Monday, April 1, 2019

Founder Investors & Scout Programs

A major trend of the last few years has been the rise of first time founders (or ones early in their startup career) investing their own, or scout fund money, into other startups. In the past, many founders would not become angels until they had either a prior exit under their belt (and therefore cash to invest) or the company was many years into its journey and they were far enough along to have a large salary or some secondary-stock-sale-based liquidity. Many early founders are now being given their own micro venture funds, or money from other funds to invest.

For founders starting to invest, there are a few key things to consider:

A. Being A Good Angel Investor Takes Time
Part of being a founder CEO is spending time with other entrepreneurs. Founders often exchange tips on hiring, distribution and other areas, gossip about which investors are good or bad, or provide each other with moral support or cross-coaching [1]. The nice thing about founder to founder time is it is optional. If you get really busy, you can more or less drop these activities.

If you are an angel, you are pledging time and help to the people you back. While not all angels are able to help all the founders they fund, you should generally pick up the phone if they call or reply to emails and asks.

When you have 1 or 2 or 4 companies you are involved with as an investor, it does not feel like a big load. You can manage the interactions with a limited set of investments. Once this number gets to 10 or more companies, it really starts to add up. While 1-2 companies is a hobby, >10-20 companies starts to feel like a part time or even full time job (depending on how involved you are).

Companies you back will need help with fundraising, people issues, hiring, M&A offers, and other events. Angel investing can start eating into your time in a deep way. The extra hour you should be spending on your own company to work on the strategy roadmap you keep procrastinating on will suddenly go to help a founder instead. The default path may become to pick up the phone to help a founder, which is easier to do than focusing on your own startup work.

The best way to counter this time sink and mode switching is a few fold:

1. Is now the time to start investing? What do you hope to get out of it?
Is it worth waiting on your company hitting some moment of momentum before starting to give others advice and capital? Is now the right time for you to invest your own money or that of a scout program (or raise a fund)?

In my case I took a small number of advisory roles while starting my first company (MixerLabs, acquired by Twitter) but did not do much real investing (in part for focus, and in part because I didn't have much money). I am not sure if scout programs had been more extensive then if I would have participated, it is quite possible I would have - however I am happy I had time to focus on my first company. Startups are always hard, and first time startups are extra hard. By the time of my second company I had been investing for a few years and continued to actively do so.

The positives of investing include giving back to others, broadening your network, information access (for example, what new distribution approaches are working for others), and the potential for financial return (although you should plan to lose any personal money you invest - so do not invest if you can not afford to lose the money)[2]. The cons include investing can become a big distraction, can irritate your cofounders or employees if a lot of your time goes to it (and your startup is not working), and the potential to lose money.

2. Time box investing.
If you do decide to invest, carve out the time you are going to spend on investing and stick to it. Is it every Tuesday and Thursday night? Your Saturdays? Treat it like a hobby. If you would not drop out of work mid day regularly to go do yoga teacher training or collect model trains[3], maybe you should not spend that same time on other people's startups. Your own startup should come first.

3. Set expectations up front.
Give founders you back realistic expectations - how fast can you reply to calls/text/emails? Are you only available to meet live certain nights and weekends? Or just breakfasts? You can write a guide to working with you as one approach.

4. Don't spray and pray.
The more investments you make the harder it will be to manage time. Make sure each incremental investment is better than the average of all investments you have made so far. If you are not moving the average up with each investment you are probably investing badly (or your first two investments were Stripe and Airbnb).

5. Focus on investments that will come to you, versus hunting.
If you have just left a key network (Stripe, Facebook, etc.) to start a company, you are part of a unique cohort. Lots of your friends are probably also starting companies and you know who is good. Similarly, if you work in Fintech or another market, you will know who the best companies and founders are in your market. Invest in people or products you already know, do not need to diligence as deeply, and who you planned to help or informally advise anyhow. This will be differentiated access and also will prevent investing from becoming a massive time suck.

6. If you get extra busy, stop investing.
If your startup goes through an especially intense period, you will need to put investing (and all hobbies) on hold. If you are investing your own money, it is easy to ramp things up and down. If you are in a scout program or have raised your own angel fund, make sure expectations are set that there may be long periods of time (even years) when you may go dormant. One way to avoid pressure to invest is not take a management fee, or only take fees on capital you have deployed. No matter how you do it, make sure you can pull the breaks if needed.

B. Scout Programs and Your Personal Track Record: It is not free money!
In the last 5 years, a large number of venture funds have started scout programs, in which they give a set of founders or executives money to invest on their behalf. For example, a VP engineering at a company may be given $100,000 by a venture fund to invest, with the VP and the venture fund splitting the upside. Some scout programs have gotten quite large, with one notable one including 30+ of people.

I have heard a number of people in scout programs say that they treat scout money as pure optionality - they have no personal skin in the game - so they do not diligence or really care where the money is going. One person told me "I like to learn new things, so the scout money allows me to pay to learn something - its not my money so its OK." Another told me "I am investing in my friend's company which isn't great, but its scout money so it doesn't matter".

While not all scouts think this way, some do. So it is important to consider a few things when investing other people's money:

1. You are building an investor track record. Don't ruin it early.
While you might not realize it now, if you ever want to become a professional investor (raise a fund or SPV, or join a venture firm), people will want to see your track record. If you invest badly as a scout it may be hard for you to do either of these things. Effectively you are destroying your reputation as a good picker of companies by thinking the scout money is free. Reputation is the highest value thing you own. Is it worth trading future reputation and opportunities for a $10K check in a bad company?

Similarly, other investors look to your portfolio as a quality signal of referrals you make. If you angel invest in a lot of bad companies early, VCs will be less likely to react quickly to companies you refer for series A or B. Effectively, people will view your past taste as a guide to your future referrals.

This means you should not treat scout money as free money. Rather you should view it as a way to generate returns for yourself and for the fund that is backing you. You should also view it as the track record you are laying down that create optionality for you to some day join a venture fund or start your own fund.

2. You are a fiduciary of someone else's money.
If someone gives you money to invest, the goal is to make them money. The venture capital funds themselves raise their money from large institutional endowments, family offices, and other sources. For example, the dollars you are investing may ultimately belong to a teacher's pension fund, or an anti-cancer philanthropy. Your goal should be to make these institutions money to keep them funded.

Some scout programs are nuanced in that venture funds are using scout programs to build information access and network. However, if you make people money they tend to like you more than if you don't. If you want to eventually work at a venture fund, the VC partners will look at your scout track record.

Thanks to Naval RavikantGarry Tan and Suhail Doshi for feedback on this post.

[1] In general I have found founder to founder coaching to be dramatically better than most self styled executive coaches. A few are actually good, but I would make sure to define what you plan to get out of the hiring of one.

[2] Most founders I know eventually end up with a tight circle of other founders they are quite close to and speak to each other very regularly (in some cases more or less daily or weekly). So informal founder to founder networks are quite strong and can provide the network and information access without the investment. That said, some founders have made more money from a friends startup as an advisor or investor than from their own.

[3] I do not know anyone who collects trains, so it is a hypothetical.

[4] You can also see this Twitter thread started by @suhail.

You can order the High Growth Handbook here.

Raising Money

Managing Investors