Learnings from Angel Investing

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I have been an investor in my previous avatar and invested across fixed income, listed equities and forex markets. I had also invested in some unlisted stocks as well like Oyo, Nykaa and NSE while heading family office at Hero Enterprise.  I was able to generate a significant alpha as I followed a disciplined approach of stop-loss and take profit and maintaining a hit ratio above 60% with regards to listed investments and the unlisted investments were multi baggers. I believe one of the key reasons for higher returns particularly in the listed space was the fact that the entry and exit were completely in our control as the markets were relatively more liquid than investments in start-ups which are illiquid in nature.

I starting angel investing in early stage Start-ups almost 30 months ago, with the aim to learn, promote entrepreneurship and generate returns. My philosophy of investing was more like investing from the Heart “Dil-Se” investing (read more). I spend most of my investing time by engaging with the founders to understand their Bio and Chemistry, sharing my learnings and also devote some time to asking first principle questions i.e. Physics and Maths of the business. I call this phase of my professional journey, Version 2.0 as a 21 year old student of philosophy, psychology and digital technologies.

Start-up investing is a very different format of investing than what I was used to in the past. In order to get a deeper understanding of this space, I met with some successful fund managers, accelerators, super angels, serial entrepreneurs and first time founders to learn from them about the nuances of start-up investing. My key findings basis these interactions were that this is an illiquid market, requires patience and long term thinking, with significant reliance on the founder, wherein one cannot enter and exit at will. I was told that only 2 out of 10 companies could be multi-baggers, 4 out of 10 will give average returns and the rest will die or return some capital. It was hard for me to believe that only 2 out of 10 companies would do well and the fact that 4 out of 10 companies may die and return partial/no capital despite the liquidation preference.

After having invested in 40 start-ups, I am extremely blessed and lucky that only 3 out of 40 companies have gone belly up and 2 have come out from the brink of closure.  The mortality rate has been significantly lower despite Covid (which is once in a lifetime event). 

I am sharing a brief about the companies that could not survive despite product market fit and/or good traction and also about companies that were able to revive the business as their founders were agile, had the grit and positivity to relive their journey.

Here are the stories and learnings from (my portfolio) companies but I will not be sharing the names of the companies or their founders.

Companies that could not survive :

Company I

The company had a rock solid founder with very innovative thinking, a true hustler and full of energy, driven by core human values and was in the space of social commerce. He had failed once earlier but he worked hard to earn and return the money to his investors who were mostly family and friends. The company was in the process of signing a term sheet, and then covid happened and the investor backed out. The company had only two months of cash left at that time. The founders had no choice but to explore options of providing exit to the investors. All the investors were very supportive and sympathetic to the founders. The founders were able to identify a strategic partner (company funded by a tier 1 VC)  who agreed to return capital to shareholders over time and also provide some returns to the founders. After 3 months of deep engagement the buyer backed out as there was a change in the CEO of the buying company and he was not fond of this space. The company got liquidated, the investors allowed founders to take some money without insisting for their capital.

The founder took a break and within 12 months he created a new company and he got inbound interest from a few marquee investors and has started to do wonderfully well now. I would have loved to invest in his company but his ticket size was much larger for me to be on cap table.

Lessons Learnt : The choice of founder was right, the business needed large capital and there were limited believers as covid had just hit and there was no cash to survive for long. In my view this was an unforeseen event of covid, otherwise the founder would have found a new use case, which is what he did in less than a year after closure of the earlier company. We should not assume closure of fund raise despite written and verbal assurance unless money is in the bank.

Company II

The company was referred to me by one of the founders of my portfolio company. The founders of this company were young and had great dreams to create disruption in their chosen vertical. The company won a competition run by one of the VC funds, as a result of which they were funded by the VC. The founders had also raised money from one of the other well-known accelerators. As a process I used to spend a few hours with all the founders listening to their life experiences and then spend time on the business before investing. In the current case, I somehow spent time with only one of the founders and relied on the fact that there were two very experienced investors participating in this round. Within 6 months of investing the founders started fighting amongst themselves and the company kept going down. There was very limited oversight during the period post investment, and by the time the realisation set in, the company was almost on the verge of closure

Lessons learnt : Never compromise on the process of investing, ensure alignment amongst founders through a founder agreement  and a regular oversight by the lead on both soft and hard data. Tough timely decisions by the leads could have helped in company survival or at least partial recovery of the investment .

Company III

The company  was set up by founders who had completed their education from one of the premier institutions of India with the founders being highly purpose and values driven and having full faith and conviction about themselves and their business. The company had raised multiple financing rounds and was ready to get to raise Series A. The company had very high growth rates for over a year, scaled very fast, offered good customer experience, witnessed significant margin improvements, had great execution and a fair amount of innovation and IPs. The company’s largest investor is a very respectable family office and a brand in their own right. This should have been a very sought after company as it ticked all the boxes of an investor.

The founders initiated the process of raising money from institutions but most of the investors believed that the space in which they operate has established and well-funded players and therefore there is no space for a smaller company even though the founders believe in their story (I too believe in their story). The other discomfort is also the fact that the large family office had the wherewithal but did not fund as they seemed to have exhausted their limit. Despite all the right ticks, the company’s business has been scaled down and is on the verge of closure.

 Lessons learnt : The founders made their best efforts to sell the story for over a year realised but they could not onboard institutional investors. They continued to manage the business by raising bridge rounds. Ideally the founders could have considered pivoting around new use cases while scaling down to reduce the cash burn and increase runway. They did not have a Plan B. May be an engaged business coach could have helped

If they start a new company, I will still back them, even in their failure they are rock star founders.

Companies that came back from the brink of closure

Company IV 

The Company has matured founders, very knowledgeable with complimentary skills, set out to build a disruptive business model using digital technologies. The company offers travel solutions. The company was in the process of raising Series-A when covid hit and revenues reduced to zero overnight with the situation continuing like that for 6 months. The company started winding down and started exploring exit options, including sale of the business as there was a very limited runway. The founders reached out to strategic investors and the offer was less than 20 percent of capital invested, which is when existing investors requested the team to put a Plan B in action. The founders came back with a plan by reducing their spend and a few of the existing investors put their faith behind the founders and invested a small tranche. The founders continued to be optimistic and positive during this period of downturn. Fortunately travel business is coming back and I hope the company will not only survive but do well in future.

Lessons Learnt: Balance scale with cash flows, be open to take some tough measures with humility. Stay positive as good times do come. Identify investors who can support you in tough times

Company V

The Company was founded by two young students while studying in a premier educational institution. While they completed their fund raise but covid hit and the business was shut since China which supplied bulk of the raw material stopped supplying. As a consequence of these unforeseen and unfortunate events, there was some mistrust amongst the investors and founders and this continued for a couple of months with couple of investors wanting to liquidate the company. Even while the founders were fighting a few battles, they continued to focus on the business and as a result of their efforts the business started to scale. Good business outcomes led to interactions amongst investors and founders becoming more conducive to finding a resolution. Good sense prevailed and misunderstandings were addressed and finally the open issues got resolved. The founders started channelizing all their energy into scaling up, creating new products and minimising dependence on China. As a result of these measures, the growth in the business was almost 40 times in under 12 months. The company has also raised a follow on round.

Lessons Learnt: Truly admire the conviction, belief and grit of these founders. They did not lose focus on business building. Since the founders were fresh out of college, they could have looked at engaged advisors who would have helped them in resolving the issues quicker and sooner through a dialogue without getting emotional.

In conclusion here are the key summary findings :

  • Alignment amongst founders and their appetite to stay invested in the business
  • Balance scale and cash flows, cash is king in the early parts of the start-up journey
  • Founders and investors’ incentives and DNA must be aligned and there must be an open communication during times of stress. Both good and bad news must be shared at the earliest
  • Founders must continue to stay optimistic, listen to the customers and investors and understand their expectations and be open to learn from their thoughts
  • Tough timely decisions by founders and investors can help in survival/recovery by investors
  • One must always have a Plan B in place whether it is for fund raise or product offering/ use case
  • While raising the round, as far as possible, founders must have the flexibility to increase the runway to at least 9-12 months
  • Investors should not compromise on their investment process and follow on reviews including focussing on softer issues as well
  • Founders may explore to have an engaged coach who is as passionate as the founders in creating a winning story while enjoying the journey of creation

I know I am not saying anything new here, but I believe this will help at least some first time founders and investors to avoid pitfalls in their journey.

This is the first essay in series of my learnings from angel investing which I will continue to publish over time.

Happy to get feedback

September 2021