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How to Invest in Startups- Learn From Other Investors

How to Invest in Startups- Learn From Other Investors

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    What We’ve Learned Over the Years: Everyone is a VC

    When I look through my LinkedIn network these days it appears every fifth contact is a venture capitalist of one kind or another. When I started in the early stage funding world 20 years ago, the VC was a rare breed since they had access to venture funding. Most of them were in a handful of tech clusters in the US- Silicon Valley, New York, and Boston to be exact and they were few and far between. Types of VCs At that time, a typical VC had a $100M fund or greater which they raised from LPs or limited partners – primarily the pension funds. They operated in ten year funding cycles which means they could run a long ways off one good return. They charged 2% management fees and a 20% carry. In the 2000s, angels grew to prominence because the cost of starting a business came down so much, startups no longer needed $5M to start a web business but could now do the same thing for $500K.  Angels became attractive financiers because they were more numerous and easier to access. Today, MicroVC, NanoVC, Venture Studios and Corporate VCs are coming onto the startup scene with new fund sizes and funding models. MicroVCs raise $25M to $50M fund while NanoVCs raise $10M to $15M funds. Aside from the size of fund, the main difference is that Micro and Nano VCs typically target a narrower criteria – either a specific geography or type of deal. Many use the pledge-fund model which means each deal the MicroVC wants to fund has to go through a screening process by the limited partners. Because the fund size is small most MicroVCs are taking 3% in management fees and a 20% carry. Given the size of the fund, they can only invest in 5-10 deals.  The fund lasts only a few years before it’s time to raise the next one. They raise primarily from family offices and high net-worth individuals. NanoVCs also raise funding from family offices and typically use a pledge fund model. They use a narrow criteria and can run for a year or two before the fund is deployed. They focus on an even more narrow range of deals since the fund size is small and there’s no room in the management fee for a large staff to help with deal flow and diligence. Then there is the Venture Studio model. This type of VC essentially builds a team from which the team then launches a startup usually with an ecosystem of providers as support.  This works well for one stripe zebra startups that provide niche products or services as they can tie into a bigger team and share resources. Finally, there is the strategic or corporate VC which seems to be popping up everywhere. Amazon recently announced their fund.  A venture fund provides a competitive advantage for burnishing the company’s brand and selling its product. They invest for strategic reasons rather than financial ones in most cases. Since there are so many funding options available the primary question today is “where do you start your fundraise?” Hall T. Martin is the founder of TEN Capital and a builder of entrepreneur ecosystems by startup funding through angel networks, funding portals, syndicates, and more. Connect with him about fundraising, business growth, and emerging technologies

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    What We’ve Learned Over the Years- Investing in Startups

    Now that TEN Capital is ten years old, we’ve learned a few lessons in helping startups raise funding and helping investors fund those startups. Here are some key principles for investors funding startups. Key Principles The team is the most important part of a startup. Diligence should focus first on the team, not the product, space, or anything else. Monitor the startup for three months before investing in gauging momentum and traction. You need to peel back enough layers of the onion to know what’s there. Your mantra should start peeling the onion. The biggest challenge in angel investing is not that the startup goes under but that it turns into a lifestyle business. Historical returns indicate that 10% of your investments will be home runs, 15% will be singles/doubles, 10% will go out of business, and 65% will turn into a lifestyle business. Ask for redemption right at the investor’s sole discretion to prevent the startup from turning into a lifestyle business. You can exit with the redemption right if they go on the payroll exit. (The Payroll exit is when a startup gives up trying to make a go at a venture exit and decides to sit back and just take above-market salaries as their exit. This leaves the investor on the equity exit with no clear path for a return.) If all you do is take, take, take- don’t be surprised to find your startup ecosystem small. Pay it forward. Read more about TEN Capital Network  Hall T. Martin is the founder of TEN Capital and a builder of entrepreneur ecosystems by startup funding through angel networks, funding portals, syndicates, and more. Connect with him about fundraising, business growth, and emerging technologies

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    Performance Based Valuations

    In negotiating a startup investment there’s always a tension between the startup and the investors in placing a value on the equity in the deal.  The entrepreneur is pushing up the valuation pointing to the opportunity in the deal while the investor pushes the valuation down pointing to the risk. Most view valuation as a single number that can  never be changed. This is one reason why there’s so much discussion around it as once you set it, there’s no changing  it. Or is there a way of changing it based on the results? Performance-based valuation puts a new spin on valuations. The valuation can change based on the short-term outcome. Achieving the expected outcome earns the expected valuation. Missing it, means a lower valuation. For example, you are investing in my company and I want a $10M valuation and I’m forecasting $3M in sales in the coming 12 months. In performance-based valuation, you agree to those numbers but add a clause that says, if you don’t reach the $3M revenue number in 12 months, then the valuation on the deal comes down from $10M to $7M. This puts the onus on the entrepreneur to hit the target or as the investor would put it “earning the target.” This aligns the price of the equity with the short term results. I say “short term” because it’s going to be difficult to apply this to the final exit outcome as valuation on the current round needs to be set before pursuing follow on rounds. It’s a useful tool to set the equity and takes some of the “discussion” out of the process. Hall T. Martin is the founder of TEN Capital and a builder of entrepreneur ecosystems by startup funding through angel networks, funding portals, syndicates, and more. Connect with him about fundraising, business growth, and emerging technologies

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    The Many Startup Investor Types and Who is Right for Your Deal?

    There are many kinds of startup investors today. Venture Capital, MicroVC Funds, Corporate Venture funds, Family Offices,  Angels, High Net worth Individuals (HNI), and crowdfunders to name some of the current types  of investors. Venture Capital- most startups think of venture capital when they start their fundraise. The reality is that venture capital is only for a small number of startups. VCs draw their funds from outside sources called LPs or Limited Partners. The VC charges a management fee and a carry (share of the profits) from the funds raised. There are VCs who still raise the funds in what is called committed capital- the funds are committed by the LPs. Newer VC funds are often called “Pledge funds” in which the LPs pay the management fee for access to the deal flow but they review each deal before funding and have a say in the funding process. For some VCs you may notice the turnaround time on questions and deal flow takes longer. For pledge funds, the VCs must gain the approval of the LPs to move forward- hence the turnaround time is longer. VCs fund only the top 10% of all qualified startups. They look for high growth, large target markets with scalable business models. MicroVCs are venture capitals funds with less than $100M in funding. Typically, MicroVCs start with $25M to $50M funds and then deploy the funds to 10-12 companies. They often have very specific investment criteria since the management fee on the fund doesn’t add up to much and one needs to keep the costs low on such a fund. Corporate VCs are often called strategic investors in that they invest for strategic reasons rather than financial. They seek new technologies, talent, and other tools to help grow their business. They often invest as follow on investors and typically do not lead the fundraise for startups. In the past some firms had a strategic fund, but today just about every company has a fund for startup investment. Family offices are investors based around a family partnership that allocates some of their funds to startup investing. Some family offices go it alone and are called single family offices while others band together into groups and are called multi-family offices that share the deal flow and due diligence. For every venture capital fund in the US, there are five family offices. They are less prominent since they invest privately and provide very little publicity around their work. Angels are individuals that meet the SEC accredited investor requirement. That means they have $1M in net worth not counting the house they live in. Angels invest their own money. Some band together into groups to share the deal flow and the due diligence. Sometimes the group is formed around the “dinner club” model and a formal application process is used to recruit the deals. Others form syndicates in which a deal that is led is shopped to others in the group. The dinner club model can be a heavy time sync since most of the meetings are in person and only occur at specific times of the year. The Syndicate model is lighter and focuses on deals that have a lead. Angels look for the same thing as VCs but often invest outside those parameters since it’s their own funds.  They often invest in things that matter to them personally such as impact funds. High Net Worth Individuals are similar to angels but typically have more investing experience. They most often invest their own funds and in areas they understand well.Some HNIs band together in informal syndicates to share the deal flow and due diligence. Crowdfunders are either accredited or unaccredited investors seeking to make a return by investing with a large number of other investors in startup deals. Because their investment size ranges from $100 to $5000 in most cases, the startup needs a large number of them to complete a round. Crowdfunders more than any other investor make their investment decision on factors other than financial return. They often invest to support family and friends, or businesses they care about in some manner.  Hall T. Martin is the founder of TEN Capital and a builder of entrepreneur ecosystems by startup funding through angel networks, funding portals, syndicates, and more. Connect with him about fundraising, business growth, and emerging technologies

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    Investing in Sectors

    Many startup investors begin with a portfolio theory approach in which one makes a few investments across a broad range of sectors. I often hear, “My strategy is to invest in good deals.” This is easier said than done. A broad-based investing approach requires the investor to come up to speed in every sector. That’s a lot of homework for an investment in one or two deals. Some investors focus on a few key domains and become experts in those areas. By diving deep, one can understand the trends, challenges, and factors that drive company success. There’s a risk that if you have too many companies in a sector, you are at risk for major disruptions. If the sector is broad enough, you can move to new areas within the space as it matures. How to find deals in a Sector You can search Crunchbase for sector-specific reports to find deals in a sector. Pitchbook produces funded reports by sector by subscribing to their daily newsletter. To meet with startups, conferences are a great place to find personal introductions. Also, venture capital is now evolving into service models in which they fund the companies and help with operations such as sales, CFO, etc.  It’s not hard to find a list of VC firms focused on a sector. Understanding the Challenges in the Sector By focusing on a sector, one can learn the challenges in that sector and look for companies that are solving those challenges in new and unique ways. By talking with startups about how their product/service works, the investor learns the key issues in that industry sector. Identifying the Risks to Overcome Every sector comes with its risks, such as regulations.  Also, disruption from new technologies is an ever-present risk in the industry. Spending time with startups and investors in the space makes it clear where the risks come from and what one can do to mitigate them. Tracking the Trends in a Sector With the increase in newsletters, podcasts, meetups, and more, one can track the trends in a sector. Some aggregator tools, such as Feedly, let you build lists of sites and find updates as new information arises. By reviewing conference agendas for sector-specific shows, one can learn the topics that are top of mind for those in the sector. Hall T. Martin is the founder of TEN Capital and a builder of entrepreneur ecosystems by startup funding through angel networks, funding portals, syndicates, and more. Connect with him about fundraising, business growth, and emerging technologies

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    How to Invest in Startups- Learn From Other Investors

    As an investor, I helped launch three angel networks in Texas. In the process, I setup training programs, attended conferences, and talked with many other investors. Hearing and speaking to other investors was a wonderful learning tool. One of the best resources I found was a podcast by Frank Peters. Frank was an angel investor out of the Tech Coast angels in southern California. The Frank Peters Show Frank interviewed every angel, VC, and startup in the southern California community. He later ran interviews across the US and all over the world. He ultimately recorded over 450 episodes which he posted on the web. As I drove my car I listened to many of the podcasts and heard from angel investors on how they invested, their investment thesis, and lessons they learned from the process. I recommend listening to podcasts that focus on startup funding. Podcasts are an excellent tool to learn from experts in the field. Some of my favorites are: Jason Calacanis: Angel Podcast, Patrick O’Shaughnessy: Invest like the Best and there is also my own personal podcast, Investor Connect.   Read More: How to Invest in Startups: ​Invest at an Available or Opportune Time Hall T. Martin is the founder of TEN Capital and a builder of entrepreneur ecosystems by startup funding through angel networks, funding portals, syndicates, and more. Connect with him about fundraising, business growth, and emerging technologies

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    How to Invest at an Opportune Time

    1 min read How does one know How to Invest at an Opportune Time? As an investor, you want to monitor the progress of the business. We’re looking for how fast they are iterating on the business and how well they do with customers. After you are convinced this is a business you want to invest in, you look for an opportune time to invest. Some companies are moving from one-time raises to ongoing raises in which the company takes the funding at any time, while others run discrete fundraise campaigns, and when the goal is met, the fundraise is closed. For recurring revenue businesses, you have the choice of raising a little at a time ongoing, and you don’t necessarily need a large cash infusion to keep the lights on in the office. As an investor, you can approach the company and make your interest clear. It’s often the case that the company can accept you at the last round of terms because the note is still open. The message here is “just ask.” Read more on the TEN Capital eGuide: How to Invest in a Startup Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group

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    How to Monitor a Startup for Progress Before Investing

    2 min read When deciding on a venture, it is important to monitor a startup for progress before investing. At first blush, all investment opportunities look attractive. As the investigation progresses, the warts, blemishes, and challenges become clear. Take Your Time It’s important to monitor deals before investing as it takes at least three months for all of the relevant details about the deal to surface. It’s also important to assess the capability of the team. Steady progress with revenue, product development, and team deployment need to be measured. The way the startup runs the campaign is a good proxy for how they will run the business. Some come in and build out their documents expeditiously. They follow up with the investors in a timely manner and they are able to close an investment using strong communication skills. Others come in and have difficulty building out their pitch deck. They get distracted with other things in life and can’t follow up in a timely manner.  Some have a hard time closing investors because their business is vague and the goal is fuzzy.  This type of campaign indicates a weak team and makes for a questionable investment. It’s interesting to watch their investor relations campaign because it’s a good indicator of how they will run their sales campaign. At TEN Capital, we give updates about our deals’ progress. We rely on the startups to provide updates in the form of a campaign to give our investors ample time to monitor the deal before investing. Read more on the TEN Capital eGuide: How to Invest in a Startup Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group

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    How to use Analytical Tools for Startup Investing

    2 min read Some investors believe the rise of data analytics will take over the decision-making process for startup investing and that most venture capitalists will be out of a job in the next decade. Data analytics works well in some sectors, such as consumer product goods, because the business models are clearly defined, and analytics can make meaningful predictions. In tech-enabled models, it’s not quite as clear. Data is used to inform the investor, it does not decide for the investor. It’s useful to have additional analytics around a potential investment, but it’s unlikely that data analytics will completely take over. TEN has its own data analytics, which it has developed over the last ten years for identifying fundable companies.  On the TEN Capital Network website, you can see the details of TEN Capital’s Predictors of Funding. With ten years of funding history, we track the results of the investments and understand why most of them succeed; however, some exceptions did well even though they didn’t meet this criteria. Successful Startup Investing Criteria The criteria we found for successful startup investing are: There are two or more industry-experienced C-level leaders The company has a strong competitive advantage. The company is solving a hard problem. In every investment, the team comes first. Competitive Advantage A competitive advantage is more than just a fistful of patents. It’s an advantage that either increases the company’s revenue by 30% over that of the competition or decreases their cost by 30%. A hard problem is a problem that customers will pay for it, and it is non-trivial. The key here is you need both. Many universities are solving hard problems, but there’s no competitive advantage in the sense the market will pay a premium. There are also “execution plays” where a company is out-executing the competition, but without solving a hard problem, it won’t last long. You can read more in the TEN Capital eGuide: How to Invest in a Startup Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group

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