If you ask an engineer what stands between them and their dream, they’ll probably make a joke about debt. If you throw a pile of cash at an engineer and ask them again, the problem may be solved, or they may tell you, “It’s just not possible yet”. New materials have been at the forefront of every technological or industrial revolution in history. We title eras of history by the materials that defined them, from bronze to steel, leading up to today’s so called ‘Silicon Age’. Electricity and fertilizers shaped the 20th century’s population boom, and progressively lighter, stronger steel gave it further form. As we begin to outstrip the capabilities of the materials that made our achievements possible in the past, materials engineers are rapidly pursuing new, novel materials to drive our advancing needs. Case in point, 2017 was the year of graphene with its promise to reshape how we do everything from computing to water filtration. 2018 is shaping up to be a year of silicon, lithium, and cobalt as we sprint towards newer, better batteries; bioconcretes are looking to be the future of roads and construction. Questions then arise. What technologies will drive the next wave of growth? What are engineers building now that will shape our next major wave of new inventions? What will those markets look like in 5 years? Ethan Harden, an analyst on the VCA team at RVC, has created an Industry Outlook about nanotechnologies and the advanced materials they’re driving. You can read it here.
It’s that time of year again! RVC’s HyperAccelerator is back for a fresh, new, June 18th installment focusing on Impact Ventures. This is our sixth run of the gamut, this time with the support BSW Wealth Partners and the Colorado Office of Economic Development and International Trade.Take a look at these companies and see if you think they are all “impact” – doing good through social, environmental and economic development. We’ve spent a lot of time thinking about impact and what makes for a good impact investment, so we’re excited to work closely with this cohort of impact companies to push their programs forward with strategy and venture capital funding readiness. You can learn more about how we think about impact investing here. Join us at the Soda Pop Garage (2150 Market) on Monday, June 25th at 2pm for our Demo Day, where our freshly (hyper)accelerated ventures will pitch for you, the public. Register today!
Achroma plans to develop a blockchain powered loan platform to help remove underlying bias in the loan system. Using a blend of anonymity and data analytics, this FinTech/blockchain hybrid is hoping to help loan seekers feel sure that the system is working for them.
Brainitz is an EdTech company building a platform for teachers to create interactive videos. CEO Clint Knox is a teacher by trade and set out with the goal of streamlining the teaching process by giving students the teacher tools to help them teach outside of the classroom. Brainitz achieves this by integrating questions directly into video lectures.
EnVision Meditation uses scientifically backed techniques in order to guide users through daily 10 minute visualizations meant to provide empowerment and self improvement. The benefits are meant to reduce stress, fear, worry, and doubt, and increase confidence, motivation, focus and awareness. The company reaches users through its app of the same name.
MFB Fertility creates affordable medical devices and digital health solutions to help women better monitor their own hormonal cycles. The Ovulation Double Check is the FDA compliant, flagship product the company produces to help women understand when they are hormonally prime for pregnancy. MFB is now producing a take home device and an app that will help women monitor their hormones for purposes beyond fertility, such as detecting early stages of menopause. MFB Fertility is a recipient of the OEDIT Advanced Industries grant.
Starfire Energy utilizes clean energy sources to in order to produce ammonia. Using proprietary technology, Starfire makes this process easier to descale and ramp. The company hopes that it can produce nitrate to help power companies generate clean power storage and fuel.
Storion Energy. is developing and commercializing advanced batteries for the large-scale storage and delivery of renewable energy. Storion’s redox flow battery provides a blend of economy, performance, and reliability. Storion continues development of next-generation technologies to increase performance and drive down costs. Storion hopes to drive a shift in the energy industry by solving the long known ‘peak hours’ problems of renewable energy.
Synthio Chemicals is a developer and contract manufacturer of fine and specialty chemicals. The company uses novel continuous manufacturing techniques to produce specialty chemicals on a continuous rather than batch basis. Synthio is able to produce chemicals at a price and purity ratio drastically superior to competitors using proprietary tools and techniques. Synthio has broken into the pharmaceutical industry with intermediaries as their opening move. Synthio Chemicals is a recipient of the OEDIT Advanced Industries grant.
Convertible debt is commonly used in seed stage transactions, and for anything but friends and family, or a true 90 day or less bridge, I cannot understand why anyone would use these to fund a company, regardless of whether you’re an investor or founder – it’s equally bad for both.
There are a lot of otherwise smart people out there who continue to support fallacies about the
benefits of convertible notes. I’ll walk you through the claims and show you how they are not only wrong, but are the exact opposite of many people’s beliefs.
Fallacy #1: Convertible Notes are Cheaper than Preferred Equity Deals.
This belief comes from a shallow idea of the cost of a note. While it’s true that the legal costs for doing a note are $2500-$5000 in many markets and the cost for doing a preferred equity round can be as much as $10,000 to $20,000, there are other costs to consider.
If the note is for two years, for $1 million at 8% interest, then the entrepreneur is going to have to pay $166,400 in interest. Some will argue that this is rarely paid in cash, but it is still a huge amount of dilution for the company and represents a real cost to them. So, when does it make sense to “save” $15,000 when it costs $166,400 to do so?
The other part of the fallacy of this thinking is that the note cost is the only legal cost. In fact, the entire premise of the note is that it will convert into equity when the company has a priced round, usually of $1 million or more. At that time, the company will still have to pay the $10,000-$20,000 PLUS the original $2500-$5000 that they paid for the note originally, That’s right – the founder is really going to have to pay for both, resulting in 25% HIGHER legal costs than just doing an equity round in the first place.
Fallacy #2: Convertible Notes are Easier than Preferred Equity
It’s true that a note is only a few pages and very few terms to negotiate and Preferred Equity requires changes to multiple documents; the term sheet, subscription agreement, changes to the articles of incorporation, etc., but in the long run, convertible notes can end up being much more complicated and require a lot of legal time to figure out the ambiguous outcomes.
Let me start by saying that “simple” does not mean “best”. Leaving major terms and issues undecided and unaddressed helps neither the founder nor the investor. I recently had a portfolio company that almost went out of business for no other reason than that they had used convertible notes injudiciously and they found themselves in default on multiple notes simultaneously.
Let’s just consider a simple case of convertible debt vs. preferred equity in two rounds. Let’s ask ourselves, how many shares does each round of investors get and how many does the founder get? (Note that this conversation doesn’t occur until conversion, so many founders, attorneys and investors don’t think about these until it’s too late.)
How Many Shares do the founders have after these three rounds?
How many shares do Round 1 investors have?
How many shares do Round 2 Investors have?
How many shares do Round 3 Investors have?
10 million shares authorized and 1 million shares issued to founders at start.
10 million shares authorized and 1 million shares issued to founders at start.
|Round 1: $1 million convertible note, 8% interest, 20% discount, $4 million valuation cap.
Round 2: $2 million convertible note, 8% interest, 20% discount, $6 million valuation cap.
Series A Conversion with Priced Round: $5 million Preferred Equity with $10 million pre-money valuation
|Round 1: $1 million preferred equity with $4 million pre-money valuation.
Round 2: $2 million preferred equity with $6 million pre-money valuation
Round 3: $5 million Preferred Equity with $10 million pre-money valuation
|Round 1: Founders 1 million/ Investors 0
Round 2: Founders 1 million/ Round 1 Investors 0, Round 2 Investors 0
Round 3: Founders 1 million shares
Round 1 Note holders convert at the better of 20% discount from the priced round or the valuation cap. Since 20% discount from $10 million would be $8 million, they will take the valuation cap at $4 million.
But wait – we have to calculate Round 2 simultaneously. They would also take the valuation cap at $6 million, since that’s less than the 20% discount at $8 million.
Now, the Series A investors get 33% for their $5 million on $15 million post-money, right?
Or, since the first two notes are now converting, this round is actually $1 million from Round 1 plus $2 million from Round 2 plus $5 million from Round 3, so the total is $8 million on $10 million pre-money.
So, how many shares do each of the investors get?
Round 1 is $1 million on $4 million cap, so they get 20%
Round 2 is $2 million on $6 million cap, so they get 25%
Round 3 is $5 million on $18 million post-money, so they get 27.8% of the company.
The Founders get what’s left – 27.2% (1-.333-.25-.2)
That works out great, unless the Series A investor has negotiated $5 million on $10 million pre-money for 33.3% of the company. That’s not technically how it should work since the post-money valuation is $18 million, not $15 million. The Series A investor might want to come in as if the first two rounds were equity and theirs would be the only new money coming in. This is called “The Golden Rule” – he who has the gold makes the rules. In that case, what does Round 1 get? They should still get their 20% since that’s what they negotiated, and Round 2 should get their 25%. So, here’s how the percentages should work out in this scenario:
Founders 21.7% (1-.3333-.25-.20)
Round 1 20%
Round 2 25%
Series A 33.33%
Alternatively, the Series A investor might require that the investors in the first two convertible notes take the dilution hit instead of the founders. Or they may figure out a way to share the dilution between early investors and founders. In these scenarios, the people who took the greatest amount of risk can be unfairly treated by later round investors who come in after the deal has been de-risked.
Believe it or not, there are still other ways that this scenario can be calculated and it gets even trickier if there is a carve-out for an employee option pool. But the point is that there is a lot of ambiguity and this can result in higher legal costs and difficult negotiation after the fact.
Ok, so now we have to turn these percentages into shares. For the first scenario, the only party to the transaction that we know how many shares they have is the founders at 1 million. We know that they will own 27.2% of the company, so we need to find the number that 1 million is 27.2% of which will be the total number of issued shares after Series A. Then we can just apply the percentages to see how many shares each party gets.
So, 1,000,000 divided by .272 gives us a total of 3,676,471 and the shares would be distributed as follows:
Founders = 1,000,000
Round 1 = 735,294
Round 2 = 919,118
Series A = 1,022,059
|Round 1: Founders 1 million, Investors 250,000 (Note – investors own 20%, having invested $1 million with $4 million pre-money/$5 million post-money.
Round 2: Founders 1 million, Round 1 Investors 250,000, Round 2 investors 416,667 (Note – Round 2 investors own 25% having invested $2 million with $8 million post-money and 416,667 equals 25% of the total shares outstanding)
Round 3: Founders 1 million, Round 1 investors still have 250,000, Round 2 Investors have 416,667 and Round 3 Investors get 835,836 (again, 835,836 is 33% of the company since Round 3 Investors put in $5 million with $15 million post-money, so the calculation is easy)
So, between figuring out the math and negotiating all the ambiguities between the parties, doing the conversion on a convertible note is much more complex and challenging than just going through a vanilla Series Seed term sheet for Preferred Equity. Anyone can read Venture Deals to learn about the terms and then work with their attorney to come up with a reasonably negotiated term sheet. That’s a lot easier than going through all the headache and ambiguity of converting complex convertible notes.
* BlockChain ICO Note: one more complexity that is becoming more common is that companies are choosing to do an Initial Coin Offering (ICO) rather than going to Series A. This can mean that the note never converts because there is no priced round to drive the conversion. Again – the complexity is much greater on convertible notes!
Fallacy #3 You can Avoid Valuation by Using Convertible Debt
Many people falsely believe that they can “kick the can down the road” on valuation by using convertible debt and then letting the Series A investors set the price and terms. While this may make sense when friends and family are investing, angel investors who are investing for profit rather than family or friendship are going to need to have a valuation cap if they use a convertible note. You may recall that in the examples above, the cap was always lower than the discount, so if investors had used an “uncapped note” without a valuation cap, they would have overpaid for their investment by millions of dollars! For that reason, virtually none of the notes done today are done without a valuation cap, so there is still valuation work to be done to calculate what the cap should be.
While many recognize the need for a valuation cap on the note, many people do not understand how to calculate the valuation cap. The formula for calculating the cap is easy:
Valuation Cap = Equity Valuation
That is to say, the valuation cap is calculated in exactly the same way that we calculate the equity valuation for a company when we do a preferred equity round.
Venture backed companies grow as much as 2X in value every year – it would be injudicious for anyone to put their capital at risk to invest in a convertible note with a return of only 20%. At that rate, the angel investing community would pack up their bags and go home when calculating the cumulative losses in their portfolios and lack of tax benefits.
I have heard no argument for why the valuation cap should be anything more than what the valuation would have been if it were an equity round. If anything, it should be lower because of the lack of tax advantages for gains or losses to investors which can cost 20% difference in terms of after tax cash in the bank because of penalties for using convertible notes vs. equity. (See Section 1202, Section 1244 and Section 1042 of the IRS code to understand the benefits to investors investing in preferred equity deals that are not available to convertible note investors.)
Valuation is a function of risk. It makes sense that the value an investor pays should be tied to the risk AT THE TIME OF INVESTMENT. Some get confused by thinking that the value should be set at the time of conversion, once the investor’s capital has been put at extreme risk in order to reduce risk for future investors and to increase value for the founders. There is simply no rationale that says that value should be set at a future date when risk is lower and even less rationale to argue that a 20% discount off the de-risked value would be appropriate.
While I’ll grant that there are a few narrow uses for convertible debt today, the widespread use of them in the startup and seed stage investing community is dangerous and unjustified for both founders and early stage investors. Attorneys should understand these fallacies and lead their clients to preferred equity deals that will better serve the needs of startup founders and investors.
In light of the recent SCOTUS ruling, we thought we would talk about an economic model that helps us understand discrimination and voting with your dollar. How your preferences affect the price you’re willing to pay for a product or service directly correlates to a business’s ability to stay open. You wouldn’t go to a burger joint that was dirty or had terrible service if the burger place a block away had the same prices and was clean or had better service, and we can explain it with economics.
Bakers Green and Blue
Anyone who has sat through Economics 101 knows this graph. It’s a basic supply and demand chart with two bakeries and the market of buyers. Bakery Green is charging Y more than Blue Bakery for reason A. In a normal scenario, Green must lower their price or go out of business as Blue takes all the business they can handle (Blue could, in theory, raise prices to match Green, but that model gets complicated as we factor in behavioral economics and the price elasticity of demand.). In the traditional, basic model, Green just has higher costs. Maybe the owner wants a higher salary, maybe the business had to take out loans at a higher rate, with the result being costs that are higher. If that price is as low as Green can charge, then Green will eventually go out of business.
Now let’s abstract a little. What if reason the price is difference, Y, is not a dollar amount? Common examples of this would be that Green is further from town than Blue, or perhaps Blue is able to keep the line short while Green has a 30 minute wait. In this case, we’ll say that Y is difference in beliefs between you and Green Bakery’s management. In some cases business will fail slowly as a result of this type of disagreement as social norms shift, while in some cases firms go out of business rather quickly. For some customers, Green will not have this additional cost Y and will cost the same as Blue. For some customers, Green’s preferences could even align with theirs, adding to business, but so long as a critical mass of Green’s existing customers have beliefs and a demand function like the gray one above, Green will lose business to Blue and be forced to shutter their doors. In this case, hinging on the critical mass of disagreement, the free market at work will reduce business for Green until the day they no longer breakeven.
We see a similar story in the allocation of venture capital. Plenty of research has shown that women executives and female CEOs outperform the indexes of male dominated companies. Women are managing to be a better bet than men by as much as a factor of three, and yet they only make up about 6.5% of Fortune 500 CEOs and only 20% of VC deals, or 2% of all venture capital. They drive additional value, outgrowing their male counterparts by 63% in the case of First Round Capital. In other words, women founders cost VCs less, earn them more, and yet, they still don’t receive equal funding. This is a lot like our bakers Blue and Green. Blue is the VC funds putting capital towards women founders and seeing results. Green is the funds that follow the industry standards and miss out on the returns of investing in female founders. Angels and venture capitalists are suffering a huge opportunity cost in not servicing the demands of female founders.
Various reports of discrimination in the community help to explain some of this. In some benevolent cases, discrimination occurs as an accident, as Katrina Lake outlines in conversation with NPR, pointing out that many VCs have pitch requirements that could exclude the growing industry of so-called mompreneurs. The offices are highly male dominated, with only 6% of VCs being women as recently as 2016.
Compare these averages to the Rockies Venture Club. Of our 31 portfolio companies, over half star female founders running companies ranging from tech solutions for kitchens to FinTech answers for any early stage startup. Enter RVC’s Women’s Investor Network, or WIN for short. Headed up by Director Barbara Bauer, WIN was founded to increase the number of active female Angel’s working with RVC. Something Barbara has identified, and highlights regularly at RVC events and talks, is the need to fund female entrepreneurs to make sure that women have the capital and the experience to be informed Angels. As an experienced entrepreneur with a background and education in science and engineering, Barbara represents the best of the best to lead RVC and the venture and Angel communities as a whole towards a better, more diverse future.
Know someone interested in working with Barbara as a WINtern? Have them send a resume to firstname.lastname@example.org!
Most interns don’t expect to learn from the Executive Director or their CEO. Fewer get to. Fewer yet get to sit through a five hour seminar on financial strategy with said executive. This is what the analysts at RVC got on Tuesday as Executive Director Peter Adams walked a group of entrepreneurs and investors through a CFO’s role in acquiring funding. From how to build adequate proformas to when to schedule your raises, the RVC Financial Class Cluster threw us into the fire of financial strategy. Sitting in with a group of investors and entrepreneurs alike, here’s a look at what we covered.
Diligence is the name of the game at RVC, with every prospective deal getting a full diligence report drafted up for RVC members. For Peter, this means believability and accuracy in the numbers. In the case of financial strategy, this means clearly defining your major milestones, your key hires, when (roughly) you’re going to raise capital, how you’re going to raise it, and the nitty gritty of each of those things. Peter’s philosophy outlines all of these alongside clear exit modeling as fundamental to a success for prospective founders. What stood out in this densely packed granola bar of venture capital knowledge? The paradox of uncertainty.
Peter made clear that a company and its founders won’t have a clear date on which they will need to raise the next round, hire that new sales star, or sit down with their dream acquirer. Peter also made clear that a company needs to have an idea of what those events look like, and while precision is not present, they key came down to milestones. Bringing on new team members shortly after key product launches, identifying the scalability inflection point, and raising enough money to pave a long enough runway are his tips for a successful financial plan.
Part of diligence is accuracy and reasonable goals, which for valuations means a lot things. One of Peter’s highlights is that while Angels would absolutely love it if their firms all became unicorns, unless that conversion happens in a fairly tight window, doing so isn’t best for the Angel. Rather than lofty goals that may provide a bigger sum after a decade, Peter instead argues for reasonable exit strategies. Acquisition by key distributors or large firms with histories of choosing the buy side of the buy-or-build dilemma, Peter argues, can result in faster turnarounds and safer strategies for both Angels and entrepreneurs.He defines clear ranges with key milestones for reasonable early valuations, and outlined a number of models used at RVC to determine those early valuations.
Peter also faced the audience with a thought challenge. Imagine an entrepreneur trying to raise their first seed round. As the omnipotent spectator, we know this company to have a specific valuation. The question at hand? Is it better for the entrepreneur if the company gets valued at double that valuation, or 10% less than its true value? While the company would be able to raise more money at the double valuation, the answer would be the 10% reduction. Less dilution and a slower, more controlled value inflation would prove advantageous for the entrepreneur.
Proformas are integral to the other parts of this class. They are the bridge between your vision as an entrepreneur and the funding to get you there. It is the blueprint of your business and your plans, the pictogram by which you assemble a successful company. This means years of financials, forecasts, milestones and targets, key hires, and more. Good proformas are believable proformas, argues Peter, utilizing reasonable projections and honest numbers to justify their claims and valuation. He argues that VCs and Angels alike would rather see that entrepreneurs have reasonable expectations and goals they know they can reach. In other words, be honest. If your burn is running $15k a month, don’t try to hide it. Instead, highlight where that burn is resulting in growth and is driving value. Show how you can scale back to balance if you need to slow down while seeking funding. Tell prospective investors honestly whether or not you have plans for future rounds. What milestones lead up to it? There are no ruby red slippers to take you back to the quiet farm in Kansas, so build the yellow brick road that takes you to Emerald City of successful exit, no matter how treacherous it may be.
In a panel on angel return data at the Angel Capital Association Summit recently the speaker went back and forth between data using ROI (multiples of the original investment) and IRR (internal rate of return). These metrics are very different and it is important for angels to have a good understanding of how using each of these will impact their investment strategy – in many cases for the worse!
Why Hunting for Unicorns May not be a Good Strategy for Angel Investors
There is a mythology among angel investors about going for “unicorns” (private companies with a valuation of $1 billion or more) in their portfolios. In many cases, real returns from unicorns may be less than hitting solid singles and doubles that exit at under $100 million. Here’s why:
While unicorns may appear to give great returns, our speaker gave an example. He had invested in DocuSign which is now readying itself for an IPO. (Initial Public Offering) After multiple follow-on rounds after his angel investment, his percentage ownership had been significantly diluted, but even worse – it took twelve years for DocuSign to get to exit from the time of his investment. While he expects to receive an investment ROI multiple of 4.8 times his original investment, that comes out to only a 15.3% IRR. Getting $480,000 back on a $100,000 investment sounds good initially. When the amount of time that the investment takes comes into the calculation, the unicorn doesn’t look as good as some of the same investor’s exits that came along in five or fewer years and yielded $100 million or less. In fact, his average IRR over his portfolio was 27%, so this unicorn was bringing his average down!
Angel Investors should think about their investments from a portfolio strategy viewpoint.
Smart angels will target 10X their investment back within five years or less – that’s a 58.5% IRR. After calculating winners and losers over time, angels who invest through angel groups will typically see a portfolio return in the 23-37% range, or about 2.5X. Getting 4.8X your money back sounds good, until you think about what you could have done with that money if you could have reinvested it after five years.
What if the investor had taken his $100,000 and NOT invested in DocuSign, but rather invested in ten deals at $10,000 each with half of them returning nothing and the returns from the others averaging 2.5X return over five years? And what if he had reinvested the returns from those investments? At that rate, including winners and losers, he would have received $850,000 at the end of twelve years for an 8.5X return or 27% IRR. Clearly, taking time into account, but also taking the opportunity to recycle exits into the next deal increases profits.
The likelihood of any one investment being a unicorn is something like 1,800 to 1, but the most prolific angel investors I know have portfolios of maybe 100-150 deals. On the other hand, getting a 2.5X in five years on a ten company portfolio is fairly common among angels. Unicorn hunting, even when successful returned almost half the cash that the diversified angel did. Using IRR instead of ROI helps angels to understand the best way to think of their strategy.
How do Venture Capitalists Differ from Angels?
Venture Capital funds often talk about how they need to go for the big multiples “because they need to return large amounts to their Limited Partners.” This is partly true, but not for the reasons they would have you think. Angels have the same return targets as VCs, and, when they invest in groups, they tend to outperform Venture Capital funds by a good margin. Over the past fifteen years VCs have been hunting for unicorns and missing out on the singles,doubles and triples that angels enjoy, but their returns averaged 9.98% – less than half of what angels have earned during the same period.
VCs are limited by time in their investments. The average VC fund lasts for ten years, and many funds have a policy of not “recycling” their returns into new investments, so they are motivated to get large multiples of ROI rather than focusing on quick returns with high IRR. It’s better if a fund can recycle its returns into new investments, with the caveat that they must return all capital to Limited Partners within ten years.
VCs also shy from using IRR to measure their fund’s performance because of the “J Curve” which refers to the shorter period between investment and failure compared to the longer period between investment and large-multiple success. Using IRR can make the fund’s performance look sub-par early in the fund’s lifecycle.
Finally, the institutional investors that are the VC’s Limited Partners often earmark their funds for long investment periods and the last thing they want is to get a 30% IRR on an investment that comes back in the first year. They would rather deploy the capital for longer periods for larger returns. Because institutional investors have a high cost of analyzing investment opportunities, it’s not as easy for them to re-deploy as it might be for angels.
So, angel investors differ from VCs in investment strategy, and if they invest in groups and pay attention to using IRR as their performance metric, they can outperform VCs and create significant returns for their own portfolios.
If you’ve read ANYTHING about cryptocurrencies and ICOs (Initial Coin/Token Offerings), you’ve read opinions from people who believe that the value of these coins will go up 100 times and others who believe that they will all crash to zero because there is “nothing there”. If you believe either of these groups, you’ll be in big trouble if you’re an entrepreneur or angel/venture capital investor in this space. Some cryptocurrencies will indeed go to zero and others will likely rise by 100X, but out of thousands of deals, how would you know how to pick the right ones?
It’s not just cryptocurrencies that have a lot of uncertainty today. We’re seeing unprecedented change in blockchain, artificial intelligence, Internet of Things, self-driving cars and more. These trends are all going to become a big part of our future, but which companies are the ones we should invest in?
Experience can be a guide in helping decipher the trends in fast breaking industries. The cryptocurrency ICO market reminds me a lot of all the dot.com startups in the 1990’s who were going public without having much more than a URL like etoys.com, socks.com, pets.com, etc.
What happened during the .com boom? Lots of companies got funded quickly and at valuations that didn’t make sense. It kind of looks like the ICO boom now. When companies get too much money too quickly, they tend to accelerate their failure rate because they haven’t figured out their product-market-fit or how to scale up quickly. We’ll certainly see some of that in the current ICO boom, but, just like in the .com boom, we’ll also see some VERY BIG winners. Google and Amazon looked crazy in the 1990’s but now they are today’s biggest companies. We will see the same thing with blockchain, cryptocurrencies, AI, IoT, intelligent cars and more.
The people who predict wholesale failure or wholesale success are bound to be wrong. The people who are diligent in digging into who the winners and losers will be with a futurist attitude will succeed. Investors who think like the hockey player Wayne Gretzky who famously said “A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be.”
Great venture capital investors have to be like great hockey players and invest where the market is going to be.
Predicting the future is hard, but we’ve got some help for you. The upcoming Angel Capital Summit, produced by the Rockies Venture Club will be focusing on Funding the Next Wave of Innovation. We’ll be interviewing CEOs of companies that have gone through major trends in social networks, cyber security and more in order to learn how to identify and ride the trends.
The Angel Capital Summit will also feature 16+ companies that are riding the trends of their industries, pitching to angel and venture capital investors. The event is open to the public and is free for RVC Keystone and Active Investor Members. (If you’re not a member yet, click HERE for more information).
The Rockies Venture Club is the oldest angel investing group in the U.S. and is a non-profit organization focusing on furthering economic development by educating and connecting angel investors and great startups.
Denver, CO – Rockies Venture Club (RVC), one of the largest and most experienced Angel investing organizations in the country, led and closed 15 funding rounds over the past year. RVC has created a community of accredited investors who are passionate about helping early stage companies raise the capital that they need to grow.
This trend of early-stage investing in Colorado is encouraging considering the fact that there has been a downward trend in early-stage activity worldwide. A November 2017 report by TechCrunch shows that despite record levels of Venture Capital being raised, the number of funding rounds has been cut in half since 2014. This indicates that capital is being concentrated into larger, later-stage companies. With this being the trend, it would seem that Rockies Venture Club and more largely Colorado as a whole is providing its companies the capital they need to grow.
According to RVC Executive Director, Peter Adams, “One of RVC’s leading principles is to be as diversified as possible when investing in companies. We believe that investing in a variety of sectors allows our Angel investors to diversify their personal portfolios while having fun learning about industries they don’t have past experience in.” This is something that the Angel group truly puts into practice if their 2017 portfolio is any indication. Among the 15 new companies that RVC backed in 2017, there was industry representation within CyberSecurity, AgTech, FinTech, Medical Devices, and Consumer Products; just to name a few.
In addition to engaging local capital through its network of over 200 active Angel investors, Rockies Venture Club also syndicates many of these deals with other Angel groups from across the U.S. Dave Harris, RVC’s Director of Operations, states, “RVC has been working to develop strong partnerships with other Angel groups for several years now. This allows companies to more quickly and easily close their funding rounds, bring deal flow to other areas of the country, and ultimately results in a greater amount of capital being invested directly in Colorado companies.”
Among the 15 deals, RVC led the seed-round in the female founded, Fort Collins company, The Food Corridor (TFC). TFC is the first online marketplace for food businesses to connect with available commercial food assets. Food businesses can find and book commercial kitchens, equipment, commissaries, processors, co-packers, and food storage spaces. CEO Ashley Colpaart put together a $550k round through Rockies Venture Club, Rockies Venture Fund, and other Northern Colorado Investors. Peter Adams stated, “I believe that RVC investors were especially interested in this deal due to Ashley’s deep industry knowledge and the promising early traction they have gained with food entrepreneurs and commercial kitchen spaces.”
RVC Angels also invested in CirrusMD’s $7 Million Series A Round. CirrusMD is a company that gives patients immediate access to providers via secure chat so healthcare organizations can excel in a value-based care environment. This was the third round that RVC has participated in, having first invested in the company in 2014. Since then CirrusMD has expanded access to care to over a million of patients and formed strong partnerships with some of the largest health systems across the country.
Beyond closing the 15 deals, in 2017 Rockies Venture Club created the Women’s Investor Network(WIN), an initiative created to address the lack of diversity in Colorado’s investor community, launched the Rockies Venture Fund, an early-stage VC fund that invests alongside RVC’s Angel investors, and collaborate with the Colorado OEDIT to create the OEDIT HyperAccelerator, program that helps Advanced Industry grant recipients raise the necessary matching funds.
Looking forward to 2018, the club will be hosting the 11th annual Angel Capital Summit (ACS) in March. The Angel Capital Summit is the largest Angel investing event in Colorado, bringing together over 300 investors, entrepreneurs, and community members together under one roof. This year the conference will focus around current, past, and future waves of innovation that have had or will have lasting impacts on the venture capital industry. RVC is excited to announce that there will be two keynote speakers at ACS this year: Divya Narendra, and Colorado’s own Andre Durand. Dyvia is the Founder and CEO of SumZero, and co-founded ConnectU, the inspiration behind Facebook. Andre is the Founder and CEO of Ping Identity who lead the company through a $600M+ acquisition by Vista Equity Partners in 2016.
The paradox in impact investing is that a large percentage of impact investors are hurting the very companies that they want to help. Neophyte impact investors have not yet figured out the difference between philanthropy and Impact investing, resulting in a confusion that causes serious damage to the Impact business community.
There is a big difference between philanthropy and Impact investing. The organizations receiving funding are focused on doing good in the world and it doesn’t matter whether they are for-profit of not for them to do good. In fact, many for-profits outperform non-profits on execution and core metrics for outcomes. Impact investors should understand their motivations for investing and they should have clear financial and non-financial metrics that they use to create their investment thesis.
A non-profit, by definition, does not make a profit. It is also owned by no one and when it has come to its end or fulfilled its mission, all assets must be donated to another non-profit. Value creation is strictly focused on mission and core metrics include outputs as well as key ratios between operational costs vs. direct program delivery.
Social and Environmental Impact investing, on the other hand, creates value on three ways. The business generates a profit. It creates measurable positive social and/or environmental outcomes, plus it creates positive economic outcomes for investors and founders. The fact that the company creates these positive economic outputs doesn’t in any way diminish the company’s need for capital nor does it diminish the impact created by the company’s operations.
To help clarify how investors and CEOs should think about impact investing vs. philanthropy, I’ve put together a sampling of six common arguments that some, mostly new, impact investors put forward, and some responses to those arguments which I hope will clarify the power of impact investing and a more productive attitude towards profitability and liquidity events.
Six Common Arguments from New Impact Investors
Argument: “I don’t want to invest in a company that is just interested in selling out, so I advise companies I invest in to never have an exit strategy.”
Even non-impact investors are wary of investing in a CEO who appears to be in it just for the money, or is planning for the quick flip. These CEOs likely w
on’t have the grit it takes to overcome the many obstacles in their way and will quit half way through, losing everyone’s investment. There’s a fine line between the quick flip mentality and the strategic CEO who is looking for ways to maximize value and leverage that to increase outcomes for all.
CEOs who hear this argument sometimes change their strategy to exclude an exit strategy, which often means that the net impact the company will have is DIMINISHED because of the short sighted demands of the Impact investor who wants to feel good about themselves in the way that philanthropy makes people feel good. By focusing on data oriented approaches to strategy, investors can come to understand the exit as a way to expand outcomes, not diminish them.
Argument:” If the companies I invest in are acquired, the acquirer may have different values, thus hurting the beneficial impact that the company creates.”
This argument suffers from a lack of understanding how exit strategies and execution work. The exit strategy entails identifying the best acquirers for whom the company will provide the greatest value. This exercise naturally involves understanding the values of the potential acquirer and seeking to build relationships with acquirers who share the impact company’s values and will likely expand on them after acquisition.
So, a company that does not have an exit strategy is more likely to be acquired by a company who has misaligned values and may fail to carry on and expand the mission of the company. Rather than decreasing the risk of a values misalignment, the impact investor increases the chances of misalignment by refusing to support talk of an exit strategy.
Argument: “Impact companies should just focus on creating a positive impact and growing a significant company and not on an exit.”
This is one of the weakest arguments against an impact company’s focus on exit, and it is one that is commonly waged against tech startup CEOs, leading to confusion and underperformance in many cases.
Let’s start by remembering the Second Habit of the Seven Habits of Highly Successful People – “Begin with the end in mind.” This habit is just as important for impact companies as it is for people. Those who focus on the end and develop a clear path to get there are 65% more effective in achieving those goals than those that try to “just build a big company.”
Impact companies create value in three ways, and I don’t just mean the Triple Bottom Line. Impact companies create value through creating a valuable good or service which is able to compete in the market and create revenues and profits. Impact companies create value because their goods or services themselves create positive social or environmental outcomes. Finally, Impact companies with exit strategies understand how to create value for their acquirers, and those acquirers are often willing to pay a multiple of revenue to get it.
Any company needs to understand its core value proposition for its customer. What smart Impact CEOs and their investors will do is to ask what the value proposition is for its second customer too – the customer who buys the whole company. That value proposition is not always the same as the value proposition for the first customer and having a clear understanding of those differing value propositions can be the difference between success and the walking dead.
So, companies with an exit strategy are 1) more likely than others to be successful and 2) will create wealth for investors and founders which can 3) be reinvested into new Impact companies to create an evergreen cycle of positive social and environmental impact.
Argument: “You can’t control the exit, so it’s a mistake to try to pretend that you can.”
People who don’t believe they can control the exit, may also believe they can’t control the market or the customers for their products. They might just as well stay in bed – they can’t control anything and are fairly weak leaders of companies.
Great Impact leaders create their futures. They may not be able to control all aspects, but they can create an environment in which their thesis succeeds. Great leaders will drive towards scenarios that align with their values and
business goals. Just because you can’t control every externality does NOT mean that you must throw up your hands and refuse to plan for the future. It is exactly because of the uncertainty of the future, that exit planning is imperative.
Argument: “Social and Environmental Impact companies are not acquirable, so they should just focus on impact.”
Companies should BEGIN with the end in mind and create all three Impact value propositions (profit, impact, exit). Companies that create profit and
impact should be highly acquirable, and by thinking about it from the beginning, value of all three kinds can be baked into the core strategy.
When it comes time for exit, it’s not a cop-out or sell-out of values. I think of it more like a “commencement.” Just like when someone goes through Commencement at the end of high school, it doesn’t mean that they’ve ended their path towards education, but rather it means that they’re graduating to a higher level of execution by going on to university. Few would say that commencement in any way diminishes the quality of the person going through graduation.
So too with a company going through an exit. By being acquired the company can further its mission tenfold or more by leveraging the capital, sales channels, R&D, brand and other resources that the acquirer can bring to the Impact company. The net result is the opposite of a cop-out, but is rather a commencement of something even bigger and the Impact investor should be right next to the Impact CEO, helping them to achieve that end.
Investors who believe that making a profit is bad should stick to philanthropy. If they need to lose money to feel good about themselves, philanthropy is a quick path to 100% financial loss. Even a zero interest loan to a non-profit results in a profit of zero which is 100% more than a philanthropic gift. Investors who have a problem with Impact companies being profitable should stick to philanthropy rather than dragging down promising Impact startup CEOs and limiting the evergreen effect of reinvestment.
The more that Impact investors focus on achieving positive social and environmental outcomes along with value creation, the more capital will be available to support Impact startups and the more good will be done in the world.
Impact investing is at an inflection point and is growing at an astronomical rate. The global market for impact investments is expected to top $300 Billion by 2020. Capital is chasing Impact deals because of a new breed of Fund managers who apply the discipline and expectations of venture capital to Impact. The more we see of this kind of investing, the better the Impact Investing space will be for everyone.
Interested in sponsorship opportunities? Find out more about the benefits of being an RVC sponsor.
Question? Check out the FAQs.