How Angel Investors Survive the COVID-19 Economic Crisis

Blakiston Owl: We need the wisdom of an owl in times like these. (c) Rosen Photo

Author: Dan Rosen

To: The Angel Community

After publishing my companion piece, “How Startups Survive the COVID-19 Economic Crisis,” I have received a number of comments about how this impacts angels and angel investing.  Here are my thoughts.

Unlike VCs, who have a fund to invest and collect a management fee for investing their fund, Angel Investors invest their own money and are under no pressure to invest in any company or at any time.  Our decisions to support a startup are totally our own.  As in previous market downturns, there will be some themes that help us through our investment decisions during the COVID-19 pandemic and the resulting economic crisis.

Angels have limited funds.  And many of us already have extensive portfolios.  We quickly will be (or already are) in the position of getting funding requests from many of our portfolio companies for new rounds of funding.  Some will make it, and some won’t – even great companies with fabulous ideas will fail when the cash dries up, and sometimes Angels alone can’t provide sufficient cash to carry them through.

For Angels, this is a good time for both investing and tough love.  Great companies are often started in market downturns.  I believe this is because only the most dedicated entrepreneurs (the ones that feel absolutely compelled to create their new company) will leave a stable, good-paying job in the middle of a downturn.

My friend and colleague, John Huston of Ohio TechAngels, commented on the last two recessions: “One strong recollection I have of those periods is that CEOs (with a strong BOD) who most effectively & frequently communicated their parsimonious plans to use the emergency funding were helped and survived.”  An inexperienced entrepreneur might neither have the experience nor the tools to manage their impending company crisis; we as knowledgeable Angels and mentors and board members can draw on the experiences we have faced as investors in those previous cycles.  It is our hour to shine and help our startups survive and thrive!

Here are my rules for Angels during this downturn:

  1. Stay in the Game.  I know that our public equity portfolio is way down, but, most likely, you aren’t bailing out while the stock market is down.  Same is true of Angel investing.  Stay in the game.  Keep reviewing companies, meeting with entrepreneurs, etc.  And be prepared to invest in both some of your existing companies and some new ones.
  2. Be highly selective.  Most Angel investors are always selective, but this is the time to turn your filter even higher.  Funding is even more limited than it was a few weeks ago.  There will be lots of great opportunities, both in your existing portfolio and new ones.  So, take your time and invest with care.  The funding requests will vastly exceed your ability to invest!
  3. Work in a group or a team.  Angel groups (or groups of Angels) can help a lot, both in terms of assessing deals and in making sure that there is a sufficient pool of capital and expertise to help companies succeed and thrive.  In stressful times like these, this is even more important.  The Alliance of Angels has survived the 2000 (dot com crash) and 2008 (mortgage crisis) downturns, with a group IRR of over 20%.  Angels and the startups they support can really benefit from that institutional wisdom.
  4. Be ruthless.  All Angels investors have their favorite companies.  We want them to succeed.  This is the time to step back and realistically consider the probability of success with limited financing.  Advise your existing companies to conserve cash and focus on how to help their customers.  (See my companion piece.)  You may think you are helping by keeping a portfolio company alive, but make sure that their plan is reasonable to actually survive – tough love.  Some of your portfolio companies will not survive – even great companies will die from running out of cash and runway.  But it is likely that some good ones will come through this crisis even stronger and give a better return than you expected.
  5. Multiple financing rounds.  This is a time to avoid companies whose plans require multiple rounds of financing with large cash needs before they can turn cash-flow positive.  I’m not saying to sub-optimize the outcome of great companies.  But for at least quite a while, it is likely that cash will be tight, and it will be difficult to raise money.  Companies that are frugal and can make the most out of the Angel cash have a much higher probability of giving you a return.
  6. Deal terms matter.  This is a time for resets.  Both Angels and entrepreneurs need to reset expectations.  The world will recover, but it is likely to take a while, so make sure that the terms on which you invest are in synch with the market and the projected future.  Resetting valuations to match today’s reality is a must.  If you agree to too high a valuation, the company will have trouble both attracting enough investment now and, particularly, more investment at the high post-money valuation later.  Watch for other terms, like liquidation preferences, that can lower your return.  And, for a less experienced CEO, do not be afraid to have some protective provisions, e.g., the company can’t exceed its budget without the approval of the investors or investors’ rep.
  7. Be careful, but not greedy.  As Angel investors, we invest for the future and to give back.  It is OK to be careful, ensuring that the return you get is commensurate with the now higher risk you are taking.  But don’t be greedy and ask for large multiple liquidation preferences, too much of the company, or asking the entrepreneur to throw all their energy into the company without retaining a big enough stake.  This is a time when we want a “rising tide to raise all ships.”  We are in this together.
  8. Exits.  In the short term, not many exits are likely to occur.  Unlike VCs, Angels can do well with modest exit valuations (provided that the initial valuation was in line with reality).  Entrepreneurs can also do well with a modest exit.  Make sure the entrepreneurs in which you invest are on the same page – look for early exits, even if they are more modest.  You want entrepreneurs who want to be rich, rather than becoming a king!

We are in a challenging period.  It is natural to want to pull back.  As an Angel investor, this can be a good time to both maximize your current portfolio and find some new fantastic deals with fantastic teams at reasonable terms.

How Startups Survive the COVID-19 Economic Crisis

Iceland Sunrise and Sunset

Author: Dan Rosen

To: All angel investors and their portfolio CEOs

Being trained as a scientist, and having lived through several investment cycles, I’ve been asked to share my perspective on the financial impact of the COVID-19 pandemic on startups.

I firmly believe that the human and societal impact of COVID-19 will be extreme, even though we are at the early stage of this pandemic.  If we, as a society can pull together, enact social distancing and other means of delaying the spread of this virus, we can come out of the other end of the tunnel.  Most people really don’t understand the concept of exponentials – it is not in human nature to grasp what this means. 

As a scientist (a biophysicist at that), this kind of modeling is something I was trained on early in my career.  At this point, suffice to say, that we cannot prevent COVID-19 from spreading and our best hope to minimize the impact is to (a) lengthen the time it takes to effect a substantial portion of the population; and (b) prepare for the impact that will have.  The key right now is to ensure that our medical system is not overwhelmed by this impact.

In 12-18 months, I expect that we will have a viable treatment for those with the disease, a working vaccine and that a large enough percentage of the population will have developed immunity through recovering from being exposed to the virus.  The combination of the herd immunity and a vaccine for the most vulnerable will potentiate the impact, provided that we can wait it out through mitigation measures in the meantime.

I went through this detail because the depth and timing of the disruption will have major impact on the startups we support and fund.  A deep and shorter disruption might actually be more severe for both our society and our companies, so let’s pray that our remediation response works.

For startups, this will be a particularly difficult time.  In the recessions of 1982, 2000, and 2008, funding for startups dried up. While many have heard me say that great startups are often created during market downturns – sometimes, easier said than done.  So here are my suggestions:

  1. Survive.  This is pretty obvious.  If you don’t survive, there is no upside.  So all of the strategies below are about survival.  It is time to put aside the wonderful plans to become a huge company with world-beating products.  None of this matters if you don’t survive.
  2. Cash is king.  Startups don’t generally die for a lack of ideas.  They die because they run out of cash.  Put in place a plan to conserve cash.  Be aggressive in this plan; early action will be much more impactful than later action.  Have at least 12 months of cash on hand, because it is likely that is what you will need.  Even if the COVID-19 crisis resolves itself much sooner than that, the turmoil left in its wake will persist, particularly for startup.
  3. Forget about raising money.  Angels will continue to invest, but expect smaller rounds, at lower valuation, in companies that don’t require large amounts of cash.  For existing portfolio companies, the sudden downturn in the market, coupled with the disruption of almost all business as usual will cause fundings to stall.  While VCs and angel investors might have cash to invest, the pullback will trigger a triage mode (as it did in previous downturns), where investments will be in select companies.  Even some good companies won’t get financed.  Assume that this pullback will last till after the COVID-19 crisis is over and add a few months to that for them to get back on their feet.   M&A will dry up; if you were in discussions last month, expect that nothing will happen until this crisis ends.  If you are lucky, you might get your existing angel investors to help carry you a bit, but expect it to be really costly and only if you have a plan to make the money last a long time.  And, as I believe is always prudent, communicate well with your shareholders, giving them the bad news and the good.
  4. Revenue is likely to be curtailed.  If you are counting on contracts in the pipeline to close, you shouldn’t.  Most big companies, government clients, and especially small and medium businesses will also go into survival mode.  Unless you are supplying a product or service that they consider absolutely mission-critical, you should expect that revenue will be deferred for at least 6 months and probably longer.  If you existing contracts have cancellation clauses, expect that some will be exercised. 
  5. Opportunities.  If you have a way to shift some or all of your business to be part of a solution to the COVID-19 problem, stay alert to do so.  For example, even as GM is closing plants, they are looking at how to make ventilators and respirators.  While there will be great economic dislocation that effects small and large businesses, there are still some opportunities, especially for direct to consumer businesses.  People are sheltering at home and online a lot.  If you are selling something that will make their lives better during this difficult period, there are opportunities.  Examples might be things like online learning or classes, online consulting, or even things that bring a smile in these difficult times.  Similarly, any product or service that makes working from home easier will have a ready market (if your customers can find you online).
  6. Downsize.  While this is a really difficult decision, survival is the single most important thing.  Many companies will have to pare back to the essential.  Salaries will need to be slashed (as they were in 2000 and 2008), if companies will survive.  I’ve already heard from several of my portfolio companies that they had company-wide meetings and agreed to 50% salary cuts, and cut non-essential staff.  While the pandemic will certainly curtail travel, make that a policy.  Cut all contract help that can be cut.  Cut marketing and sales spend until the your customers are back to work and buying once more.  Again, any step that cuts your burn early on, will have a lasting impact on the later cash balance and your cash horizon.
  7. Non-equity cash raise.  Look for sources of cash that are non-equity.  Think of ways to get government grants.   Explore the SBA programs that have been put in place to help small businesses.  Be creative about finding sources of cash to stay alive, including potentially doing some short-term deals that help the immediate crunch.  These are things that you would never have considered doing three months ago.
  8. Stay alert for the inflection point.  As with almost all things in life, this too will pass.  It is hard to tell what the country and market will look like when this is past, but if your company is alive and flexible, there will be great opportunities.  Watch for it, since none of us can predict when it will happen.

Hope this is helpful.  Comments appreciated.

Merger of Angel-backed Companies

Most startups first create a feature. If they are smart, it will be a unique feature that fits a demonstrable customer need in the market and they can have many customers adopt their technology. If the company is really good, they will transform this feature into a product. If that works, they might get to create a series of related product and make a product line. Rarely will the startup create a full-fledged company.

It is when a startup grows its business to the Company stage that it can get exceptional value (<$100M). In general this takes experience and skills that aren’t usually found either in a startup or on their board.

Most angel-backed startups have trouble making it beyond the feature or product stage. In the past, many startups counted on VC funding to grow to the product line and company stage. This is now exceedingly rare, given both the number of angel-backed startups and the limited activity of VCs (see some of my previous posts).

So what does that mean? One outcome is that we move our angel-backed startups to profitability and they grow organically. This can lead to an acquisition, but more often than not, exits are rarer than we would like. (I will be doing a post on this soon.)

I predict that we will begin to see a wave of mergers between successful angel-backed companies. This makes perfect sense.

When two companies are in alignment and have products/features that can satisfy a broader set of customer needs, builds revenue and a customer base that exceeds critical mass, and gives the combination the chance to get to the company stage – creating a lot more value than the two companies separately.

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