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.

Why Cloud Computing Is Happening Now

Sometimes things just happen. But rarely do they happen without many antecedents. And rarely do we see the antecedents until after they happen.

I believe that Cloud Computing has followed this pattern. The obvious antecedents are Moore’s Law (http://en.wikipedia.org/wiki/Moore%27s_law), the rapid drop in disk prices, the proliferation of virtualization, and the emergence of large, efficient datacenters. Much has been made of all of these factors.

One that isn’t mentioned is the network capacity required to move vast quantities of bandwidth required to move the huge amounts of data from customers to datacenters and between datacenters. The networks have a long lead time to install. And require vast sums of money. Think about digging very long trenches and laying fiber optic cables between cities. And then each of the cities need to be hooked up with fiber. This is outrageously expensive, especially when you consider that rights of way and approvals need to be acquired, etc.

Given that the lead time for installing these networks was decades and we didn’t know that cloud computing was going to be a key application, how did these networks get installed to be there when we needed them?

I think the best answer is bad business decisions. Wait … did I just say that? Cloud computing is a key technology for the future, so how can it be a bad business decision? At the time vast quantities of network infrastructure we being put in, the Internet was in its infancy and doubling in size every 90 days. Companies (like WorldCom, Global Crossing, and MCI) decided to install capacity at a fever pace. And then the bubble burst in 2001 and the companies had a ton of stranded capacity and many went out of business. But the capacity remained, and at lower cost basis when acquired out of bankruptcy. Sometimes decisions made for one reason in one era have massively positive consequences in another.

The changing nature of communication

In my lifetime, I have witnessed the transformation of communication. When my grandparents were born, electronic communication meant telegrams. A couple of generations earlier, sending a letter from new York to san Francisco required writing a letter, getting it on a ship, and having it sail around South America, taking months. In rapid succession, we deployed railroads, telephones, highways/cars, airlines, data networks, and the Internet. The result is we can now send the same information that required months in less than the blink of an eye.

But, one aspect of this communication remained the same – you needed to know who you were communicating with and their address.

In the last few years, this has all changed! We can now communicate, individually or to a group, with people who we don’t know. The rise of social networks allows people to find others that they don’t know, but with whom they share an interest – around the world! This has changed the definition of community. And the definition of “friend.”

I think it will take many years to understand all of the impacts of this profound change in communication.

At the tip of the iceberg, we see the revolts in the Arab world in North Africa, where dissenters used Facebook to organize and communicate.

I saw the precursor of this in Eastern Europe and Russia (actually the Soviet Union) in the late 1980s. When visiting frequently on business, some of my colleagues would ask me to bring blank video tapes (pre-recorded video tapes were seized on entry!). I didn’t understand this at first, until I was taken to a “secret” video exchange market, where you would bring a blank video tape and pay some money to get a current-run Western movie. It gave the populace the ability to see Western culture, values, etc. I believe it was a contributing factor in the changes that later swept that part of the world. The Internet and Facebook is a much more potent force for knowledge, freedom, and understanding.

We live in a time of sweeping change.

Technology & Revolution

I admire Thomas Friedman’s intellect. In today’s NYT, he wrote a particularly insightful analysis about the events in Egypt and the Middle East, called China, Twitter and 20-Year-Olds vs. the Pyramids (http://www.nytimes.com/2011/02/06/opinion/06friedman.html). Like in many of the revolutions that swept Eastern Europe, there is clearly a link between modern communication technologies that were spawned by the Internet and the ability of people to quickly gather around key societal issues. This was one of the original promises of the Internet. Like with many technologies, we often overestimate their progress and impact in the next two years, but underestimate their impact in ten years.

Social networks are one of the first communication media that allow like-minded people to communicate without knowing each other. In the past, you had to at least know someone’s address (physical or virtual) to send them a message. This is no longer true and the vast societal impacts of this will reverberate for decades. I saw this first hand when I was in charge of AT&T’s communication businesses in Eastern Europe in the late 1980’s (even having the good fortune to be in Berlin on the day the Wall was opened.) Even then people realized that communication was a necessary ingredient for change.

But Tom takes this a step further. He points out that “the whole Asian-led developing world’s rising consumption of meat, corn, sugar, wheat and oil certainly is” fueling the revolts in the Middle East. What a fabulous insight about the interconnected global economy! Couple that with an increasingly educated and aware population of 20-year-olds who can now easily communicate their frustrations and gather on social networks – that’s fuel for change. Especially in societies where there are a great many of what Tom calls “the educated unemployables” that have college degrees on paper but really don’t have the skills to make them globally competitive.

It is axiomatic that most new technologies are generational. It is not surprising that the aging autocratic leaders of the Middle East (and elsewhere) at best have a limited understanding and therefore underestimate the impact of Twitter, etc. While those of us in the technology field know that none of these are revolutionary technologies per se, the societal impacts wrought by the wide-spread adoption of them are!

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