldy or uneconomical, no one’s buying it. It’ll be an extremely cool project no doubt, but at the end of the day, a fairly useless one!

Every problem that you solve should tie back to the user and/or to enhance their end experience. Be careful of not getting stuck in your own technical world that is insulated from the user completely. Though it does vary by industry, for consumer facing products more specifically – it is the end user who is king. It is easy to get lost in day to day technical, legal, product, financial, investment problems, but if what you’re working on doesn’t help the end user – you’re not moving forward.

Expressed in slightly broader terms, whenever you look at a hard problem, you need to assess its value independently to determine whether it is truly worth your effort. Becoming the top restaurant in the city: Is it hard? Of course! But how valuable is it given that the next 10 best restaurants are almost always going to be head to head with you?

Passionate engineers, by nature, get excited by challenging technical problems. However, take care that you never lose sight of the user so you don’t end up spending all your effort on creating something which doesn’t end up doing anything.

On the flipside, thinking from a user’s perspective brings focus, where the complicated tasks that you were dreading, often no longer seem to be relevant or worth pursuing. It simplifies things! Not everything is wrong with the world… 🙂

Overthrowing the 600lb Gorilla: Create a Platform Shift

As the little guy, albeit with some pretty large aspirations, how do you exactly go about taking on the 600 lb gorilla that has billions of dollars in resources and tens of thousands of employees? The gorilla has been in the industry for ever, knows all the other chimps in the space and is the undisputed leader. So, how do you, with limited resources, almost no name and a tiny team expect to, well, overthrow this big guy? You did have large aspirations, remember?

Assume the incumbent is in the industry of creating horse-carts. He knows everything there is to know about horse carts – which breed  works best for what purpose, what  food the horses should eat, how comfortable the cart needs to be and so on. You can’t compete with this guy on horse-carts. He has tens of thousands of horses for every imaginable type of cart and he is killing it.

So, how do you beat him at his own game? Well, you change the game! If the entire industry is making horse carts, you do the unthinkable and get rid of the horse! Bring in a motor car.

Initially you will be scoffed at – “A man derives his worth from his horse”, “It’s so unnatural”, “Instead of a horse, you are creating a bunch of explosions 2 feet away in your fancy-schmancy car? Did you hit your head somewhere?”

You are crazy! Why would anyone want to copy a crazy person? So, while you are being scoffed at, you get ample time to solidify your base and perfect your product. You debut your invention and start selling to the early adopters. People are coming around to the idea – “The engine did not explode on anyone yet, right?” You start taking off – slowly, but surely.

Meanwhile, the 600lb gorilla is still selling billions of dollars’ worth of horse carts, although growth is taking a hit. Maybe it’s a one-time thing? Maybe they need to innovate more. The CEO calls for increased investments in R&D. The department gets to work and finds a substantial 5% increase in the horse’s energy output if they feed it a new combination of grain!

You release version 2 of your motor car – which is even better! People are warming up more to your invention – “You don’t need to take care of such a large animal anymore”, “My friend’s neighbor has one of those motor-things”

At Gorilla, Inc. there is a crisis. Sales are 80% of what they were. The CEO thinks they need to start looking into this motor car thing after all. He pulls up a team from across his company of the best horse-trainers and the best cart-makers to go and figure out this motor thing.

The Gorilla debuts its own motor car. Unfortunately, it doesn’t run too well. Turns out, the engine doesn’t eat a liquid diet of horse grain.

One extremely forward thinking employee in Gorilla, Inc. goes up to the CEO. “Horse-carts are old news. We need to stop making them and put everything we have into perfecting our motor car.” The CEO isn’t too happy – “You’re telling me that we should abandon a product line that accounts for 70% of our revenues over something that could just be a fad? Have you completely lost your mind? Who hired you?” The CEO fires the employee – “We can’t have people making such ridiculous comments in time of crisis here.”

Even though you’re doing well, the entire process has taken its toll on you. Either you’ve greyed all your hair or maybe lost most of it but there is a lot more ground to be covered. Now, there are a lot more companies now trying to create their own motor cars, though you clearly have the most advanced one – for now.

You’ve put the 600lb Gorilla on a diet. Play your cards right and you may end up taking it down after all.

If you study the rate of development in different industries since 1980, you’ll see that it is only the technology industry that has made significant progress. The rate of innovation in medicine and pharmaceutical industries is the same; commercial aviation has actually regressed and average air-speeds have slowed down since the Concorde got decommissioned; finance has become massive, though it works on the same principles as before; there hasn’t been a significant platform shift in manufacturing; and classroom instruction is pretty much the same since the 1800’s.

Most of these industries use newer technology as tools to do the same things that they keep doing, slightly better. It is the equivalent of finding a 5% increase in output by feeding the horse better grain. Industries need to be re-thought from the ground up for you to discover a motor car in there.

Now, technology is progressing to the “internet of things” – you know, when your front door pings you on your phone asking if it should lock itself since you forgot to do it. Mobile internet and cloud storage are already in place, while robotics and artificial intelligence are making a lot of progress. Technology will soon permeate the very essence of what you interact with – covering pretty much every industry.

So, while the incumbents use technology to make their horses slightly better, when will you debut your motor car?  

For the US to remain competitive, it needs to outsource *more* jobs to China & India

Globalization has made the world a smaller place. A consequence has been the shift of jobs, especially in manufacturing, to China and India. Contrary to popular belief, the fall of US manufacturing is to the benefit of the US by making the industry more competitive than before.

Lets take a bottoms-up approach. With respect to American manufacturing, the way it works is:

I am a US corporation. My costs are ridiculously high and profits are very low.
I discover I can reduce my costs by 40-70% if I move manufacturing to China. So, I do that (lets hold the fact that I need to layoff a bunch of people in US for now and come back to that).
As a company, that increases my profits which enables me to re-invest it and grow. Being a US corporation, US government sees more cash by taxing my higher profits, which it can use to build society, healthcare, infrastructure etc. and do other public good.

If all American companies do this, then US industry in general grows, becoming more competitive – creating more jobs everywhere – both in the US and China. To support growth, I will need more skilled employees in the US and more unskilled employees in China because that’s what their strengths are at. It is basically trading on comparative advantage making everyone better off. This helps everyone by creating more jobs overall. I would argue this means that more jobs get created by more financially stable companies than before, compensating for the original layoffs multi-fold.

So, as the US Govt., I would not focus on manufacturing, since that needs more unskilled labor and China can do it much cheaper comparatively. So, I may as well send all my manufacturing there and focus my resources on maintaining and building the skilled labor advantage – whether that means increasing access to education, lowering costs to education, attracting the world’s smartest people to work in America or encouraging entrepreneurship in general. This way, I can export my services and innovation that comes out of that. So, I can import my kid’s toy train from China, but export new drugs or even, say Microsoft Office out (stuff that can only be built using US’s core advantage of skilled labor). On the other hand, since US is and will continue to be a hub for skilled labor, most of the world’s innovative and profitable companies (like Apple) will be of US origin.

However,a caveat is in the manufacturing of complex machines. Complex machines require more skilled labor for quality and if people are willing to pay more for a better quality product, then that is a clear market opportunity. So, that is a case for the resurgence of US manufacturing, where skilled labor is needed for quality goods. But, unskilled labor nonetheless should be exported out.

It is really hard to be great at everything. The human race was able to reach today by specialization in fields and then trading. The same argument here. US specializes in skilled labor and leave the unskilled part to someone else.

The reality behind “We got 70k users in 2 days of launch”

For any startup, gaining traction depends on two things: 1) How many people are you bringing and 2) How many users getting engaged. The first one has a lot to do with marketing, while the second one has everything to do with the product.

How many people are you bringing?
Companies launch not over one day, but over a process that can last almost an entire month or maybe more. Phrases like “We got 70k users in 2 days of launch” often have a back-story behind them.

1) Instagram – For instagram, they had Jack Dorsey (founder of Twitter and about 2m followers) back them. So, when they launched, it was fairly easy for them to get their initial users since they needed to get people like Dorsey reach out to their network and the press picked it up pretty quickly.

2) LinkedIn – I was speaking to one of the co-founders of LinkedIn, who was VP of Marketing. He said that initially most of their users were PR based because in the early days, the product was not too viral. LinkedIn took its time to grow compared to other social networks.

3) SkyFire (funding: $41m to date) – Speaking to one of the founders, they launched when the iPhone had just launched and so were a very press friendly story. They also had closed their Series A which enabled them to invest aggressively in PR. So, a lot of their users were PR driven and then word of mouth referrals.

This is pretty interesting since mostly when you hear stories like “we had 70,000 users in 2 days of launch” – a lot of that is paid for or has significant help. It is very rarely viral just from the product.

The effectiveness of PR campaigns is often questioned since a lot of it depends on content, relevance and visibility. However, besides PR, there are other avenues like SEM, SEO, Social etc. which you can tap into for your initial influx of users.

How many people are getting engaged?
A key point is that after the initial influx of users is established, it is up to you to create a wonderful user experience with your product – create something that is useful and usable to have them stay and give referrals. Instagram grew virally after its initial influx because its users simply loved the product. Similarly, users gained significant value from having a LinkedIn profile, which enabled the network to grow further.

For this reason, before you invest in marketing, you need to keep gathering data, testing and failing in front of a smaller network, probably your own Facebook network till you figure out your product actually works. The product almost will never go viral if you only invite all your Facebook friends, though you will get some very solid data from them using it. Doing this will ensure that when you finally pay for the initial influx of users to come and “launch to the world”, you are better prepared.

Good Luck!

Unreasonable Obsession for the Startup Grind

When getting a co-founder, employee, investor or any other stakeholder for your startup, one of the most important metrics you want to scan for is belief in the startup over and above any monetary compensation. Simon Sinek says it beautifully – “If you hire people just because they can do a job, they’ll work for your money. But if you hire people who believe what you believe, they’ll work for you with blood and sweat and tears.

In any startup – things will go wrong, stuff will break, investors will pass, your product will suck, employees will quit, hiring will be a problem, deadlines will be pushed, users will not be engaged, partners will bail – but you and your team still need to keep pushing through.

You will face rejection over and over and over again – from investors, users, and pretty much everyone you talk to. You will hear people give several reasons why the startup will not work – but you and your team still need to keep pushing through.

Ben Silbermann, CEO of Pinterest said, “There are lots of ways for investors to say no to you, and I’m pretty sure I’ve heard every single one”

Elon Musk compared running a startup as “eating glass” and “staring into an abyss of death.

The TechCrunch stories of “we got 100k users in 2 days” – all have a long grind where they failed over and over again before their overnight successes.

Instagram slogged through Burbn, Twitter slogged through Odeo, Foursquare slogged through a failed acquisition by Google, Rovio slogged through 51 games prior to Angry Birds, Starcraft was almost abandoned, SpaceX blew through $120m almost bankrupting Elon Musk with 3 failed rockets – but they all kept pushing through.

When things go bad, and they always do, you need people who work with you with “blood, sweat and tears.” Startups are never easy and only unreasonable obsession can power you through the grind. Make sure you have it.