The finance world lives on the mantra of “cash is king”. Why, you ask? Well, it’s because it’s a company’s cold, hard cash, not its reported profit, that determines the value of a business.

Profit is merely an accounting mechanism. Future cash flows actually pay the bills. And the investors. And, most importantly, the investors’ investors.

But, how does one going about creating this tsunami of future cash? You best believe it’s by buying your customers’ delight and loyalty, which manifests in continued purchasing and future cash flows.

After all, it’s their cash that is ultimately all of our king and your ticket to success.

Here’s a crazy statement…“customer-focused companies are 60% more profitable.” Ok, we’re talking about cash not profit, but you get the point.

Bottom line, focusing on your customers’ happiness is important to ensure steady cash flow.

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Here are 4 steps to generating future cash from customers:

Step 1: Get Customers

This is so obvious that it’s almost painful to type, but let’s be clear here: without customers, you have no one to buy your products. This likely means you have no sales and no customer-generated cash. This, in turn, means you’re beholden to other people (i.e., capital providers) who can provide you with cash. Problem is, these people like customers’ cash too, so the fact that you have none will turn them off. No accounting shenanigans, beautiful decks, or even talent will overcome this on an ongoing basis.

Step 2: Keep Their Business

Acquiring a new customer costs five times as much as keeping an existing customer. So, you better make the customers you’ve already gotten happy; else, you’ll spend more of their cash replacing them with new customers you have to keep happy. This is one reason churn is so painful. Another reason is the extremely dilutive impact it has on your company valuation as you miss out on the compounding magic of compounding recurring revenue growth and its contribution to your future cash flows.

Here’s a simple model we’ve built we’ve built to play with your bookings and churn rates and see the impact on your potential valuation.

Churn's Impact on Future Cash Flow

Step 3: Make Them Mouthpieces

80% of customer service related tweets are negative and critical. That’s a crazy stat. How are we that bad at servicing our customers? It’s probably because we think we’ve done the hard work by getting them to actually pay us. Our onboarding and activation flows are so dialed, they can take care of themselves. Troops, we must find more customers!

I think we all fall victim to this top of funnel mindset. I think we’re suffering from it. We’re missing out on the engagement opportunity to build the relationships that make our customers comfortable to say, “You’ve got to give [your_company_name] a try. They’re amazing!” Which leads us to…

Step 4: WOW THEM

Answer their chats with empathy. Take their calls and listen to learn. Don’t direct them to your FAQ. Don’t point them to obscure features that might kind of solve their problem. Make them want to reach out to you, both because you solve their problems and your enjoyable to interact with.

There’s your funnel humanized. Next, we’ll delve into how to delight the customers who have chosen to give you their cash.


This article was originally published by our friends over at Bigfoot Capital on their blogBigfoot Capital provides growth capital for SaaS businesses that have achieved initial revenue scale ($30K-$150K MRR) by selling to SMBs. Our ongoing capital investments range from $150k-$750k to support efficient growth and help Founders retain the lion’s share of their equity and upside. Beyond capital, we have built relationships with specialized services firms across sales and marketing, product development, and operations to help you scale beyond your current human resources. Want to learn more? Visit www.bigfootcap.com or schedule a time to chat.

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 info@rockiesventureclub.org!

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

Angel Investing Unicorn

 

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.

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.

We’ve known for years that Colorado has more startups per capital than anywhere else.  Yes – per capita.  It’s a great location to start up a company and maybe you’re wondering if there’s a Venture Capital infrastructure to support that?  Well, now there’s incontrovertible evidence for Colorado’s leadership position in MicroVCs and it all comes down to … beer.

Just check out this CB Insights research relating MicroVC Tech Deals to Microbreweries.  That’s right – the more microbreweries you have, the more MicroVC deals you get.  And take a look at Colorado’s number 3 position in Microbreweries – what does that tell you?

 

Yes – a vibrant MicroVC community is brewing here in Colorado.  We’re seeing a huge influx of MicroVC and NanoVC funds as the state begins to mobilize its local capital to support its burgeoning startup community.

Ok, maybe that’s just a facetious stretch of statistical comparisons – but there is definitely a rapidly moving trend in Micro Venture Capital and Colorado is feeling the benefits of new sources of capital coming on-line!

This trend mirrors a national trend in increasing Micro VC firms.  Following the drastic drop in VC firms from over 1000 to just over 500 after the economic downturn in 2008, MicroVCs have flourished.  There were fewer than fifty active MicroVCs in 2011 and today there are over 550 in the U.S. A tenfold increase in just a few short years and many of them are in Colorado.

MicroVC is changing the venture investing landscape and is responding to the needs of startups who need small amounts of capital to prove their product market fit and grow big.  MicroVCs offer a scale that the big firms can’t efficiently provide and they get companies up and going quickly and efficiently.

MicroVCs aren’t just for small companies though.  Check out these results from MicroVCs who are growing a new crop of Unicorns (private companies with valuations of $1B or greater)  It’s not just the big funds that are hitting the grand slams – the Micro’s are slamming it home as well.

MicroVCs are creating a huge impact in the startup world and Colorado is the place to see this transformation taking place on a rapid pace.

You can learn more about MicroVC, NanoVC, and how accelerator VC funds are changing how startups get funded, and how angel investors can get involved in new ways previously unavailable to them.  You’ve got just a few days to sign up for the Colorado Capital Conference coming up November 6-7, 2017 in Denver, CO.

Visit www. coloradocapitalconference.org for more

information and to register.

The conference is hosted by Rockies Venture Club, the longest running angel group in the U.S.  Membership is NOT required to attend the conference, but if you’re an entrepreneur or angel investor, this would be a good time to look into the savings that RVC members enjoy on conferences, angel groups, workshops, masterminds and classes.

 

 

 

 

 

 

 

 

 

 

 

 

It seems like a majority of pre-Series A deals are done with convertible debt these days and I’d like to point out a few reasons why this is a bad thing for entrepreneurs and investors alike.

Just to get definitions out of the way, we’re talking about the decision to raise funding for startups by either equity investment in stock of a company, or in a convertible debt instrument.  Equity is pretty straightforward – invest money, get stock.  Convertible notes, on the other hand are not widely known to those outside of startup investing.  Convertible debt works like regular debt in that there’s a promissory note and an interest rate.  The interest is rarely paid in cash for convertible notes though, and it’s usually rolled into equity when the note converts into equity.  There are usually a few “triggers” for h

RVC Convertible debt vs. equity

aving the note convert to equity, but the most prominent one is that there is a “qualified financing round” which is usually around $1 million.  The idea is that the professional investors at that stage know how to value the business and set the terms. The first early investors who invest will convert at the terms set by the VCs, but usually with a 20% discount in price to compensate for investing earlier.  Convertible notes today also have a “valuation cap” which is equal to what the equity valuation would have been if the deal had been a stock transaction in the first place.  So, when the qualified round causes the note to convert, it converts at the lower of the 20% discount or the valuation cap.

Ten Reasons to Avoid Convertible Debt

Reason 1:  Convertible Notes do not qualify for Section 1202 QSBS Tax Breaks<a href="http://www.freepik.com/free-photos-vectors/business">Business vector created by Dooder - Freepik.com</a>

Angel investors get a 100% capital gains tax break if they invest in equity in early stage companies that meet certain criteria such as being a C Corp., being under five years old, under five million in revenue and they hold the 

 

 

 

investment for five years.  Convertible notes don’t qualify for this tax break, so if all things were equal, the investor makes 20% LESS on convertible note deals since they have to pay capital gains tax on the investment, whereas investors who invest in equity do not have to pay any tax at all.

Reason 2: Equity is cheaper than convertible debt

You may have heard that it’s cheaper, faster and easier to do a convertible note, but the fact is that convertible notes are going to end up costing the company approximately 25% MORE than an equity deal.  The reason for this is that when the note converts, then it converts into EQUITY.  That means that the company pays twice for the legal: once to do the note and another time to do the equity.  So if a convertible note cost $2500 in legal fees and the equity deal cost $10,000, then the convertible note all-in is going to cost the company $12,500.  Why not just do it right in the first place and put all that money to work for the company?

Reason 3) 80% of Angel Investors Prefer Equity

If you’re selling something to a customer, wouldn’t you want to sell them what they want and not some more expensive and inferior product?  The American Angel Survey shows that investors prefer equity and I suspect that if the remaining 20% of angels read this blog, they’d prefer equity too.

Reason 4) You can lose your company if you default on a convertible note

When you take out the note you’re confident that you’ll have a qualifying follow-on round within 18 months, but many times it takes longer and the note comes due and payable and you’ve already spent the money and can’t raise any more.  You’re in default and investors can take your company from you.  Most investors don’t want to do that, but why go through the heartburn and stress of facing the potential loss?

Reason 5) Investors have to pay tax on interest they earned but never got

As interest accrues on convertible notes, interest is due.  Investors need to pay tax on those notes, even though they didn’t actually get the interest in cash.  So, if someone invests $100,000 in an 8% convertible note, they have to pay $2640 in cash to the IRS on that income.  Nobody likes paying taxes on money they never got and also, BTW, there is no tax due for equity investments.

Reason 6)  You have to come up with a valuation for convertible notes just like equity.

Many people think that using convertible notes lets them “kick the valuation can down the road.”  Nothing could be farther from the truth.  Every convertible note has a provision called the “valuation cap.”    The formula for calculating the valuation cap is as follows:

Valuation Cap = Equity Valuation

This means that when someone invests in a convertible note, they should never have to pay more than what the company is worth today.  If the valuation cap were higher than equity valuation, that would mean that note investors would have to pay more than the value of the company.  Just because it may convert at a higher valuation some time in the future does not mitigate the risks that the early stage investor has today.  In fact, the only way that the higher valuation comes about in the future is that the angel investor puts in the capital early, when risk is highest, so it doesn’t make sense that they should pay more than what the company is worth.

Many companies get confused about this.  One company told us that the valuation would be $5 million, but it would be $7 million valuation cap “because it’s going to convert at $12 million some day.”   It’s crazy to think that somehow using a convertible note makes a company worth $2 million more than one that uses equity. This kind of thinking makes no sense and hurts the startup community.

Putting valuations on early stage companies is something that is done every day and there’s no magic to it.  Seed Funds and Angel Groups have well established valuation methodologies that work well on pre-revenue companies.

Reason 8) Entrepreneurs get diluted with convertible notes

Entrepreneurs should be cautious about the cumulative dilution that paying interest which will be rolled into equity will create.  The longer the note goes on, the more startups will be diluted with the interest that they have to pay in the form of equity.  It would be better to preserve that equity for future growth.  Founders who chose equity over convertible debt don’t have to worry about interest accumulating and diluting their shares.

Reason 9) Equity creates better alignment between investors and founders

When convertible debt is used, there is a misalignment between investors and entrepreneurs.  Founders want to use high valuation caps or worse, no valuation caps, and prolong the amount of time before conversion, so that investors get the short end of the stick.  Some founders openly state that they want to use convertible debt to preserve their equity.  Those are founders that every investor should avoid – not because they want to build a strategy that preserves equity, but that they want to create unfair terms that preserve equity at the expense of investors.

Reason 10) Equity deals have all the terms defined

With a convertible debt deal, the conversion price is negotiated, but all the other terms which are extremely important to the relationship between the founders and investors are left open.  This represents a risk to investors and also leaves many matters unsettled.  One example is that there are usually terms about board representation which are not found in convertible notes.  Investors in early stage companies can offer much more to companies than just a check if they can serve on boards and help move the company along.  While there’s nothing to say that companies with convertible notes can’t have boards, in fact many don’t and that’s bad for both investors and entrepreneurs.

Last Words:

With all that being said against convertible notes, they can still be useful for the FFF rounds with friends and family who don’t know how to value a deal and who are investing primarily to support the entrepreneur.  Convertible notes can be better than some of the amateurish deals that get put together for early family investors who are often non-accredited that can make follow-on investments difficult or even impossible for the company, thus limiting its chances for success.

Visit www.rockiesventureclub.org to learn more.

 

Peter Adams

Managing Director, Rockies Venture Fund I, LP
Executive Director, Rockies Venture Club, Inc.
 Buy Venture Capital For Dummies on Amazon

 

It’s a common misconception that angel investing and venture capital is extremely risky.

But when best practices for investing are followed, tax breaks and portfolio returns can consistently outpace even the best mutual funds.  If you’re wondering how this can be true – read on!

Angel investing involves capital investments by accredited investors (people with a net worth of $1 million or more excluding the value of their primary residence, or with income of $200,000 or more per year/ $300,000 for a married couple).  These investments are in startups, usually with less than $1 million in revenue and less than five years old.  These startups have high growth potential and angel investors look to invest in companies that have a believable plan to be able to return 10X their investment or more within five years.  

Yes, some of these companies will fail, but let’s compare two investors.  The first one, Freddy Frugal, invests all of his money in mutual funds yielding a healthy 8% return. The second one, Andy Angel, invests his money in ten startups.  Both investors hold their investments for five years.  Let’s look at  their returns.

Freddy’s returns are 8%, but he must withdraw $2,640 in the first year, and more each year to pay taxes, so the compounding is based on his after tax returns each year.  After Freddy pays his taxes, his actual return is less than 5.93%.  Not bad, given the relative lower risk of a mutual fund and the liquidity it provides when funds are needed.

Freddy Frugal – $100,00 at 8% compounding
Year Investment Returns Failures Taxes Returns After Tax Portfolio Value After Tax
Initial Investment $100,000 -100000 -$100,000 $100,000
1 0 $8,000 0 $2,640 $5,360 $105,360
2 0 $8,429 0 $2,782 $5,647 $111,007
3 0 $8,881 0 $2,931 $5,950 $116,957
4 0 $9,357 0 $3,088 $6,269 $123,226
5 0 $9,858 0 $3,253 $6,605 $129,831
Total $44,524 $14,693 $29,831 $129,831
IRR Before Tax 8.83% $144,524
IRR After Tax 5.93% $129,831

 

Andy’s returns are a bit more complicated.  

First of all, because Andy is investing in a Colorado company he is eligible for state investment tax credits of 25%.  (many other states have similar credit programs)  This means that he gets $25,000 back immediately from the state government, so he actually has only $75,000 of his capital at risk.   We’ve shown this below by adding the $25,000 cash returned by the state to the value of his portfolio.

Also, Andy’s returns for his portfolio match the HALO report of thousands of Angel investing deals reported, so in the second, third and fourth years one company totally fails each year, resulting in a complete loss of investment and another is liquidated and returns $.50 on the dollar.  This results in a tax loss of $15,000 each year which he can take accelerated write offs against ordinary income thanks to IRS Code Section 1244.  This results in a cash benefit to Andy each of these years in the form of reduced taxes which we’ve calculated at $4,500 per year.

In the fifth year, the remaining four companies have exits ranging between four and ten times the initial investment amount, resulting in a $295,000 positive cash flow.  Because Andy made equity investments in early stage C-Corporate startups and held the investment for five years, he is entitled to a 100% long term capital gains tax exemption thanks to IRS Code Section 1202, so his tax bill for that year is zero.

 

Andy Angel – $100,000 in ten startups at $10,000 each
Year Investment Returns Failures Taxes Returns After Tax Portfolio Value After Tax
Initial Investment $100,000 $25,000 $25,000 $125,000
1 $0 $0 0 $0 $0 $125,000
2 $0 $0 1.5 -$4,500 $4,500 $114,500
3 $0 $0 1.5 -$4,500 $4,500 $104,000
4 $0 $0 1.5 -$4,500 $4,500 $93,500
5 $0 $295,000 0 $0 $295,000 $333,500
Total $320,000 -$13,500 $333,500 $333,500
IRR Before Tax 31.5% $333,500
IRR After Tax 31.5% $333,500

 

There is a lot of mythology about how many startups fail on average.

So, how risky was Andy’s Investment?

The statistics about how many startups fail on average can be deceiving.  Many of those statistics come from the SBA or local Secretaries of State who report failures of hair salons, restaurants and lawn mowing services along with other companies.  But, companies that receive venture capital investment have to reach a higher bar than just registering with the state.  They need to have gained significant traction and have gone through a lot of due diligence and had to jump the hurdle of convincing dozens of angel investors to write a check.  These companies are far less likely to fail than the general population of company formations.  In fact, HALO report data shows that about 52% of these companies will return less than $1.00 for each dollar invested.  Of that 52%, about 18% will be complete failures.  So, we’ve been a little hard on Andy Angel and had him with three total losses and three returns of less than a dollar.  On the upside, we’ve also been a bit conservative.  About 5% of venture backed startups will return 30X or greater, and there’s a good distribution of returns between 10X and 4X.   These winners more than pay for the losers.

Andy’s key to success was that he diversified his portfolio into ten investments.  Smart angel investors know the value of spreading out the risk so that the winners can more than offset the losers.

Another point to observe is that we’ve valued Andy’s portfolio at the value of the investment only until the returns came in.  Despite that conservative accounting, he barely dipped below his $100,000 investment amount in year four with a portfolio value of $93,500.  This means that if the four remaining companies had returned only 1X, his loss would have been limited to $6,500.  

But, his returns were a more typical 3X over the portfolio, resulting in a return of $295,000.  We can add in the $25,000 state tax credit and his $13,500 in accelerated write-offs  from the $45,000 loss, and his net cash return AFTER TAX is $333,500.

Andy was hardly more at risk than Freddy, and yet the internal rate of return on his investment was more than FIVE TIMES GREATER.

So, who is the smarter investor?  Freddy Frugal with a 5.93% after tax return or Andy Angel with his 31.8% return and $333,500 in cash after five years?  Angel investors have figured out how the system works and have been profiting handsomely from it for some time.  Accredited Investors should consider contacting their local angel group, preferably groups that are members of the Angel Capital Association, like Rockies Venture Club, and consider membership so that they can benefit from great deal flow, a community of smart investors, group negotiation and high quality due diligence.  

Visit www.rockiesventureclub.org to learn more.

 

Peter Adams

Managing Director, Rockies Venture Fund I, LP
Executive Director, Rockies Venture Club, Inc.
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Life Science Investing is Different than Software Tech Angel/VC Deals.

 

Companies seeking early stage investment in their biotech, life science, medical device or digital healthcare companies face al

 

l the hurdles that software tech companies face – and then some more.  Many of the hurdles have to do with misconceptions that people have about life science investing, and others have to do with the real differences that exist in this market.  Companies raising money in the life sciences have to go through all of the things that tech companies do, plus more, in able to successfully raise funding.  

Life Science companies should consider attending the RVC/CBSA BioScience HyperAccelerator to help them through the process. We guarantee participants will be amazed with the quality and usefulness of this unique content that can be found nowhere else!

 

What BioScience Companies Need to Know

Time-Lines – there are a lot of investors who think that all life science deals take ten years or more because of the huge regulatory hurdles that have to be overcome, and that the capital requirements could be in the hundreds of millions before the company gets to an exit.  These investors are missing out on lots of great opportunities.  What they don’t realize is that companies rarely move all the way down the regulatory pathway before achieving exits if they’re developing a novel drug, for example.  Usually the hurdle is Phase 1 Clinical Trials before a company is acquired, so the pathway can actually be shorter than for some tech investments.  Also, many companies are working on repurposing existing drugs for new uses.  In this case, all they need to prove is efficacy for the new use which can be a relatively short process.  Devices, in contrast to drugs, can achieve FDA approval in just months in some case.

 

FDA Regulatory Risk – many investors who don’t understand the biotech space have heard horror stories about the capricious, costly and time consuming process of FDA approvals.  While these fears are not totally unfounded, most companies pass through the process in a relatively short time and at low cost.  We budget about $50,000 and six months for a 510K approval process in some cases.  Angel investors have special opportunities to invest in pre-FDA approved companies because valuations typically double or triple after FDA approval, resulting in good returns for investors.  

 

Liquidity Events (Exits) are more obvious for many biotech, medical and life science companies because there is a clear playing field with companies that are regularly acquiring companies as a part of their innovation strategies.  There are enough players that companies who are intentional about crafting the best exit can create a situation with multiple bidders to result in the highest exit valuation.  Even if the exit pathway seems clear to founders, their presentations should include a clear description of their exit strategy in order to bring the most investors on board.

 

Intellectual Property is Critical – while most tech and software companies have dropped patent filing altogether, IP is the core to creating value in the life science and medical space.  Granted patents are always best, but at least having patents pending with a strong defensive strategy is critical for success.  Companies will also need to be able to demonstrate that they’re not infringing on the patents of others.  We’ve seen companies who we’ve found to be infringing on patents which made them uninvestable.  This is something that companies should research well and be able to demonstrate instead of doing a lot of work, only to have investors find that the project is dead on arrival after several years of effort.

 

Team Considerations – tech companies often suffer because they have a bunch of coders who’ve been working for years to come up with a product, but they don’t anyone on marketing, finance, or business strategy.  Life Sciences can have these problems when they’re staffed with teams of smart PhDs who don’t have the experience or track record to be able to raise funds, transform from a research organization to a marketing organization, or to understand value creation for acquirers.  Make sure your company has the appropriate finance and marketing team members on board before raising money.

 

Market Fluctuations – it seems like biotech is always way up or way down and the current market position may influence investors’ desire to jump on-board with these companies.  Founders should be prepared to talk about trends in the industry and why their company will be providing value that either transcends the current market situations, or that the investment cycle is expected to be long enough to stretch beyond any current market challenges.

 

Marketing Strategies for life science companies are going to be significantly different than for tech or other physical product companies.  Some life science companies build an expensive and time consuming strategy that involves hiring and training a sales force who then try to forge relationships with doctors and hospitals in competition with some of the largest and well funded companies in the world.  If the company survives that process and gets to an exit, then the first thing that the acquiring company is going to do is to fire all those salespeople and add the company’s product line to their own and get their own sales people up to speed on marketing it.  So, life science companies should think about how they add value to their acquirers.  Is their value primarily the product itself, the team, the market share, the sales organization, research under way, or something else?  Make sure that you’re not pouring resources into something that won’t create value for your acquirers.  With that being said, companies will need to establish a market presence in order to validate that the product is of interest to customers and will be a success in the market.  This benchmark may be achieved with as few as one thousand sales.  These can be achieved through forging partnerships with sales organizations rather than starting from scratch.

 

Valuation  for life science companies seems to have a significant spread which may be caused by inexperience on the founders’ side, or by the uncertainties in the market.  Companies that want to raise funds quickly should price their shares competitively with other startups and keep in mind that not every startup ends up with a five hundred million dollar exit.  

 

Life Science founders have a lot of opportunity in front of them if they understand their market and how to take advantage of it.  Founders should be prepared to dispel myths and to focus on the clear strategy they have for product development, regulatory strategy, marketing and exit.  These will lead to most investor interest and fastest pathway to funding.  Life science and medical investments currently comprise about 30% of venture capital investment which shows that investors recognize the opportunities that this space brings.  Founders and investors alike should have a clear understanding of the differences between life science and software/technology investments and how to take advantage of them.

 

All companies raising capital should be well versed not only in the specifics of their industry, but should also prepare solid strategies and complete the following steps before starting their fund-raising activities.

Ten Steps for LifeScience Companies to Prepare for Venture Capital

  1. Exit Strategy Canvas – identify comparable transactions in the market for both dollar amount and multiples of revenue.  Identify early, mid and late stage values the company presents to acquirers. Identify who the acquirers are at each stage of the company’s development.
  2. Business Model Canvas – this is the core business strategy document that allows a company to understand their unique value proposition, their customer, the channels used to reach customers, core metrics, partners, and how they spend and make money.  This one-pager is key to understanding the key concepts behind any company.
  3. Strategic Plan – Not your grandpa’s strategic plan, but a two-page document that provides a roadmap from where the company is today through its growth.  This is the difference between success and failure during Q&A with investors and for the company overall!  Research shows that companies with written strategic plans outperform those without plans by 65%.
  4. Go to Market Plan – people take this for granted when they’re heads-down in the science or tech development, but this is the key risk companies face – getting customers to actually buy the product.  Without a strong go to market plan, you’re out of luck with investors who are always concerned about this key risk.
  5. Proforma – you need more than a great idea to raise money, you’ll need to model out your use of funds, needs for capital, revenues and expenses.  A good detailed proforma that is well researched and validated is a must for planning your business and for determining your capital needs and valuation.
  6. Finance Plan – you need to know how much to raise now (this is harder than you think) as well as your future raises between now an exit.  You’ll need to know this to help model your cumulative dilution and to understand what the major milestones are that you’ll need to achieve at each level of funding.
  7. Valuation – let’s make this simple.  You can’t raise money without knowing your valuation, regardless of whether you’re using equity or convertible debt.  Go through five valuation models and play them off of eachother to have a defensible position when it comes time for negotiation.
  8. Term Sheet – this is the key document used in negotiating the deal.  Make sure that you’ve got a term sheet in your pocket before you meet with investors so you have a solid understanding of the key terms and how they’re used in venture deals.  
  9. Executive Summary – When investors ask for information, they’ll want a two-page executive summary and pitch deck.  The executive summary has all the core elements of your company in a concise format that investors can use to determine their interest in moving forward.
  10. Pitch Deck – when you get in front of investors you’ll need a pitch deck to present your information.  Get this done professionally so that you can communicate effectively in a highly competitive capital market.

 

Life science companies can get templates, education and mentor assistance in creating all of these in a two-day BioScience HyperAccelerator hosted by Rockies Venture Club and the Colorado BioScience Association.   The two day workshop is $995.00 per company and includes a one-year membership in the Rockies Venture Club for the primary participant and a free subscription to the IdeaJam platform to help companies securely get feedback and input on their Provisional Patent Application.  Companies using the IdeaJam platform can file patent applications in a fraction of the time and cost of using patent attorneys.

Apply to Join the BioScience HyperAccelerator here ===> https://rockiesventureclub.wildapricot.org/event-2614776

 

The Next Session is August 29-30th in Denver.  Apply by August 22 for preferred admission.

 

At the beginning of summer, I was brought on as an AngelList associate intern at Rockies Venture Club. Unsure of what that would entail, it turns out, I was going to be building a following on AngelList, one of the most disruptive, and uniquely social investment platforms to date. The focus of this post is not about the platform or how useful AngelList is, because it been vindicated by many notable Venture Capitalist and by the amount of capital that has been raised on the platform already, but to rather talk about AngelList in accordance with social proof. Read more