22. Lessons from 5 Years of Angel Investing (Gabriel Weinberg)

Nick:      Today we have Gabriel Weinberg back with us again to talk about his lessons learned after five years of angel investing. Of course, Gabriel is the founder and CEO of DuckDuckGo, and he writes excellent content for startups and investors at his blog, gabrielweinberg.com/blog. Gabriel, thanks for joining us once again to talk angel investing.

Gabriel:                Thanks for having me back.

Nick:      So can you first highlight the basic stats of your first few years angel investing?

Gabriel:                Sure, so I started angel investing in 2009 and I kind-of went into it thinking about it a little quantitatively and decided that I needed to spread the risk – and you probably cover this in other podcasts as well – like you need to invest in at least a dozen deals. And so what I did was, I have decided to put aside a certain amount of money per deal – in my case the bidding was $25k – and say “I’m going to do this over a series of years.” And so I’ve been doing about three deals-a-year sets.

Nick:      Got it. And talk to us about how you first set that basic strategy. What were the main components of it, and how did you look at it going into it?

Gabriel:                So I set that basic strategy… There were never things that went into it. One is, you know, I took the advice and I still believe that, you know, this is a super-risky area. You’re competing on the angel investing side with people who either do it, you know, completely full-time versus your part-time that puts you at a disadvantage, and also people who just start rich and don’t really care about their returns. You know, just want to be in it for other reasons. And so from that you have to understand that it can be super risky, and you may lose all your money. And so you should only be doing it with a portion of money that you’re willing to lose. And so I figured out what that portion was to me and put that aside. And so that was the first thing. Second thing was I’ve realized – and there are some simulations behind this that other people have run – that, you know, you need to do a bunch of investments because it’s really hard to tell, especially at the early stage, what’s going to be successful or not. You obviously fall in love with every deal, but it’s like there are a million things that can go wrong. So you can’t just put all your money into one investment. So I went on the expectation that I was going to do at least a dozen. And so people say you really need to do twenty or even thirty to spread the risk. But the way I calculated was, you know, you really need about $25k to get into most deals. You can get away with lower, and it’s been better with angel less, but I still think that’s probably the right number to get into the deals that you need to get into when that happens. Otherwise some people don’t want to move for you. And so I divided that number into what I said aside and decided that’s going to be about twelve. And then the third thing is, there is this vintage year kind-of concept where, you know, certain years are just better for angel investing than others, even venture in general, because of the stuff in the economy that’s completely out of your control. And so you want to distribute those investments over a series of years. And so that set the pacing. I wanted to do this over at least four years, and so do about three deals per year. And I wasn’t like, “I’ve got to do a deal every third of a year,” but just not try not to do it too quickly or too slowly. So that’s the basics stats of how I got into it. But the other pieces that went into what kind of strategy is, I saw the kind-of Series A stuff coming pretty early, Series A crunch, and decided that I could do well. I don’t have tons of deal flow but I could do well hitting doubles instead of home runs. And so I was looking for things early on that didn’t necessarily have a ton of financing raised, that is after the Seed stage they might be sustainable on their own and get to $10 million to $30 million exit. You know, if things are going well, people are [00:07:28.13] but even on that first Seed Stage, that was a viable outcome. And it worked out reasonably well so far.

Nick:      So you do have companies that you’ve invested in and your portfolio that have reached profitability without subsequent rounds?

Gabriel:                Yeah, that have both reached profitability and have exited on relatively small but meaningful exits to the extent that they only raised a Seed round. And so that thesis, I think, worked out well. I think that thesis… I’ve personally become less interested in it now because as my company has taken off and that’s taking in more and more of my time, the amount of money, you know, the money component of that portfolio strategy is not moving the needle for me. And so I need to kind-of re-think that strategy going forward.

Nick:      And it’s not just a function of getting more money in. It’s also a function of the multiples, the cash on cash, and the timeframe?

Gabriel:                Yeah, I mean, getting more money in would definitely help. I mean, that’s one way to solve it but I don’t have more money to put it in.

Nick:      Yeah, not yet. Great.

Gabriel:                Great. Not yet. So like, yes. A part of it is that. A part of it is, you know, just going for spreading the risk more, going for companies that could do not the billion dollar [00:08:41.00] thing but at least more, you know, could do viably do a $100 million exit. And then the other two pieces of it are, you know, I’m finding those companies more interesting to me personally, and I like to get involved with the companies that I invest in if I can. And I want to see a big impact on the world so I’d like to see companies just do more than get acquired for $10 million, because I think the impact could be greater. So all of those things just kind-of add up to changing the strategy up a little bit what I invest in.

Nick:      When I ask angel investors or venture capitalists for their personal strategy, often I hear stage, sector, theme, geography. Did these factors weigh into your strategy as well?

Gabriel:                So I was kind-of geography agnostic at the beginning. I since kind-of changed that because I really like to be involved and it’s easier to be involved when they’re closer. And I also have a kind-of, you know, I love to see things grow close to me in Philadelphia if possible. It’s like a selfish interest.

Nick:      Sure.

Gabriel:                And so I’ve been looking for things more along here, around here. But I’ve been somewhat geographically agnostic. Stage, I think there is an edge to leading rounds, and if you don’t have a lot of money, that means going really early. You know, being kind-of first money in, helping do a syndicate or something like that. But that’s the only way that works. You can’t go in with little money later, except [00:10:07.19], you know, for anyone. So I’ve tended towards kind-of really early teams I know, geographic. You said stage, geography, did you mention another thing?

Nick:      Stage, sector, theme, geography.

Gabriel:                Oh yes, sector. I was pretty sector agnostic to begin with. I’ve definitely since realized that I add the most value on the consumer side because that’s where my history is. And I’m also most interested in it, so I’ve tended towards consumer a bit more than Beta B, although you know, honestly that’s probably a money-losing strategy. So I’m kind-of sensitive to that and I’m not like hard against Beta B but it’s just like my natural information needs to go towards it, so…

Nick:      Yeah, I specialize more on the Beta B side.

Gabriel:                That’s smart.

Nick:      Well, certainly decisions can be made pretty rationally based on efficiencies, cost savings. I always love the Beta C side with the opportunity for one-click purchases. You rarely find that on the Beta B side, you know, enterprise sales and the sale cycles can be long. But at least you’re hunting elephants, so… So we touched on how your strategy has evolved with regards to geography. Can you also talk about some of the other items in your approach that have changed and evolved over time?

Gabriel:                Yeah, sure. I mean, so we talked a little bit about kind-of the size of the opportunity. I was in a few investments and I have no regrets because the teams were awesome and, you know, they did well. They exited and made good returns, but they weren’t exactly acquihires in the sense that they were acquired and shut down. You know, but they were… because they stayed with the company and they’re still part of those companies today, but they integrated successfully which is fair. But it was still smallish exists. And the founders, in all the cases they were looking at it and saying, “Okay, I’m at a decision point here. I could sell this for a smallish-y exit and make a decent amount of money for myself as life [00:12:08.12], or I could go raise money now and kind-of double down for a bigger exit. I was in the same situation. I didn’t have investors, but I was in the same situation in my last startup and [00:12:21.19] and took the exit. And so it had changed my life and it enabled me to do this startup now, DuckDuckGo. So I don’t begrudge anyone for that decision, but from the investor side – I’ll have to get on a side of the table here – it’s a little heartbreaking, because you’re like, “You guys are pretty successful. This could be huge.” You know. Not only could it be huge financially but the impact, being independent, I think could be cooler in a lot of cases. That’s changed for me a bit. I’m looking for kind-of people who are really committed to not taking that early exit if there’s a credible path to victory at a much higher valuation. And that is really difficult to actually fair it out, because… and maybe impossible, or at least you could clearly ask the question, because it’s hard for people to really know that until it’s in front of them. You know, especially if they don’t have an exit under their belt.

Nick:      Sure.

Gabriel:                But it’s at least something that I talk about now and get a read on. So that’s one area. Another area is, you know, after doing angel investments for five years I know more where I can add value, and I’ve been trying to look for startups that I can add value in. And this is kind-of counter-intuitive to… or counter-[00:13:34.02] to I guess industry practice in a way. I mean, people always say they can add value and that’s how they get deal flow and stuff like that, and that’s great. And that is true, but like Fred Wilson and other people have kind-of commented that the good investments usually don’t touch, and you can’t, you know, screw them up anyway, even if you try it. And the bad investments are where you can add the most value but they don’t really end up being good financial returns anyway. And so this idea of you’re going to go in to add value is sort-of not necessarily a good financial strategy. That said, you know, I’m not doing it totally for the immediate returns in front of me. I’m not a full-time angel investor right now, and I’m actively learning different things. So I like to add value where I think I can learn about things that I like to be involved with founders and see it from their perspective. So I have been more excited about kind-of getting my hands dirty with stuff to the extent that I’m learning. So that’s one that has changed. And I would also try to… related to that, is I don’t really want to work with people closely who I don’t think I, you know, could get along with or who won’t work with me well. And so I’ve tried to tend to know people for longer to invest, whereas at the beginning I was more, you know, in the kind-of angelist model where your C deals come through, you’re participating, and being a syndicate, but you’re not like… you weren’t the first person they went to for money, right?

Nick:      Right.

Gabriel:                A lot of my recent investments, it’s been that. It’s been people I’ve known for a long time who were starting another company and were talking about it together, and I like that a lot. All that said, my main takeaway is, as you’ve probably realized being a full-time angel investor, is if you’re going to be really serious about this you’ve got to be full-time. And I don’t have time to be full-time because I’m running a company. And so, you know, some of this evolving is opportunistic in, “What’s the strategy that fits my current lifestyle and budget?” And that’s a large part of it, just kind-of introspective about what I can realistically do and get done.

Nick:      So I apologize if we’re rehashing anything that we’ve discussed, but you mentioned some key takeaways on your blog, and I’d like to touch on each of them. The first is about being in it for the money. Can you fill us in on this takeaway?

Gabriel:                Yeah, I mean, if you… and I know you’ve co-invested with a lot of people. I am guessing you’re seeing the same thing. But you know, some people are really in it for the money as angel investors and some people really couldn’t care less about the money they’re making back. And, because there’s a lot of other reasons you can angel invest. There’s a status symbol, especially recently. You know, investors are cool. It’s fun. You know, if you were in a company before, you don’t want to run a company again. But you do want to be involved, and so it can be your connection to the scene. You could see it as giving back. All these things are great reasons to angel invest but they have nothing to do with making money. And the problem with that as an angel is, people who don’t care of making money don’t really care about valuations. And you can debate whether you should care of valuations at an early stage or not, but I do. And if you’re competing with people who don’t care about valuations that can be challenging.

Nick:      Yeah, you see the stats on seed investing. Valuation is in the $2 million to $3 million range. And then I meet with startups frequently that have done a C round, and it’s a crazy high valuation, like $10 million plus. And I’m wondering who the investors are that got involved that early, and how they closed at that valuation. But…

Gabriel:                Yeah, and a large reason is the influx of VC’s in seed investing, and just essentially buy at an option for a later series A. And the $500k they put into the seed deal is just kind-of a [00:17:31.06] for their large fund, and that’s kind-of the long and short of it, you know. And they’re buying themselves into it.

Nick:      Interesting. Okay, the second key takeaway you had was about going earlier. What do you mean by that?

Gabriel:                Yeah. So, I mean, if you… the way they get good valuations, kind-of we’re talking about, and get in deals that are going to get overheated later and would be hard to get in, is to get early and be the first money in. The problem with that is, you have to find them, right? But if you can do that and you can find them, there’s a big edge there. You can kind-of set terms. If they’re raising small amounts of money at the very beginning, people are very less sensitive to delusion, so the valuation can go way down because you’re not [00:18:14.06] them that much. And you’re also, if you’re kind-of saving stuff for follow on, you yourself kind-of buying an option if you’re playing it that way, to really double down later, and you already have a good kind-of stake in this company. So I really look to, if you believe in the team, which is a large part of this, because an investor doesn’t even know them for a long period of time, you can really jump in pre-revenue. But it’s difficult because it’s super risky. But that’s been my takeaway. There’s definitely an edge there.

Nick:      Gabriel, you caution readers about the acquihire. What is it and why the caution?

Gabriel:                Sure. I mean, we were talking about this a little bit earlier, about kind-of the small exit, and the acquihire is even kind-of a worse extension of that which is, you know, the company is going along and big company X comes along and says, “Oh, you know, we need some of that innovation. This seems innovative. They have clearly shown they’ve built this product. They don’t have a lot of traction. They’re young guys who probably could use a million dollars in their bank account. Let’s just offer them that and shut down their product, but get them to kind-of inject innovation into our company.” And that is really the acquihire. And so it manifests in what I consider kind-of low-ball offers. And there’s different versions of it. If the company is kind-of tanky and it really isn’t going anywhere, that could be a soft sale, a soft exit, right? And there’s nothing wrong with that. But what I’m cautioning against is, you know, if a company is actually doing well or they haven’t had much chance to do well because they just launched a product – all these opportunities come right after they launch – and the company is going to jump at an acquihire offer, that’s just, you know, not great for the angel investor side, especially if you put a lot of time into helping them get there and are personally, not only monetarily, but emotionally invested in their product and want to see them make a difference. The acquihire is really going to shut that product down. And so I’ve become pretty weary of that and, you know, the way that to ferret that out in the best way I think, what I found is to try to figure out if the founders are really passionate about this idea. They just come with an ideation process but I think this was a good idea, start a marketplace, or did they come at this because they a decade of experience and this is what they see, want to see in the world. If it’s the latter, then they’ll probably scoff at the acquihire and say, “You know, no. I want my product to exist in the world.” And that’s really what I’m looking for.

Nick:      It seems this is only increasing in frequency. I used to work at this large multi-national and we had an [00:20:42.12] group, open innovation group, and I saw over time that the investment in R&D and human capital in our own D was going down and down. And the company was looking for external innovative small companies that were building something great where they could not only acquire the business but also acquire the talent.

Gabriel:                Yeah, and I think that’s apt, and I think it’s just going to increase more as kind-of… my conditions notion of software in the world, you know, is basically resaying what you’re saying, is software is injecting itself into every industry now. And a lot of those industries and companies are kind-of suck in software.

Nick:      Yeah.

Gabriel:                And they have no culture to make it. And so the best way… You know, if they went out to hire software engineers they wouldn’t even know what they’re doing, right?

Nick:      Yup.

Gabriel:                I mean, at least then they’ll have them, but you know, hire innovation, etc. that they need. So I think increasingly, we’re going to see all sorts of companies wanting to acquihire any kind-of startup kind-of in their region, you know. To a big company, what’s, you know $5 million to kind of jump-start this kind of innovation inside the company? It’s like nothing.

Nick:      Sure. And they don’t have a sunk cost of the people, the time, and the investment working on whatever project it would have been for the previous five years, right. So…

Gabriel:                Exactly.

Nick:      Alright, the next item was about opportunity cost for a large active investment. What’s the message here?

Gabriel:                I mean the message is that angel investing, if you’re active, especially very early, it takes time. You’re helping companies do all sorts of things, like raising financing is probably the biggest one. And if you’re a full time angel investor, that’s what you’re doing. You have that time. If you’re me, and running a company, you do not have that time. And so as your portfolio grows, because companies stay around along [00:22:31.15] – that’s one misnomer when people get into angel investing – your portfolio, active portfolio is growing and that takes in more and more of your time. And so the opportunity cost… You realize that when you’re investing in something, that’s going to take some of your time. And to me that has gone way up. And so I, you know, at first when I started I didn’t recognize that there was any cost really there. But now I do. And I think about that. Do I really want to spend time with this company? How much longer do I want to spend with them? There’s lots of ways as an angel investor to do that. I mean, you could just be kind-of passive angel investor – that’s the extreme approach – and not spend any time, or you could be very more strategic about which companies you plan on spending time with and why and how you’re going to get involved with them, and that’s where I ended up. How could I add value in situation? How much time do I want to spend with them? How would I structure it? That kind of thing.

Nick:      I suspect with your background and your domain expertise there is a number of startups that would welcome your funding.

Gabriel:                Yeah, I mean, I have particular ways that I think I can add value, including on the tech side. And so it really depends. I ask, “What are they looking for?” And it really varies across like a lot of startups – I’m sure you’re aware – are very good at one area but are very terrible in others. And investors at the very early stage can help them with those areas they’re terrible at, at least kind-of thinking through how to hire the right person, and stuff like that.

Nick:      The last item you mentioned relates to board seats and party rounds. Can you fill us in on the definition of party rounds and the key takeaways on this point?

Gabriel:                Sure. The party round concept is, you know, someone raises a seed round with lots of different seed investors, but no one really puts in a lot of money and is really leading that round. And so no one’s invested in making that investment work. And the reason it’s called party rounds is, the startup looks cool, everyone puts in a little bit, and it’s like a big party. It’s going to be awesome, but no one’s really the actually kind-of get in there and – I don’t know how to further take this metaphor, but you know – clean up the party when it’s done, that kind of thing.

Nick:      So it just be like, no lead. Just…

Gabriel:                Yeah, no lead is the main indication that there is no party and mainly cause a party round. And the lead could happen in a lot of ways. You know, it could be just someone who is really more financially invested or could involve other things like back lead. They don’t even have to put in the time and money, but they’re committed to take a board seat or their committed to be a real active advisor, like me with a company. Ever couple of weeks there is something like that. But looking for some external person to get involved. And it’s not to say that… I think where this is often misread is to say that, “Oh, companies need to be babysit or they’re not successful.” But I don’t think that’s really it. I think it’s more about having the forcing function of this meeting every couple of weeks or three weeks or something, and some external perspective being injected into the company on a regular basis. It’s just healthy for any company. And so it doesn’t necessarily have to manifest in a controlled permission like a board seat. It could just be, “Okay, this is what we’re going to agree to do, and we’re just going to do it.” And that can involve extra conversation or not. But just the fact of agreeing to doing that and making that a regular thing, I think makes a lot of difference.

Nick:      So good to get this perspective from an angel investor that has experience as a founder and an exit. Gabriel, what other advice would you give to individuals that are new to startup investing?

Gabriel:                If you’re brand new to it, I would advise to get someone else who is not new to it, both either on the investment side or the operator side, and to work with them to invest alongside you. You know, you can join other deals for people who don’t know much of investments. That’s the best way to kind-of get started, or kind-of go into it with a group of people with varied experience. But don’t go off just totally by yourself. The other advice would be, from the very beginning we talked about is, don’t put all your money into the first investment.

Nick:      Yeah. Right.

Gabriel:                Definitely put aside a bunch that you’re willing to lose and go… at least go and make the mental note that you’re going to go into ten investments.

Nick:      Yeah, I think most of the people I’ve talked with say the minimum is kind-of ten. So set aside enough that you can at least get into ten, and spread that risk. Diversify a little bit. Do you have any recommended resources on the topic of angel investing?

Gabriel:                I think the online resources, namely blogs from VC’s and other angel investors, are probably the best out there, and so the ones that are most familiar are good places to start. You know, Fred Wilson, Mark Suster, Brad Feld, and a bunch of angel investor blogs as well. And you can follow these people on Twitter. That’s a good place to start. The venture deals book that Brad Feld wrote, I think is particularly good to talk about kind-of get into what term sheets are and the different [00:27:38.23].

Nick:      Yup.

Gabriel:                Most of that stuff is also available on his blog if you want to just go back and read it there, but it’s in the book form. It’s nice too.

Nick:      Tell us more about the venture and startup scene out in Philadelphia.

Gabriel:                So, I mean, Philly is pretty much, I think exemplifies the broader story in that Silicon Valley – you could call Silicon Valley [00:28:00.14] – it’s coming up in almost every city, and I bet Chicago kind-of feels somewhat relieved. I think this is a natural occurrence, just how easy it is to start a startup and how we’re becoming more global in general. But almost every big city, you’re seeing kind-of a revitalization of the late 90’s, but it seems more sustainable now. And that’s what you’re seeing in Philly. You know we have a lot of accelerators, we have a lot of angel investors. I think Philly has some unique components like any city that makes it a little more kind-of advantage for certain things. You know, we have a lot of healthcare here, and so it’s particularly kind-of good for healthcare startups. And then we have a lot of kind-of Beta B stuff, because we’re like a day’s drive from most Fortune 500 companies. And so we see a lot of kind-of Beta B startups forming here that could do the initial sales stuff themselves with not a lot of travel budget. We see less consumer-focused stuff. My company is an outlier there. And we see a lot of grassroots community. I’d say in that regard Philly’s a little different in that there’s a lot of bootstrapping here. We’ve seen most of our Series A rounds come from external investors – don’t know what it’s like in Chicago – over the last 24 months here, which has been an interesting phenomenon for me to see, in that lot of those companies are bootstrapped really before that, which is just interesting.

Nick:      He is @yegg on Twitter, that’s Y E G G. The blog is gabrielweinberg.com/blog. If you haven’t grabbed his book, Traction: A Startup Guide to Getting Customers, that we discussed last time, I’d encourage you to grab a copy on Amazon. Gabriel, thanks for your generosity and transparency. It’s a big help to those of us that are trying to become better angel investors.

Gabriel:                Thanks again for having me.