The Future Of Early Stage Investing; Why Elevator Pitches and Fast Pitches Are A Bad Idea.

Thanks for the links to those informative articles Frank.

Of course I wish you the best with Trius Therapeutics, but that is too risky of an investment for me even if I had the money; over $67 Million invested before making a profit and still looking for more. And isn't it a given that the resistant bacteria will develop a resistance to their solution which in turn changes the market size for their solution? At its current burn rate it seems to have less than your remaining lifetime if it is going to pay off.

According to the article, success was measured according to who raised the most money. That's a different skill set from making the business profitable. It seems in the past that an article with the title "most successful" would refer to the return on investment. I hope the culture does not swing this way, where the measure of success does not include the investor.

My professional background is in real estate, both sales and management. I have always refused to go along with the hype, preferring long term relationships instead. I often look at my role as protecting investor clients from themselves. But everyone has more than one friend in real estate and they sometimes insist on doing things against our advice.

They buy at the wrong time for the wrong price, build something wrong so it is harder to sell or rent, remodel incorrectly, and so on. Because we also manage property we end up sharing their mistakes with them.

If one needs the investment to pay for itself, typically one should not get into the rental market unless one can afford a down payment of about 5/8ths of the value. Any upgrades would be in addition to that. If one doesn't have 5/8ths but can handle a negative cash-flow, plan on only breaking even for the first ten years of ownership.

From time to time in real estate markets, there are short periods of time when the rent is high enough to pay the mortgage. Agents jump on this and pump up the market, telling everyone to get in on it. But the high rents never last long enough to payback for money spent on the commission, loan fee, appraisal fee, painting and upgrades, vacancy time, and so on, let alone the 20% down payment. So the new owner ends up selling at a lost and the agent makes two commissions.

As someone who has been seeking startup funding for years, the Forbes article, Venture Capital's Coming Collapse, is no surprise at all. The tell tale signs of any industry that practices "pump and dump" have been out in the open for years.

In his interview on the Frank Peters show, Josh Wolfe of Lux Capital, rightly called most funds spray and pray funds. Meaning they make a lot of investments and hope one hits.

Here is what I saw that told me this was coming. 1) Most VCs that say they invest in seed and startup stage opportunities actually do not. Anyone can wait until they see some profits in order to jump in. Refusing to get in early shows a lack of skill or willingness to do the work to identify the next big thing. 2) Most VCs never lead an investment round; they just wait to be asked to join another VC's investment. This shows a dependency on another firm telling you what to do or willingness to let you in. Of course the ones with bad investments will always let you in. 3) As the size of the funds they managed increased so did the amount of required work to be successful, but the number of partners did not increase to match the added work load. 4) You can see some VCs spending too much time at speaking engagements such as conventions and fast pitch competitions. As if the same entrepreneurs at those events haven't already submitted to their firm. But the speaking and judging fees must be nice when your fund isn't returning yet. 5) The portfolio of many VCs was not matching what they claim to be looking to invest in. 6) Just look at the portfolios for yourself, you will find your own reasons to disagree with many of the investments. 7) The refusal by many VCs to make their full results public. It is a reliance on hype and not actual value.

The usefulness of the internet is still evolving, and we are going to see more changes in the VC and Angel industries for the better. For example, the video presentations at AngelSoft are a step in the right direction. But to paraphrase Neil Armstrong, the first man to step onto the moon; one baby step toward improved presentations, NO giant leap in being able to identify the next big thing.

The folks at Lux Captial claim that one of their partners has started 17 companies from scratch and 14 of those had an IPO, and have a cumulative market cap of over $20Billion. They also say they look to only make four to five investments per year, instead of the 20 per partner that other funds make. We often hear on the Frank Peters Show that Angels need to make 25 investments to get ahead in this game.

The other school of thought, which Lux Capital is an advocate of, says instead of making many investments, identify something novel which the masses have not appreciated yet, build the risk out of it, and then find the right team to run it.

If Lux Capital were to follow the 25 investments method, at four investments per year, it would take them over six years to achieve the quota, and then they would have to wait years in addition to that, for the one pay off, if any. And that one pay off would have to pay for the whole firm and all the investors.

It is obvious that a 1 in 4 success ratio is more desirable than a 1 in 25 ratio. The folks at Lux Capital say it is harder to do the work of identifying the next big thing than to do the work of spray and pray.

Angels are overdue to ask themselves if a 1 in 4 ratio is possible, why are they in such a hurry to resort to the 1 in 25 of spray and pray? As long as one's money is parked somewhere where it is growing, it seems they have the time to seek out the next big thing. If they have the time to seek out 25, don't they also have the time to seek out 4?

This brings us to why the elevator pitch and the fast pitch is a bad idea. They cannot be used to identify the next big thing.

Take a look at any invention in the past that was considered a next big thing. Unless they were part of an investment bubble, such as the dotcom craze of the nineties, or the biochem bubble of the seventies, they all had trouble getting funding. It would be wrong to say that if they just had a better fast pitch or better elevator pitch they would have more easily gotten funding.

I will use some common examples to illustrate my point. 1) It took the Wright Brothers three years after they flew to get a single investor, and they had to go all the way to France to do it. 2) Alexander Graham Bell was unable to sell or license his patent for his telephone invention, so he had no choice but to start his own company. 3) When automobile manufacturers were selling 300,000 cars a year they still couldn't even get a bank loan to expand their businesses because people still held to the belief that the car will never replace the horse. 4) The idea of having a computer in the home was ridiculed.

Knowing what we know now, it is still impossible to create a fast pitch or elevator pitch for these modern marvels that would have attracted early investors of their day. Modern man has the reference point of benefiting from these inventions, and living in a world that is designed to accommodate them. But to the early investor of the time there is no such reference point.

In the early days of the PC there was no word processor, so I didn't need one and I didn't know anyone who did. I was not even an early adopter of the internet. There was nothing on the early internet that helped my business. Today selling the concept of the hydrogen car has been a struggle because there are no hydrogen fueling stations in most areas. This illustrates what it must have been like for early automobile manufactures; not only did they not have fuel stations and repair shops, most roads were still more suitable for horses that don't get stuck in the mud. In the early days of the phone, homes were not wired. So parties in different cities had to agree on being at the phone centers at a specific time in order to talk to each other. This was considered a waste of time by early potential investors.

History shows us that it takes more than 10 slides written at 30 font, or a 30 second elevator pitch, or a 5 minute fast pitch, to be made aware of all the variables that indicate if something has the potential to be a next big thing. Understanding the invention is only half the issue, if even that. One has to also understand the affect it will have on economies, how economies will evolve to include it, and how new industries will be created because of it.

For example the PC led to a lot of different industries. Without the PC we wouldn't need an internet. It also led to PC games, internet movies, and so on. These in turn led to more demand for the PC.

Lux Capital has told us that to achieve the higher success rate, it has to be something that the masses have not appreciated yet. If you can appreciate it in a fast pitch, chances are the masses are already at that level of understanding also.

Inventors are being advised by Angels who in turn are being advised by VCs. But in light of the current report in Forbes, we need to qualify that advice. If that advice leads to preparing the opportunity to try and do business with firms that are going bankrupt, it is not the advice to follow.

In my opinion there is too much focus on getting through more pitches faster. What are the handful of successful firms doing differently? I doubt their success is due to shorter and faster pitches. It must be the quality of the investments.

The fast pitch makes sense if your profits are dependent on a bubble that you intend to ride. The typical pump and dump practiced in many industries. In that case you are trying to get in and out before the bubble bursts, but the startup industry is not currently in a bubble and has not been in one for years.

Time will always be an issue but it should never come at the expense of careful planning. If one is in a hurry to spend their money, it seems according to the Forbes article the old saying "a fool and his money are quickly parted" applies.

The future of early stage investing belongs to those early stage investors who openly disclose their success and failure rate. Those with the higher rates of success will attract the best ideas to them giving them the higher quality portfolio.

This is important to inventors and entrepreneurs for two reasons: 1) they don't want the burden of making up for the more than 10 failures of the fund, and 2) when the early stage investor says he would be a good advisor for your business, he has the record to back up that claim.

Those without the good track record will either: 1) be satisfied with the lower returns associated with the quality of the deals they attract, or 2) get out of this game, or 3 ) put their money in a fund that operates under the reputation of someone with the ability to attract great ideas to the fund.

Relying on a reputation to attract quality deals is something that most early investors already do, but it is just a reputation of hype and not substance. For example TCA talks about its almost 300 members, and VCs talk about the size of their fund or past successes that might have more to do with the bubble or another firm they partnered with than any skill on their part. But in the end, it still comes down to spray and pray. They don't talk about what they do different, or how they have a better success rate.

This idea of disclosing the success rate will not happen overnight but it will come relatively soon. After early investors have participated in AngelSoft for a while, maybe a couple of years, they will notice that their success rate has still not gone up. Someone will realize that the answer is not to change the videos from 5 minutes to 2 minutes, or to change the presentation fee from $250 to $3,000.

AngelSoft culls but it does little to attract. The only attraction that AngelSoft has for inventors and entrepreneurs is the one size fits all format. But it doesn't say that its 49 VC members are who an investment opportunity should be targeting.

Angels like the idea of having many eyes on a particular opportunity because they feel there is safety in numbers. But having many eyes look at the same snippet of data doesn't lead to any one set of eyes being able to make a better decision than another set. At some point they are going to have to be willing to look at more than 10 slides written at 30 font before they feel they have learned enough.

For those that are going to stick to the spray and pray method I will close with one of my personal quotes; "your expectations are your god". All religions of the world seem to teach that you have to have faith in order for your prayers to be answered. Since what a person expects are also those things that one actually has faith in, expectations set the limit on what one can pray in faith for. If you expect it takes 1 in 25 then you are not likely to do better than that. It is another way of saying that better known quote, "as a man thinks, so is he".

Mat

After reading this (Forbes article), somehow angel investing looks better than Fool's Gold!

Re: "AngelSoft culls but it does little to attract." We're dropping a product for Entrepreneurs in early March that we very much believe will attract! You all will be some of the first to know. Here's hoping!

Ryan Janssen
COO, Angelsoft.net