John Huston of Ohio TechAngels joins Nick to cover The Exit. We will address questions including:
- How should angel group leaders think about the exit as a part of their investment strategy?
- Not every geographic area has produced multiple unicorns or any unicorns for that matter. Why is this a key factor when considering the exit at investment?
- In the past, your investment group has employed an investment strategy where you establish if VC funding is a necessity or a nicety. Can you talk about how you think about subsequent investment requirements and types of investors?
- Is it the degree to which a startup is capital intensive that determines whether VC funding is necessary?
- During the evaluation of a startup for investment, do you have a clear target acquirer in mind engage with strategics?
- Can you talk about how you engage with strategics to help facilitate acquisition and a startup exit?
- I’ve talked to a number of folks that disparage angels who are exit-focused or for the “”quick-flip””. Why do you think they have this position and why do you believe they have it wrong?
- What advice do you have for early-stage investors regarding exits and how to think about the exit very early-on?
Before we jump in I want to say a big thanks to all of those who voted on the name of our new Angel List Syndicate. The results are in and “New Stack Ventures” was the overwhelming favorite. This was also a great fit for mine and my partner Jeff’s philosophy, so we’re are very happy to announce that the syndicate has been created and is live on Angel List. If you’d be willing to back us that would be great. Whether or not you plan to actively invest, there’s no obligation, it’s just a good way to show support and also monitor our dealflow.
I’ll include something in the newsletter as well that provides some info on how to follow us. Speaking of which, I lost my assistant in late May and had to put the Newsletter on hold until I could find someone to help out. There’s a surprising amount of time that goes into Venture Weekly, publishing audio, doing blog posts and such, so I appreciate the patience with that and am excited to get things going again. So, be on the lookout for the Newsletter tomorrow morning.
1- Four Key Questions when thinking about the Exit
1. What does the company have to look like (ie. what metrics does it have to achieve) in order to have multiple Strategic Bidders with high interest in buying the company?
2. How much capital will it take to get the company to look like that? And is dilutive VC funding necessary to get there?
3. Assuming we could raise the necessary capital to get the company to that point, is the management team capable of getting the company to look like it needs to look.
4. Presume that 1, 2 and 3 are satisfied. So, the goals to get strategic bidders interested are attainable, the management team can get it there and the necessary capital required to get it there can be raised… Is there Exit Goal Congruence? In other words, are the management team and board aligned on the exit expectation? Remember that if the board and founders are not aligned, there will be issues. If the co-founders are not aligned with each other, there will be issues. For John, it’s critical that the key stakeholders agree on the eventual exit from the very beginning.
2- The Necessity of Optionality
We spent a bit of time talking about the ability for a startup to get multiple competing VC term sheets at a subsequent round. Without multiple offers, the startup is really at the mercy of the VC and is subject to the cram-down as we talked about on the episode with Gil Penchina. Optionality is required. The startup with multiple options is in great shape to pursue what’s best for them and most consistent with their Exit goals. The startup w/o options or only one option, really has no options and they take a bad deal or die. They get screwed and their early investors get screwed w/ them.
3- Three Reasons for a Capital Access Plan
1. Allows them to forecast whether they can hit their necessary hurdle rate (IRR). And remember that John focuses on Internal Rate of Return over Return on Investment. The former consider the total return as a function of time. While the later is akin to a multiple and while many investors like to talk about their return as a 5x or 10x, returns can’t be compared apples-to-apples or evaluated for their true merit without considering the time-horizon in which an investment is made. And as John mentioned, this drives one to focus on an earlier exit instead of just a return multiple.
2. Puts focus on whether subsequent VC financing will be required.
3. Exit Roadmap for allocating resources. If you know the acquires and what they need, money will not be spent in areas that provide no accretive value.
Tip of the Week: Startup Quality & Investment Quality
Nick: The one and only #John Houston joins us on the program. He’s chairman emeritus of the Angel Capital’s association and is also the founder and chair emeritus of #Ohio TechAngels. John, I think just about every Angel guest I’ve had on the program has suggested I get you on. So it’s a huge pleasure to have you and I appreciate you making the time for us today.
John: Well I’m looking forward to our conversation.
Nick: John, can you start us off by talking about your background and how you got your start in Angel Investing?
John: Actually, it’s a little boring. I was a commercial bank of for thirty years, retired at fifty-five flunk retirement. After being on the side-lines for a year, really miss deal flow of. Thought I’d join the local angel group in Columbus Ohio. Found out there wasn’t one so I thought, “Wow! Here’s my retirement project” and I started the Ohio TechAngel. That’s about it in a nutshell.
Nick: Wow! So what did you, sort of your investment track record look like for that first period of a year or so?
John: It was dismal and dreadful on almost every level because I was afflicted by thinking I knew an awful lot about risk. In my thirty years as a commercial banker, I spent about half my time as Chief Credit Officer on the risk side and the other half, not counting when I was bank C.E.O. The other half was really as a Commercial Lending Officer so I thought I knew all about risk. Then it took me the first five years of Angel Investing and I’m in my fifteenth year now to realize that this doesn’t involve risk. Risk is mere child’s play compared to what we do in Angel Investing. This is all about uncertainty and it did take me five years to parse the difference. Once I figured that out, I really started to enjoy it an awful lot more.
Nick: Were you active early on in terms of volume of investments?
John: Between fifty and sixty companies in my personal portfolio, I haven’t counted recently. I’d guess fifty-five and I originally started out solo Angel, saw as much deal flow as I could see across Ohio; wrote individual checks. Soon realize that’s an awful lot of work to be a lone wolf and do all your own due diligence and that’s one of the things that spurred me to pull together a group where we would have much broader expertise available and that’s what led to the Ohio TechAngels which we launched in 2004.
Nick: Yeah, out of curiosity, how was the size of that group when you first launched and how did that sort of progress over the next few years?
John: We started with fifty Nick, initially for a first fund and now the Ohio TechAngels investing now their force fund and have three hundred forty members across all four funds.
Nick: Wow! That’s a pretty good size angel group.
John: Yes, by body count so to speak, it is one of the larger but then keep in mind, each fund itself is limited to a maximum ninety nine investors and we’ve tried to attract new blood if you will or more precisely, new check books with each fund that we launch. So, by design we’ve tried to have a large group and increase the size with every fund we launch.
Nick: Absolutely. Well, look forward to potentially getting #Parker or #Michael on the program to talk more about some of that but today’s topic is Early Exits. So, clearly in the past you’ve been chairman of the ACA and I’ve also led one of the most successful angel groups from a return standpoint. In previous episodes John, we’ve covered angel groups and a number of topics related to angel investing but can we start off the discussion today with your take on how a leader should think about strategy and objectives?
John: Well, I think it starts with the decision of whether or not you want to appear pretty mercenary by focusing on analysing with every possible investment. So, tell me again in whose hands this company will have the greatest value and I guess that’s a nicer way to say, “Tell me about the exit…” but we’ve seen a lot of groups that focus much more on really exciting science, great ideas, game Changers, transformational teams, all the usual but I think angel group leaders have to out of the chute, decide how much they’re really going to focus on returns and if they’re going to focus on returns to just build a great company and hope someone buys it at a nice price tag provide you your return hurdles, I think that’s placing far too much reliance on hope. In fact, my view of the evidence is that certainly can happen but it can happen swiftly enough, so the angels can recycle their capital and continue to build their portfolio. So I would say the an issue of decision an angel group leader has to make is, how much should we boldly go into focus on trying to get our money back with a multiple as swiftly as possible or are we just going to try to fund great ideas and hope for the best?
Nick: With regards to some of these compelling technologies, new innovations maybe reinventing a market or establishing a new market, how does one reconcile this focus on early exits and identifying a strategic acquire when maybe it’s an ill-defined market or there’s not a existing set of strategic acquirers that can be targeted and identified at a very early stage?
John: Well, I think there are two steps. The first step is to decide that you only want to invest in companies that will be attractive to what we call ‘targeted strategic’ bidders as opposed to financial buyers. The problem with financial buyers, and this reflects my banking background when we did L.B.O.’s or M.B.Os or whatever you choose to call them, where you could leverage the companies up based on a multiple of EBITDA and a lot of financial buyers of course, look at companies acquisitions from the perspective of, it needs to turn their dials being a creative website but the problem with that in angel investing, it just takes so much time and so much money to build a meaningful EBITDA so that a multiple of EBITDA can hit you return hurdles. So the first thing you have to take in my opinion, is to just decide where not going to invest in companies where the management team defines their success as selling to a financial buyer who will pay a multiple of EBITDA. In our own case, one of the ways we did that is we set our internal hurdle rate at a fifty-eight percent internal rate of return. So, Ohio TechAngels hasn’t or never really invested in a company where we couldn’t adequately lie to ourselves that it was possible to get a fifty-eight percent internal rate of return. We can discuss why it’s so high and how that works but it was quite clear that if that’s the goal and since it’s notice an I.R.R and not an R.O.I, the I.R.R focus really drives you an earlier exit rather than an exit in ten or twelve years. So that’s the first thing; have our hurdle rate, focus it based on I.R.R and that will almost definitely call out Companies that Think their exit is too Financial bidder.
John: Then the second point of course is to figure out, “Well, who are those are strategic bidders in whose hands my venture will have the greatest value?” and that’s where the real art comes in. Particularly when a lot of the companies are in industries that didn’t exist five years ago. So, that’s what makes this so much fun, to try to identify what is going to be happening out there, who this successful bidders will be and why you have company will really increase or dovetail with their strategy.
Nick: John, with regards to potential exit size and potential I.R.R., not every geographic area has produced unicorns or billion dollar plus exits. Why is that a key factor when considering the exit at the investment stage?
John: I think it’s important in life in general to fight hope with evidence. We all hope that we’re going to invest in unicorns and have gargantuan exits but if you really look at the evidence in your backyard, wherever that is, you should be brought back down to earth and understand how high the odds are that that’s not going to happen. I mean, just thinking of the Ohio land scape, we’ve not had a unicorn and all the unicorns that I’m aware of and that count Nick is what, over one hundred thirteen recently? The unicorns seem to all have been funded by the major V.C…
John: …and so if you’re going to unicorn hunting, you have to first of all be able to back teams that can attract top tier V.Cs and then secondly of course you have to hope that they can attract so many of them that the term sheets are competitive and you don’t get crushed in a down around. So, I think it’s very important for angels to look at their backyard, see what the evidence it is, what the history has been and then ask yourself, what really is the likelihood that this particular idea or adventure will hit one hundred million dollars in revenues in the first three years for instance or five years? The experience in Ohio is, we don’t have that many companies successful in hitting twenty million dollars of revenues in three years and if you can’t do that, it’s unlikely you’re going to become a unicorn faster than ten years and that’s time horizon is far too long for most angels who want to recycle their money and help more companies.
Nick: I assume this is why you’ve established an approach toward early exits and sort of securing in planning out what the investment horizon could look like for a start-up and who those strategic target bidders may be?
John: Yes, specifically and we always ask this question before we would ever let them pitch to our membership, “Just tell me why somebody wants to be the high bidder to own your company? I mean, is it your installed base marquee customers, your IP, your idea?” EBITDA is the wrong answer 10:22 (loop) team and if you start thinking about that, then you can hone in on the likelihood that this team will be able to build a company to look like that. In other words, there are five basic questions in our opinion which should be asked with every deal and the first is, what’s coming have to look like so that there are multiple drolly and salivating cash bidders wanting to be the high bidder to own your company?; and when I say “What does it have to look like?” I mean, is that installed base 10:53 (unclear) odd ball, whatever it is. The second question is, how much capital does it take to get the company to look like?; and by capital, I really mean dilutive or a non-dilutive of and of course the 11:04 (unclear) question there is whether or not V.C. funding under the dilutive category is absolutely essential. So, the third question is, let’s presume we could raise that amount of money for this company, could this management team get it to look like that?; and then the fourth question is, presume we raise the money, they get the company to look like that and there are multiple bidders. Is the management team and the board aligned to actually have a lucrative exit and is there any evidence to suggest they’ve done it before and understand the exit drill and if not then tell me again why I’m investing in this company?
Nick: If you can’t get your return of the end of the day then it doesn’t really matter how interesting the opportunity is.
John: Yeah. The most important thing to me an initial chat with any entrepreneur is I want to ferret out exit goal congruence. Clearly their goal is to figure out what I need to hear so that I will be supportive. My goal is to not reveal that but to have them reveal what their definition of successes and in Ohio, it would be unlikely that they will be able to put one hundred million dollars in their pocket. The exits in Ohio, if you were to count in terms of numbers, the most common exit ban is twenty to fifty million dollars and that certainly is never going to put tens of millions of dollars in the entrepreneurs pocket book. So, exit goal congruence or to say another way, a realistic understanding of what the final outcome might be for the founder and the team is really essential going in. I think it’s a travesty when angels don’t interrogate entrepreneurs for what they think is a possible outcome for them because to let them think it’s going to be one hundred million dollars and drag their families if they have one, through an awful lot of intensity telling them it’s one hundred million dollars and to walk away with three to five, we’ve done a disservice to their entrepreneur and the team. The reality is, it’s more likely they’ll only walk away with five to ten million dollars, not one hundred. So that’s what goal congruence is, for me extremely important or exit goal congruence and reality based on other outcomes at least in our marketplace.
Nick: Yeah and I want to touch on can groups between investors in a second here but something I’ve noticed recently in meeting with entrepreneurs is that sometimes the congruence between co-founders is different where I get one co-founder that maybe he’s got a family and very excited about maybe a strategic acquisition in the eight digit range. Whereas, the other co-founder is thinking billion dollar unicorn, I.P.O. Have you encountered this when it comes to the teams and not having that congruence on goals and exits amongst the founding team?
John: Yeah, we’ve encountered it far too often and I hope we’ve avoided all of those. As you know Nick, there are things you can do such as vesting founders shares to really defend against that terrible thing called ‘stranded equity’ where you have a co-founder who left the team, usually and discussed…
John: …but yet has a significant ownership but while there are things you can do Nonetheless, exit goal congruence is probably three times as difficult when you have two founders.
Nick: Right. So, jumping over to the investor side of that, I know in the past that your group has employed an investment strategy where you establish if V.C funding is a necessity or a nicety. Can you talk about how you think about subsequent investment requirements and types of investors?
John: Sure. If I could only ask one question after I’ve established there’s enough exit goal congruence for me to get interested, if I can just ask one question of every entrepreneur in other proverbial city on the island out there having to make investment decisions, it would be. Can I have a lucrative exit without V.C. funding or is V.C. funding an absolute necessity for an exit?; and the reason that’s essential is again going back to at least what our group is trying to do which is build entrepreneurial wealth to benefit Ohio by growing more high tech, high paying tax paying jobs. That’s very much of the core of our mission and to accomplish that mission, we’re quite concerned about the care and feeding of entrepreneurs and for instance, if I’m looking at a deal and I know the entrepreneur just doesn’t have the background, the presence, the intensity to ever really raise V.C. funding, they just won’t pass muster and yet for their idea V.C. funding is absolutely a necessity, I think I am committing a profound nasty blunder if not downright mean action steps if I for proceed forward knowing that after the angel round it’s going to be let’s say a three to five million dollars or larger V.C. ground and this founder won’t continue in the saddle and so that is the most important reason why to V.C. or not to V.C. is really a big question.
Nick: So in that scenario, that would be a situation where you don’t believe the C.E.O. would be the right fit once they get to sort of that gross stage and you want to disclose that up front and be transparent?
John: Well, we don’t feel great saying, “You’re not fundable. Your baby’s beautiful but you’re an ugly parents and you’re not fundable…” but we really do hit very hard and try to assess through our due diligence team whether we think there’s a basis on which this founder really can pass muster in the V.C. community and there’s another reason, not just because we care about our entrepreneurial community. The other reason that we want to know the answer to, whether V.C. funding is a nicety or necessity is because clearly if there can’t be an exit without V.Cs that a very thick additional layer of risk because not only do we have to have the company perform so that it can attract V.C. funding, it has to form at such a level so that it can attract multiple term sheets. So, the angels have some hope of not getting crushed.
Nick: With regards to V.C. funding being a necessity, is it the degree to which a start-up is capital intensive that determines whether you think V.C. funding is going to be necessary downstream?
John: Yes, absolutely. If you look at our life science portfolio, we’ve never found a life science company that could tell a credible exit pathway story that didn’t involve multiple V.C. funding rounds and obviously we are not opposed to V.C. funding rounds because we invest in life science companies and the issue is not the V.Cs are bad. They’re only bad if the angels didn’t know from the outset that they would absolutely be needed. Conversely, we love that case where a company performs well and we didn’t think V.C’s would be needed for the exit but to really now Optimize the idea V.C. funding is necessary. That’s great but that’s an example of a nicety as opposed to a necessity. If you look across all of our failures the real commonality is it died for one of two reasons: First of all, they ran out of cash or secondly the team got tired. Why did the team get tired? Because they were sick and tired of being turned down in their fundraising effort. So, it just comes down to what kills these companies is lack of money and the more money they have to raise, the larger the financing risk. Defined as their ability to not just perform but actually raise it and raise it on terms that incinerate angels economic. That’s really the concern. We have a great number of companies that have been successful in raising V.C. capital just as planned. Unfortunately, too many of those were raised on a basis where our economics totally evaporated which was not to suggest it won’t grow into a truly great company but we already know it is now and absolutely a lousy investment for the angel Conduit and that’s what we’re trying to avoid. Frankly and speaking personally, when I lose all my money, I expect that a lot. I don’t get grumpy at all. I’d never write a check that I ever expected to see again or I’d never sleep again but what really makes me cranky, is when I write checks, help build a great company, people come in after me in the V.C. community and it does become a great company and there’s a fabulous exit and I make no money, that’s more upsetting to me than just losing all my money because I’ve spent years and years watching the company and the end of the day due to the preference stack and the fact that the V.Cs drive the exit, I really don’t enjoy building great companies that are the investments.
Nick: So is that the fault of lack of preparation on the front end with regards to terms and in protecting the investment or is that the V.C’s doing some sort of shady engineering on the funding side that can water out an angel’s position regardless of what they’ve done to try and protect themselves?
John: Well first, I love V.C. I would comport myself exactly the way they do if I were one of them because my loyalty would be to my L.P.’s. They’re doing all the right things and I don’t begrudge them about their behaviour whatsoever. When they are able to come in and take advantage of the angels which is exactly what they should be doing to benefit their L.P.’s returns, then it is the fault of the angels and management that enables them to do that because the company has not performed at a level sufficient to get multiple competing term sheets on a basis that doesn’t destroy the angels economics. So I’m not disparaging V.Cs whatsoever. I’m just saying that it’s quite disappointing when you see a company ends up being successful but because they were unable to raise capital on a basis that preserves economics, it’s a really an interesting investment.
Nick: John, you’ve talked in the past about the capital access plan and how that’s a mandatory part of due diligence. Can talk a little bit about what that means?
John: Sure. I stated that we use a fifty-eight percent internal rate of return hurdle rate and we couldn’t possibly calculate if we could hit that if we don’t address the most important factor that hurts our economics which is dilution… Of course putting aside being crushed to common. Let’s just presume everything happened as advertised, we need to understand as I said earlier, how much capital is this company need to get to an exit and that’s what we model and what we’d call a capital access plan and the capital access plan simply says that, as an example, we’re going to raise a two million dollar Angel round and old get us to survival cash flow break even and then really step on the accelerator and raise a five million dollars V.C. round at a twenty percent uptick in price and then we think the company will hit the ten million dollars of revenues that we think is essential before any of the targeted or strategic bidders will be interested. If you don’t do that and estimate the follow on capital and play around with what the impact of an uptick or downtick in evaluation, there’s no way you can calculate whether there’s a scenario in which a fifty-eight percent or whatever hurdle rate you like internal rate of return is achievable. So, it’s a capital access plan that does two things. First, as I said it enables us to at least guess whether we could possibly hit our hurdle rate and then secondly, it puts great focus on the question of ‘to V.C. or not to V.C.’. In a round terms in Ohio, we can pretty routinely race three to four million dollars among the angel community in multiple rounds but when we look at a company that we know can’t have an exit unless it raises more than four million dollars of capital. Across Ohio, we all tend to think that puts us into V.C. land which is not a kick out factor, it just now adds that other layer of due diligence like, can this team raise a venture funding?
Nick: I’d imagine that a pro rata would impact that capital access plan, have you traditionally sought out in secured pro rata rights and then use them in subsequent rounds or has that not been a part of your angel strategy?
John: Oh, from day one back in 2004, we’ve always demanded that we have pre-emptive rights or pro rata rights or however you want to call them which does not mean that they’re always respected because the only defence against being brutalized by 3:33 (unclear) founders is dry powder. If you have investor fatigue, even if they have the ability to continue to write checks, they don’t have the willingness, then you’ve just got to admit or put up with whatever happens to you because the new investors are out obviously. They’re worried about their returns and not yours, so they’ll take advantage of you as they should because you’re out of gas.
John: So there’s nothing in my opinion regardless of what comes to mind when I tell you, there’s nothing I’ve ever seen in any documents that protects me against being brutalized when I am out of money and more money is needed to keep the company afloat.
Nick: Got to reserve some capital just in case, right?
John: Yes and at some point angels, most angels in Ohio at some point run out of their allocation for each one of their investments and so we know going in that if the company requires an awful lot of capita and we cannot all provide it and we need to rely on venture capitalists, then that’s additional layer of risk that I referred to. It’s not as simple as, “Can the capital be raised?” It is, “Can this team raise capital on a basis it doesn’t destroy my economics?”
Nick: So John, during the evaluation phase of a start-up for investment, do you have a clear set of target acquires in mind? We touched on this a little bit before but I’m curious if you actually identify those upfront and then let’s say post investment, do you as an investor engage with those strategies and sort of facilitate discussions between the start up or has that not been included in your past activities?
John: Well, first of all, we’ve rely on the board of directors to really orchestrate the exit in situations where V.C’s are going to join the captive and we want a board seat in every case and as you know so well Nick, most of these start up boards are basically a two-two and one to common to preferred investors in one dependent for five person board. So, we would very much like to have one of those preferred seats. We only buy preferred stock if you buy SES corps that qualify for USVS tax treatment and we hope that the other preferred director is also quite the student at driving exits. So from a valuation perspective initially, what really drives it for us is whether or not the deal can be syndicated because our group just puts three twenty five from our fund in the initial round on the first checked we write and we usually get a few hundred thousand dollars of side cars from our members but most of the rounds in Ohio are one and a half million dollars you say on average. So, we clearly have to syndicate with other investors angel groups mainly across Ohio and they all know what the market terms are and that pretty much stipulates what the terms and conditions are going to be and a very narrow band of valuation. So the issue is not so much we can set the valuation in a vacuum. The issue is a) most of the deals are syndicated and we have to really set the valuation that the market will take and then secondly having been in business you know, over eleven and a half years, we’re very concerned that we provide some consistency in terms of our current investees. So, if someone were to deal an evaluation that was grossly outside what we’ve done historically for others, we would feel uncomfortable. Now, we’d feel much more comfortable if we had any evidence to suggest we can pick winners but I’m not seeing much evidence to suggest Angel group consistently pick winners and therefore this one I’ll give an eight million dollars free money evaluation to and that one I will only give a two million dollars free money evaluation to. Although I’d like to think we can pick winners, you know the evidence is all little scanty.
Nick: It’s a little scanty but I have seen some reports on Ohio Tech and pretty good I.R.R figures for that particular angel group.
John: Well, thank you. I don’t want to get into the specifics. You should really talk to #Parker 7:41 (unclear) are running the group now.
Nick: So I’ve talked to a number of folks that disparage angels who are exit focused or for the quick flip. John, why do you think they have this position and why do you believe they have it wrong?
John: Well, I think they have the position because they don’t understand it and that’s why they’re wrong. The right way to look at it does not, that the only action is a quick flip. The right way to look at it is through the lens of optionality. I’ve never had anybody convince me that it is better to have no options and it is to have multiple options and so the advantage of starting at the outset from identifying what are the alluring aspects of your company you’re going to build that make you attractive in the eyes of the most likely targeted strategic bidders. So that maybe they will want to acquire you and provide your investors a lucrative return. I’ve never had anybody tell me that ‘hope and pray’ are better strategies. Just build a great company and somebody will of and surely by you. That happens all the time but I don’t see how that suggest having a plan. Whether or not you choose to execute it when you get indications of interest. I just don’t understand how having a plan is an inferior approach to no plan, hope and pray and just build a great company.
Nick: So by increased optionality you mean having multiple strategic bitters that are interested in buying as well as the option of continuing on and potentially not accepting a bid but proceeding toward maybe an I.P.O. or a larger acquisition at a later stage?
John: Exactly right. I mean, there’s nothing as great as having people being highly interested in you and you being uninterested in them because you don’t need to exit now. You think that there’s much greater growth and value down the road but that’s an awful lot better situation than having nobody calling you and being impressed; and the other issue that I’ve always found quite interesting is the value that an exit roadmap provides in terms of allocating resources. As an example; If you know who the most likely three to five strategic bidders for your company will be and you know how you would fit within their strategic portfolio, you should think long and hard before you should spend an awful lot of resources replicating all of the assets that they currently have. It tickles me for instance, if you think in this real days even, you think back to web van that flushed about a billion dollars building warehouses. Everybody who was ever going to by web van already had warehouses and as an example in our business, to build parts of your team that you know will absolutely not make it through the acquisition or the merger, the team merger, the beauty of a roadmap is it makes you think long and hard whether you are building strategic value in the minds of the bidders. So it’s a resource allocation discipline. The goal is not to build shareholders value, that’s a mere accounting contrivance. The goal is to build buyers value and if you look at it from that perspective, then how you spend your money or how you should spend your money or more importantly what you should not be spending your money on because it has no value to the buyers and that becomes much clearer in focus. You know, which is not suggest you have no sales people because they have sales people but you understand very simplistically that why would you build any sort of software that you could get much cheaper or that they also or don’t have own proprietary from that perspective. So it’s a resource allocation discipline. That’s what we like about it.
Nick: So with this focus on the T.S.Bs. that target strategic bidders from the outset, I used to sit on the table of the strategic acquirer. So are you guys studying acquirers in those verticals and figuring out what is most important to them and what sort of multiples they’re paying for companies in the sector?
John: We aren’t doing as much of that as we would like to because we feel the bankers can keep us apprised of that and they have better data bases than we probably can afford. So, while we’re a tune to it at a high level, we aren’t spending an awful lot of time taking deep dives with all the target of strategic bidders, particular early on because the game will change so much over the next three to five years.
Nick: So, what advice do you have for early stage investors regarding exits and how to think about the exit very early on when they’re in the investment phase for a start up?
John: Well, the most important painful lesson I’ve learned is to try to avoid falling in love with really big ideas, great science and all the wonderful startling technologies that are out there and focus first of all on, ‘can this be a great investment not just a great company?‘ and a great investment often means it’s going to be capital efficient and that’s why I’m not a big fan of those folks out in the hinterlands such as Ohio chasing unicorns. There’s no question number of the Unicorn are just amazing companies and what they’ve been able to pull off but a great number of the investors are still donors but I define find a donor as any investor who hasn’t gotten any cash back as yet and until and until the exit, Angels are always just donors. Rarely do we have the opportunity to take some of our chip off the table so, I view myself a donor until exit. I only become an investor maybe, hopefully if I get some money back and that really means I should try to avoid being mesmerised by the really big exciting ideas if I am not convinced that they also can be a great angel investment.
Nick: John, can you talk about some of the things you’re currently up to and what you’re most focused on.
John: Sure. My number one focus is to figure out how to get better at the craft of angel investing. I think having spent my life in finance, it is in my opinion the most exciting aspect of finance and business. It is the toy store of finance and the reason I said earlier is because it involves uncertainty, ambiguity and randomness and not mere risk. To say it another way, the analogue for mere risk is gambling and that’s child’s play. You drop a ball in the roulette wheel. If it’s a true wheel, to greens, it pays five point two six percent in the house like clockwork and that’s an example of risk but uncertainty is you drop the ball in the roulette wheel, you don’t know this out on. You don’t even know the distributions of outcomes and the analogue for uncertainty in my opinion is warfare. We’ve never been able to handicap warfare If you look throughout history and of course I spent five and half years in the Navy so I have some affinity to military history but there’s just been so many times that in a particular battle the inferior force wins. You have some hero or that general get shot off the horse and as I said earlier, it’s very comforting to me to look at this as uncertainty, ambiguity and randomness. Comfortable spot playing very, very large parts and roles in our outcomes rather than mere trying to partially analyze quantify risk. So, that’s why I love it so much. It is really the most intellectually stimulating thing I’ve ever run across.
Nick: John, if we could cover any topic in Venture what topic do you think should be addressed and who would you like to hear speak about it.
John: I don’t know who I will like to have speak about it. There are so many big names and you’ve had many ready that you’ve interviewed but what really intrigues me is if you are willing to agree that there’s an awful lot of both luck and uncertainty involved, then how does one really get good at this craft? #Michael Mobius has done some of the best work on this that is parsing skill versus luck and that is an interesting topic to me because I think we all know a great number of angels who have had huge home runs that they never could ref and as Mobius has said it’s really fascinating. You know, that there is no skill involved if you cannot lose on purpose. So I’m intrigued by the role that luck plays in angel investing and in venture. I’m intrigued by how we are victims of the extremely long feedback loop. Often when you have a lucrative exit, you look back and you’re in the investment five to seven years and all the factors that enable to be successful no longer exist. So, what have you really learned that you can replicate? I’m quite intrigued by that and I think the reason so many people don’t take on angel investing as a skill to develop. They’d rather just have great outcomes and hope for the best as opposed to figuring out what they can do to increase their odds of success.
Nick: Well, hopefully we’re on the right side of that position with the show here but John just to wrap up here, what’s the best way for listeners to connect with you?
John: Email is best: jh at ohiotechangels dot com.
Nick: Okay. John, thanks so much for coming on the program. As I mentioned before, everybody has mentioned to me that I got to get you on the show and I’ve been looking forward to this moment for over a year now. So, really appreciate you making the time for us and sharing your wisdom.
John: Thanks Nick. Hope our paths cross again soon.