Advertisers Are Also Your Customers

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I was just reading this post Techcrunch Europe: The long lost formula for start-up success. No, really by Nigel Eccles and found it to be a great summary of Steve Blank’s Customer Development methodology. But one thing stuck out for me which was a rather short two liner:
For apps that are supported by advertising, your customer is the person who hands over the cash. That is the advertiser, so the criteria still holds.
So much insight packed into these two sentences and yet no further discussion on it!
This was something that we discovered through the dotcom bust years at Yahoo!, and really didn’t become something more apparent until we were down in the dumps in revenue after the crash of 2000-01 years.
For years, Yahoo! built its products on the mantra of always taking care of the users. Do what users want and traffic will come, and with it all the rewards including revenue. It really did work great, and arguably Yahoo! became the powerhouse it did back then amongst users because we had a single focused view on users’ needs. It seemed to us that no matter what we did, money still came in and the product teams largely ignored any extra effort in taking care of our advertisers who were paying our bills.
This was exceedingly apparent in the ad banners that we ran and refused to change for years, which was the 468×60 banner. When traditional advertisers started toeing the internet advertising waters, they looked with disdain on the small rectangle that sat on our pages, which, when compared to the traditional ways of doing advertising, provided no where near the capability of producing “wow” for their clients. Our technical specs didn’t help either; while they protected users from downloading huge files and slowing down their web experiences on Yahoo!, they severely limited what advertisers could do in those little rectangles.
And so it was that we went through the dotcom boom to bust period, saw its primary sources of ad revenue die away – the OTHER hugely funded dotcoms – and with traditional advertisers who really didn’t want to put any time or effort into producing ads for Yahoo!, but were looking elsewhere at sites who were beginning to use other ad technologies like floating ads. It wasn’t until Yahoo! started loosening up its standards and allowing different and new ad technologies on its pages that traditional advertisers started coming on board Yahoo! and trying internet advertising.
We realized that we actually had another customer besides our users, which was our advertisers. We also realized that our business was like a three-legged stool. The first leg was the company, which benefitted from having users and revenue from our advertisers; the second leg was our users; the third leg was advertisers. All three legs must be in balance or else the stool tips over. In our early years, we really only took care of two legs, which was the company and our users. The third leg existed, but we didn’t really do anything about it because no matter what we did, revenue poured in, and mostly from all those dotcoms that had way too much money to spend on advertising. These dotcoms just wanted to get exposure to users and fast, to build their businesses quickly and get out ahead of their competitors (never mind that their business models weren’t sustainable). So they spent a ton of money advertising on Yahoo! to do that and Yahoo! didn’t really need to do anything else to get them to come on board.
When these dotcoms died, so did the revenue and we realized that we really didn’t do much for people who had been doing advertising for years, well before the internet existed. So we worked hard to remedy this and bring our advertising technology to a place where it could support what traditional advertisers were looking for. The three legged stool became truly balanced and Yahoo! launched ahead of its competitors in the years following 2001, as we went out and wooed advertisers with much improved ability to create “wow” (as well as all the other important things like advertiser sales, support, and operations).
I think too many startups today don’t think enough about the three-legged stool. They focus on their company and their users, and then slap ads on their pages and get frustrated when they pull in a small amount of money every month and wonder why their CPMs are so low. Or worse, some companies build their businesses solely for advertisers and forget that their users need to have a product or service that helps them, and not just advance the wishes of advertisers. Thus the three legged stool becomes unbalanced yet again.
Not suprisingly, users and advertisers go hand in hand. Advertisers look for users to market their products to. But not just any users; they want exactly the users that would want their product. Just giving a bunch of users to advertisers means giving what is called remnant inventory to them; it’s the lowest cost inventory that they’re willing to pay for since you haven’t been able to tell them what kind of users they are reaching. So sites need to find a way to deliver those exact users that advertisers want to see their ads.
Users on the other hand, tend to hate advertising because most of the time it’s irrelevant to anything they want or need at that moment, can be annoying, and a lot of it can be interruptive of whatever it is they are doing at that time. Aspirationally, companies need to find ways of delivering the right ad to the right person at the right time. Tough job, probably tougher than figuring out what kind of users you have to sell to advertisers.
However ignoring the third leg of the stool is just folly. If a site is going to ad supported, startups should realize there is a third customer for their site, the advertiser, and put steps into motion from the very beginning to take care of this customer. As we learned at Yahoo!, doing it later on is potentially painful – you don’t want a downturn, or watch your startup’s bank account run down to zero, to shock you out of the realities of what you should have been doing.

Combining Startup Investing and Distribution

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A while back I wrote about “me-too” products and that one of the biggest issues facing early stage internet startups is the lack of distribution to get their product out there. After going to Ycombinator yesterday, I, again, felt that similar feeling when I wrote my post many weeks ago.
I thought that some of these were really great, but most of them were much-improved twists on what was already out there. In this crowded world where people already have multiple ways of doing things, I thought it was a damn shame that many of these startups would fail not because they weren’t better, but just because they could not get enough customer exposure before their bank accounts ran out.
Just the other day, I had lunch with a buddy of mine at a small publishing company and the topic of distribution came up again. We talked about how valuable the traffic they had on their site was to all these little startups who had none at all. From this conversation, an idea emerged.
Here’s the idea, and it’s one that is best executed by people who have traffic, like a Yahoo or a Google, or even a NYTimes.
Any of these companies and their like all have done venture investing. But it’s been very much like a investor-startup relationship, which is we give you money and you go out to make something big out of it. To me, I think this should change. I think there should be a way to give both money and distribution. To an emerging startup, a firehose of traffic could be worth its weight in gold, in addition to the money.
Suppose at the bottom of every page, which is not worth very much to advertisers since they want to be at the top of the page, there was a row of links which was labeled, “New things to try:”, or “Cool startups:”, or even something more explicit like “Check out our new ventures:”. Then for each startup you invest in, part of the deal is to gain a place in that row of links. You could have permanent placement, or rotating placement if there are more startups than link slots.
Then just let them run. I think you’d be surprised at the amount of traffic the bottom of the page can generate. Certainly, even 1000s of clicks per day driving to a new startup would be extremely valuable. At Yahoo, we did some exploration on placing links down there. At Yahoo traffic levels, they were driving a tremendous number of clicks to Yahoo products and services each day! But yet that space at the bottom of the page wasn’t really being monetized otherwise, or of any use to users after the main content of the page had ended.
So why not give it to the startups you invest in?
Today, startups are in a fight for attention. The only way for most startups to get noticed, induce trial, and thus get true validation from the marketplace that they are better, is to point a firehose at them. SEO is too slow, SEM is expensive – what else is left – perhaps partnerships with companies who can give them exposure. But I think that while it is possible, it is a lot of effort to do a BD deal for distribution. As an investor, I would think that it would be easier to just give it them ourselves, right? If you can firehose your investments to show the world they exist, induce trial, really prove out their models, wouldn’t that take a huge amount of risk out of your investments and increase the chance of a startup being successful? Of course it would also show whether or not you chose wisely or not….
So c’mon big media companies – work with your venture arms. Invest AND offer a firehose. These guys need it, and, aspirationally, we do want some of these products which ARE better than what we have out there now.

The Problem with Early Stage Me-Too Product Startups

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I believe the universe of internet businesses has become extremely crowded in the last few years. In the early days, you could come out easily with something new because there weren’t that many competitors out there. Now, it’s hard to find somebody who isn’t working on something similar to what you’re thinking about. So competition is fierce and many times you’ll find entrenched competitors with a lot of product inertia and a great head start.
The other huge problem is on the consumer side. Consumers are deluged by new products and services all the time. They have overload and just keep to the products they know best, and need to have a really good reason to change and move from another service to a new entrant. We saw this first in the past with email addresses; Yahoo Mail users were hesitant to move because the cost of changing your email address was super high and thus user retention was very high. Now add what makes up our digital lives on services like flickr (all our pictures that we’ve uploaded for half a decade now), or facebook (our friends are all here, plus their interconnections), or linkedin (our business connections are all here, plus all their historical connections). The cost of moving has become so high because we’ve invested so much time and effort into those services and we don’t want to redo that, let alone adding the cost of learning a new service.
As an early stage investor, I’ve found that this makes picking companies exponentially harder and it’s a shame. I meet a lot of smart entrepreneurs with some really great ideas, but then I do some research online and find that there are others who are working on something similar or in a close enough space to be competitive. Then I start to get worried about their prospects.
You can find tons of books on the subject of competition and winning despite having entrenched competitors. In general, I have found that entrepreneurs are doing what they should be doing to attack a crowded market. These are things like (my thanks to Andrew Chen for helping me with this list):
1. Innovate on the product experience (ie. Posterous vs. WordPress).
2. Business model changes, where you are going free (or freemium) for a product that’s usually subscription (or fixed charge).
3. Changing the market where you’re going long tail instead of hitting the larger market (ie. casual games versus hardcore games).
4. Change in distribution model, where you are delivering something as a service rather than a download, or bundled into an existing thing (ie. Facebook app) instead of a standalone thing.
5. Change in branding. An example is where you cater to an upscale prestige market or niche market instead of a mass brand, or vice versa like taking a niche product and making it available to the masses.
6. Create a business that is better, out of a larger part of another business (ie. Lefora created a message board hosting product for those who don’t want all the bells and whistles of a full social networking product).
7. Innovate on design, which appeals to those who want a similar product but one that looks/feels better.
8. Offering more features on a product, or customization on product.
And the big, traditional way of taking a new entrant into a crowded market:
9. Mass advertising to gain broad awareness and induce trial and adoption of new product in face of existing competitors.
So I am not saying it’s not possible to win against a crowded marketplace. My issue is with early stage startups: in order to win in a crowded marketplace, early stage startups often don’t have enough resources to last long enough to compete effectively and win. While a lot of the above can be implemented, growth time is limited by whether or not you have enough capital and revenue to survive until you run out.
To me, if you’re developing a me-too product, it’s ultimately going to boil down to a marketing game more than in any other situation. You can develop the best product or service, but if nobody knows about it because they’re busy using something else, then you’re still dead.
So distribution for a me-too product is critical. In the past and present, large corporations could do this because they had lots of money to launch large advertising campaigns. They knew distribution channels and could insert their new product there. They had contacts in their market and it was straightforward to get word out that they had a new product even if it was similar to existing products.
As a new startup, you may not have those channels and contacts established, and certainly you don’t have money to spend on advertising plastered on the Superbowl, magazines, online, and elsewhere.
However, once you finish your product using one or more of the strategies above, you need to jump to strategy number 9 as soon as possible and get it out to consumers. You don’t have time to wait until people notice you; you need to get noticed.
Some possible ways of doing this:
1. Buy advertising. As an early stage startup, this is the least viable unless you somehow have enough money to do this. Lead gen advertising can be better than CPM based advertising as you’ll be able to pay only on a referral, but still this costs money. Let’s move onto cheaper alternatives.
2. Marketing that involves barter space. You trade something of value for advertising space on their side. Something of value can be advertising space on your site, or donation to their cause for charities.
3. Word of Mouth Marketing. Contact bloggers, magazines, users and get them to try and talk about your product. Getting in the NYTimes is a big traffic driver, as well as many other national circulation magazines. Online publications like C|Net and The Huffington Post can also be great. Twitter is also a great up and coming means for getting your word out.
4. Get distribution partners. Existing companies can add your product on their sites and can help you promote it. This is usually in deeper partnership such that it goes beyond just buying ad space. You look for exclusivity in contracts and features that your product has that enhance an existing company’s product and prestige.
5. Viral marketing. This is a very hard avenue to execute, which is to start with a few users and then it blossoms outward to many. Determining how your product can be viral can be an elusive game and if you don’t hit on it early, you could waste a lot of time tweaking and hoping that something you create will be virally popular and spread.
In working with a few startups, I am disheartened by the fact that the importance of distribution is still not well understood. The leading thought is that “if I build something great, then everyone will come find me.” Unfortunately, that is rarely the case in this crowded marketplace, and most early stage companies don’t have enough time to let people just wander around until they find out about the product.
They did not do enough work to go out and contact bloggers. They didn’t go out and try to woo corporate partners to see if they would help them get their message out. They just waited for users to come and they didn’t come in great enough quantity to support their business by the time their money ran out.
So don’t let your product fail simply because you can’t induce trial. Remember, you have developed a me-too product, one that users already have a solution for and switching costs and barriers may be too high for them to take action to look for a better solution. You need to get them to know that your solution exists, and attract them to try it out – and since you’re an early stage startup, you need to do this ASAP to give yourself enough time to let consumer adoption grab hold and ultimately take off, all before your money runs out.

World Domination Plan

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I love it when I hear entrepreneurs are working on a world domination plan.
I see a lot of entrepreneurs arrive with pitches that are limited in scope. They talk about how the world needs this function, how great it is, and how current products don’t have these features. Usually, they really are great ideas. When we get to revenue, sometimes there is a plan and sometimes there isn’t. But many of these revenue plans only seem to get to a few million a year at most. This may be a great small business, but for an investor, we need to ply our limited resources into those opportunities that will grow into huge businesses, and not just a million a year.
The need for a world domination plan is important to me. I want to invest in businesses that will grow into huge businesses, which will maximize my return on investment. I don’t want to invest in businesses that will grow into small businesses, even if they are great small businesses. I only have time and resources to work on so many projects and need to maximize my efforts.
The plan needs to be believable to both me and the entrepreneur. It’s not enough that I just believe it’s possible; the entrepreneur must also believe the plan since he is executing it. If only I believe in the possibility, that’s not good enough. To me, it’s a form of personal deception; I see the idea, I see its potential, and it doesn’t matter who works on it – it must build into a big business as I believe, right? It’s not that simple even if I wish it was. I’m not the one executing the idea and doing all the ground work. The entrepreneur must believe in the idea and be able to do all that. If he does not believe in the idea and/or cannot execute it, it’s going to fail.
Some people have enough resources to invest in experimental projects, meaning that there is no clear path to success at the beginning. I unfortunately don’t have enough resources to deploy like that. Thus, I need to at least have some comfort that both the entrepreneur and I believe there is a world domination plan (and yes I know there is a great probability that this will change).
What is your world domination plan?

Is Angel Investing for You? Essential Qualities for Beginner Angel Investors

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On Hacker News, someone posted that they could not find a good tutorial on becoming an angel investor. As I wrote in my previous post, “What I’ve Learned in Angel Investing, March 2009”, there is practically no one to teach you or we’re all too busy to hold your hand. So I thought I’d write a bit about starting out.
I thought about writing a whole tutorial, but I kind of backed off on that. I’ve only got about 2+ years of angel investing under my belt; hardly “expert” status on this topic! There are plenty of people who have been doing angel investing for decades and would be much more qualified to teach angel investing than me. However, I thought about what I could do to help budding angel investors start out and figured that I’d start by talking about whether or not you have the basic qualities for becoming a successful angel investor.
Don’t Get Caught Up in the Glamour
Angel investing is glamorous. It’s like sitting at the Monaco blackjack table that has a minimum of $10000 per bet. People look at you as if you’re some rich celebrity. It’s the same with angel investing. People think that you’re going to make it rich as you go find the next Google and make a gazillion dollars. In fact, they think you are making a gazillion bucks even as they talk to you.
I would be the first to say that I get some attention for angel investing. But that’s because they always hear about the great successes of venture capitalists and startups getting acquired or going public. They never hear about all the other startups that fail miserably, and taking investors’ money with them down the tube.
So if you are thinking about becoming an angel investor because you think it’s glamourous and you’ll gain fame from it, I think that’s fine but I can probably think of other less money-wasteful ways of gaining fame (for instance, join Twitter and challenge Ashton Kutcher to see who gets to 2MM followers first). Personally I would not become an angel investor because of this reason so don’t get caught up in the glamour.
What is Your Reason for Angel Investing?
I think you need to think hard about why you’d want to angel invest. I would also suggest that you should have alternative reasons for angel investing beyond making money. That’s because angel investing is probably one of the riskiest ways of making money and betting it all on this as an overall portfolio strategy.
So have other ways of gaining return from angel investing since there is a good chance you’re going to lose all your money doing it. Feel good that you’re getting something back from it even if the money doesn’t.
My alternative returns from angel investing are:
1. I love hanging with smart entrepreneurs.
2. I love learning something new.
3. I love teaching and get joy from watching others learn.
4. I love being part of something growing.
5. I love the challenge of the process of startup and product building. I love the brainteaser aspect of trying to solve this problem.
You Need Money to Angel Invest
Angel investments range typically in the $25K-$100K range but can go lower or even much higher, upwards of $1MM. You can just do a few angel investments, or even one. But this substantially increases your risk of losing your money. To maximize your chance of making your money back and hopefully a bit more, you should consider that you need be able to make at least 10 investments to spread your risk.
Ideally you’d have a minimum of $25K x 10 = $250K to deploy. And the amount goes upwards from there depending on your target investment size.
Then, if you think about popular overall personal portfolio investment strategy, then you shouldn’t have more than 2-3% in any one investment (ie. single stock) to mitigate risk. So is $250K (or whatever amount you are thinking about investing in total) only 2-3% of your overall personal holdings or less?
Remember, betting it all on angel investing is a dumb dumb dumb move.
Are You A Risk Taker?
In order to angel invest, you need to be comfortable with deploying huge sums of cash. You need to be able to do this decisively and without regret or anxiety.
If you are a conservative person, angel investing is not for you.
If you have anxiety about throwing large sums of money out there, this is not for you.
If you can’t let go of your money emotionally, this is definitely not for you. You’ll drive everyone crazy because you’ll be so worried about losing your money and it WILL NOT BE A GOOD THING. Please PLEASE…just do us all a favor and don’t angel invest.
Just Because You Like To Gamble, Doesn’t Mean You Should Angel Invest
Angel investing is a lot like going to Vegas and gambling except for one important point. In Vegas gambling, the money is gone instantly; you have no recourse but to let go of the money at the moment it’s gone. In angel investing, your money isn’t instantly gone; if anything it can seem to drag out the loss process for an incredibly long and painful time.
Can you deal with that?
Do You Deal Well with Chaos and Uncertainty?
You might be a risk taker, but if you lose your head during times of great chaos or uncertainty, this is not good. Every startup goes through periods of high stress and low periods. As an investor, you’ll probably be dragged along with those sentiments. I’ve lost my head once and blew up with entrepreneurs once, and learned my lesson that it just isn’t productive. You gotta keep a cool head so that you can think clearly and strategize correctly.
Are You Disciplined?
Can you develop a plan and stick to it? Or are you tempted to toss your plan to the wind when something comes along so juicy you can’t pass it up, even if it violates your plan?
I have found that sticking to your plan is crucial. It keeps you honest and focused. It also keeps you out of trouble. There is nothing wrong with altering your plan; that’s not what I’m saying here. But once you figure out what is right for you, don’t mess with it or else you’ll get yourself in trouble.
Can You Exercise Tough Love?
As a parent, I often think about tough love with respect to my kid. The same applies to startups and entrepreneurs. When things are going south, somebody has to step up and say that you are heading south and something needs to be done. This can mean things like saying to the CEO that he needs to go, or closing down a startup because it’s going nowhere. Anyone can say positive things during good times, but can you tell someone that something is really going bad and that they need to change/stop/leave?
Some of the hardest conversations I’ve had occurred beginning last year, when I began having talks about cutting burn due to money running out, and the lack of possibility of further funding. With the economy the way it is, I fully expect to see more tough conversations coming up.
An effective angel investor needs to be able to exercise tough love.
Are You Good at Saying NO?
Some people have this issue where they just can’t bring themselves to say “NO”. It’s painful, it risks dealing with negativity coming from the other party, it’s uncomfortable as you worry about hurting another person. It also feels bad being negative.
In angel investing, you MUST absolutely have the ability to say NO decisively and stick to it. Clarity is critical and wishy washiness sucks for everyone involved. If a deal is wrong for you, you just need to be able to say NO no matter how much an entrepreneur is begging, making you feel guilty or inadequate. Remember it’s their job to sell you on investing in their company. Can you not fall for that and just say NO when you’re supposed to?
Do You Have Great Intuition?
I run with intuition a lot. I listen to my gut and if something doesn’t feel right, I just don’t invest. I don’t care what it is. If my gut just doesn’t feel the least bit good about a deal, I just say NO. Intuition detects those things that are immediately obvious or things that are hidden. What is it about this deal that sets off the butterflies in my gut?
Intuition is that primal survival instinct that our ancestors and apes gave to us, but civilization just destroyed. We all know people with zip intuition; you know, the ones with seemingly no common sense whatsoever or always getting in trouble? Are you one of those people?
If you have a highly developed intuition, it will pay you in spades with angel investing.
Do You Have Something to Offer Startups?
I’m fond of talking about angel investing as a probability game. You always want to do a whole bunch of things that maximizes the chance that a given startup will succeed and return your investment with profit.
One of those is your money. That’s easy.
The other is how you yourself can help. How can you help a startup you’re investing in? Can you lend your experience to the entrepreneur? Your business contacts? Your ideas and creativity? Did you specialize in a particular area that you can teach? What else?
If you don’t have anything to offer, then you should consider not angel investing, or at least not in the industry in which you have no experience to offer. Remember that you want to increase the chance of your investment’s success always; why invest in something that has a lower chance of success? Why do people learn how to count cards to play blackjack, or at least learn blackjack strategy?
Are You Willing to Learn?
You should not be arrogant in thinking you know everything. I thought that by coming from Yahoo!, I could pick successful startups. And I was wrong. There will be a lot to learn, lot that you will not expect, skills that you will realize you do not have. To go into angel investing thinking that you know everything is only going to cloud your decision process. This is bad.
Following on the previous comment, you should be open to learning. If you are not receptive to finding out that others know more than you and learning from them, this is a big problem. You’re going to think that with all your previous experience that you’re going to be successful, and I guarantee you that you will miss the important finer points that will throw the odds in your favor and not against you.
Regarding Picking Companies
You have to be good at spotting opportunities. I have already said I have fooled myself in the beginning in thinking I was good at this, but then discovered there was much to learn beyond just the idea. Let’s just say you have to be willing to learn and deploy intuition and objective measures for picking entrepreneurs and their ideas in order to be good enough at picking companies that you’re not throwing money away.
Someday I may write more about what I’ve learned in picking companies. It’s a tough subject with many moving parts. Suffice to say that if you somehow are good at this before you start, then it’s a great quality to have. But if you don’t have this quality or are unsure, then let’s hope you learn because if you can’t ever pick great startups, then you’re toast no matter what. Go to Vegas and hang out with hot chicks at the $1000 Blackjack tables instead. At least you can hang with the hot chicks while throwing your money away.
Do You Have These Important Other External Factors?
Over these last 2+ years, I have found these external factors to increase the probability of success as an angel investor:
1. Your business contacts include those at companies which can result in strategically important partnerships or acquisitions.
Right now, one of the biggest problems that early stage internet startups face is access to customers, whether they are consumers or other businesses. If you know someone who can create a distribution deal for your startup, that would accelerate the growth of the startup, potentially past competitors who don’t have those contacts.
Also, providing more opportunities for acquisitions is also strategically important. This can be as simple as just providing an exit for investors, but in times of economic crisis, it can become a survival lifeline for a business who is running out of money and options. Casting the net as wide as possible can only increase chances for a startup to be acquired.
2. You know and are trusted by other investors, either angels or venture funds, and can invest alongside others who will be helpful and advantageous to a startup.
Again, it’s a probability increasing thing. The more helpful people involved, the better the chance of a great outcome. Thus, having experienced investor friends who will allow you to get into the deal is a very positive thing. If you’re investing alongside not so helpful or experienced people, it just reduces the chance of success especially if you’re in a tough situation, like running out of money and are looking for further investment or facing hostile competition or in need of strategic partnerships.
3. You have access to great dealflow.
This is always critical. If you don’t have access to great deals, then why invest in only crappy deals? If you live in the middle of Montana and all the internet deal flow exists in Silicon Valley, how are you going to get included in those deals and/or pitched? There are probably a myriad of ways to access great deals: location, relationships, going to conferences and startup/entrepreneur gatherings – probably worthy of an entire post in itself. But this is a critical part of being a successful angel investor.
Last Important Attribute: LUCK
Are you lucky? Do good things fall in your lap out of the blue? Does opportunity knock for you more often than for other people?
As in all forms of gambling, being lucky gives you an edge over everybody and everything else.
If you are UNLUCKY, angel investing is DEFINITELY not for you.
Over the last 2+ years in angel investing, I learned a lot about myself while doing this. I also learned a lot from interacting with others and learning from them. Exhibiting these intrinsic qualities will enable you figure out if this occupation is right for you, and whether or not you’ll be successful in it.
Endnote: Did I miss any essential qualities?

What I’ve Learned in Angel Investing, March 2009

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Paul Graham of YCombinator ran a great afternoon conference called Angelconf where he brought together a great afternoon of Silicon Valley angels to talk about how to become an angel. He then wrote a great blog post about it. I managed to watch a lot of it, although I was in NYC at the time and it was tough to watch the whole afternoon.
I was also impressed with Naval Ravikant’s segment, which is posted on VentureHacks. Reading Naval and Nivi’s post sparked some thoughts about angel investing in my mind, so I thought I’d talk about what I’ve learned, and my views on angel investing. One thing you’ll notice is that many of the things I consider important are what others think are important, but there are definitely differences too. So angel investing can have individual differences between angels.
The Problem With Angel Investing Is…
There is no one to teach you. No one to hold your hand. At least until Paul Graham ran his Angelconf. Yes there are many blog posts out there, but there is no really good guide that leads through the topics in an orderly and easily learn-able manner. You get a lot of information piecemeal and you can’t always tell what it’s relevant to, or whether it’s relevant to whatever deal you’re working on now.
I paid my lawyer 1.5 hours of time to have him walk me through, explain, and let me ask him questions about term sheets. Even that was not enough. The ins and outs and subtleties of investing I had to learn on my own, and only by doing 10+ deals in the last 2 years.
Should You Be an Angel?
First thing is you need cash – $250k is minimum, which would put $25k into 10 companies. This gives you good diversification, and you get some good learning which would otherwise be missed by investing more sparingly. Investing regularly also gives you good market information. I now have a good picture into valuations for companies with and without revenue, as a reference for whether or not a deal is good or too expensive.
You can start out lower than $250k, but generally it is rare that entrepreneurs will let you put less than $10K into a company. You usually must have some sort of alternative attraction, like being a prominent business individual.
Starting out with more is always fine….but….the starting amount needs to not be your life savings! You’re likely to lose it all in angel investing! If it’s not your life savings, then mentally you’ll also be better prepared, since if you can lose it all it matters trivially to your life.
Also do not invest with people who are investing what you think is a significant part of their life savings. There is a high probability that they will not be happy to lose it all and could cause no end of trouble to the entrepreneur.
What’s your risk profile? If you’re conservative, you shouldn’t be doing this. Angel investing can be akin to playing the lottery or going to Vegas. Really.
Expect the ratio of 9 failures to one success. Naval thinks it’s much worse, like 1 out of 20 or even 30. So you have to go wide to minimize your loss potential.
So it’s hard to make angel investing profitable if it’s just a hobby, ie. investing in a startup every once in a while, like one a year or less. Probability is far against it.
Do you have something useful to offer to your companies? If not, then your money is just dumb money and it is less likely you’ll get included in great deals. Entrepreneurs look for people to be involved that can help them.
Discipline
Stick to your operating philosophy. Don’t waver. For example, I don’t do notes and have not since, or only under very strict conditions.
Intuition
If something doesn’t feel right, don’t invest. You may have a funny feeling about the entrepreneurs, the business potential, the deal terms, or something else. Trust your instincts.
Picking Companies is Hard
I thought that with all my Internet experience at Yahoo!, I could pick great startups. Boy, was I wrong.
Don’t delude yourself in thinking you can pick a great deal every time. There are so many factors that exist in generating success. You can find total idiots who have made it big, and totally smart people failing miserably. Market conditions could also affect success rates simply because capital is not available or the market is not ready for a product like yours. Just because you think this deal is a great idea doesn’t mean it’s going to actually be one.
Also be wary of laying your own way of getting to success onto the idea but the entrepreneur has not bought into that. Don’t fall into the trap of thinking this is great idea because you personally think it should be executed in some way but the entrepreneur is attacking it in a slightly different way. If he has not bought into it, it won’t be done your way; it’ll be done his way. But also remember that if you think of a great way to execute, it is possible that you are the only one who can execute it that way, meaning you have the business contacts, the experience, the thought leadership etc. The entrepreneur may not.
So if you love the idea and space, but hate the execution plan and think you have a better one AND can’t convince the entrepreneur that you have a better plan, I would walk away.
Dealflow
I am lucky to be able to filter my dealflow by referrals.
Try to be friendly and useful to more experienced angels and VCs out there. They’ll direct some great dealflow your way because they know you’ll help load the odds of success in their favor.
I would caution you on investing in companies in industries you know nothing about.
I personally don’t like to have an inbox full of proposals from strangers. I can’t tell what is good and what is not. So build referral networks if you can.
Don’t Be a Flake
Say you’re going to do a deal or not. Don’t be waffling in the middle. Nobody wants to invest with a flake who can’t decide or is really just unwilling to part with his money but can’t say so.
Branding Yourself
I started David Shen Ventures, LLC and it has become a slowly growing brand. People know me for being useful and many entrepreneurs appreciate, and can attest to, my usefulness.
People do think I’m bigger than I really am though. It’s the risk of sticking the word “Ventures” on the end of your name. I’m just one guy, with an advising and investing operation and that’s it.
Don’t Refer Anything That You Would Not Invest in Yourself
This is brand building, which is to refer only great deals that you’re personally going to invest in. No better validation can be given than if you vote with your own money. Don’t get known for passing only junk that nobody else wants.
On the other hand, if for some reason you do want to help, be clear that you’re not investing but think it’s interesting. But don’t do this often. Investors’ inboxes are clogged enough with random deals that are coming from everywhere. Don’t clog investors’ inboxes further. So I would not do this very often at all.
Be Wary of How Many Deals You Can Handle at One Time
I went out very fast. It was fun, I learned a lot, but I also quickly throttled the process because advising too many companies at once was getting tough and I didn’t want to short change anyone. I also started running short of available capital so be careful of putting too much money out there all at once.
In addition, I would be very disciplined in deploying the same amount of capital every time. Don’t get caught up with the excitement of deals in the beginning and put more money in than what you planned. You’ll run out of money faster, and also I guarantee that the probability of finding your google isn’t any higher in the beginning than it is later on.
Pitches
I can’t sign NDAs unless I get involved. I see too many pitches across many different internet industries and my business can’t survive if I limit that.
The quality of referred pitches is much higher than randomly appearing pitches.
Be wary of being dazzled during a pitch, but be impressed at people who can be so dazzling. Always come back to earth after the meeting and take an objective look at the pitch when you’re out of the mindcontrol ray that some great pitch people can point at you.
Let your intuition be your first guide, and then verify the rest: integrity/intelligence/energy of entrepreneurs, market idea, etc. If something feels wrong, don’t invest.
Investing in More than One Company in Similar Business Areas
I generally try not to do this. I don’t want to accidentally say something that one company is doing to another possible competitor. I also don’t want to be accused of conflict of interest if I’m introducing one company to another for business development or M&A.
There are those who are willing to do this but I don’t think it’s a good idea for me.
Learning to Say No and Walk Away
You need to go into angel investing by having the courage and discipline to just get up and walk away. Every pitch will sound like a game changing next google opportunity for you. That’s their job, to sell you the idea and get you to invest. Do not get mesmerized by that. Be objective in your decision and not emotional, and just say no. Don’t be a flake and waver on telling someone yes or no.
By the way, it’s easy to stress AFTER you say no. You feel regret that maybe you walked away from a great deal. In my experience, this is natural especially after a great attractive, sales pitch. Who can walk away from a hot woman who walks up to you, puts their hand on your rear end, and wants you to come home with her? Let me tell you; I have never regretted walking away from a deal. Remember your intuition – if it says no, it’s saying so for a reason. Better to live to fight (invest) another day, then to get into a deal that may make you miserable later. Also, the probability of any early stage deal being successful is extremely low no matter how sexy the pitch is.
The Best Way to Say Yes
Don’t just say yes. There are many first time entrepreneurs out there who think that when you say yes at the first meeting, they mean they have you. But that is not really true. It’s only the first yes in a string of yes-es, which follow due diligence, checking references, checking the idea independently, or any other decision process items you may have. So make sure first time entrepreneurs understand that.
Do Not Skip Due Diligence
I ask my investments to give me a whole list of due diligence items. It’s a good discipline to have and gives you a deep dive into the company. Luckily, early stage companies don’t have much to dive into, but you can still see problems, like weird debt, or bad corporate structure. You may not want to invest if the entrepreneur is unwilling to clean problems internally.
Also be wary if the entrepreneur is unwilling to give this info to you freely and openly. This only sets the stage for how the relationship will be later on for other things.
I have walked away from deals in failing the due diligence process.
Trust
There has to be a large amount of trust no matter what all the business docs say. You have to see integrity in your entrepreneur and be able to trust that this person won’t screw you later on, because business contracts still can’t protect you 100%. Fundamentally, you need to trust the entrepreneur and he has to be trustworthy.
Be Wary of Business Guys With No Technical Partners
It’s not that I don’t think business only teams can make it big, it’s just that in this day and age it’s more expensive to run an internet business as just a business guy with an outsourced team, which results in increased burn and increased need of capital. And you have to ask why this person can’t court another technical founder to help – is there something wrong here that you’re missing?
Be Wary of Entrepreneurs Who are Building for Businesses They Have No Experience In
Most of the time the idea is great. But then I ask if they have any real world experience in the area they are building in and that’s where I get them most of the time. I don’t like it when people are theorizing about how a certain market is or isn’t. They will most likely find problems that they have no experience tackling. It’s better to find a company who has a veteran of the industry they are tackling so that they have at least have some first hand knowledge of what goes on in that industry.
I know that many would argue that entrepreneurs often need to adapt and dance back and forth a bit before they find their sweet spot. My only issue with this is that learning takes time and they may not have enough time to learn before their money runs out. This is especially relevant at the early stage where we angels often play.
Reputation is Everything
Totally agree here. Build your brand by being a good angel, useful and helpful to the entrepreneurs.
Learn the Terms, and Don’t Just Trust the Entrepreneur to Treat You Right
I spent a lot of time and money, and doing a lot of deals before I could get a broader understanding of all the terms and legal speak of term sheets. It’s tough to keep track of all that. It’s also tough to understand the effects of all the terms in each situation. Experience helps you learn, and, unfortunately, making mistakes.
As I mentioned before, I asked my lawyer to help me understand the terms. But also get a good lawyer to review every term sheet for you and point out what is good and bad and explain why. I have found many angels to barely seem to care about the terms at all. They just “trust” the entrepreneur. I think this is bad. I think you should not fall into this kind of behavior and get a good lawyer to work with you on your angel investing.
If you can affect the terms to your favor, I would advise you to try no matter who is leading. I have also even been able to affect the terms AFTER the financing was over, so it never hurts to ask if you are the last one into a deal and you find something not to your liking.
Selecting a Good Lawyer
It’s unfortunate but I have not met many lawyers who are experienced in the early stage. There are many who have done larger financings at later stages but not many who have done a lot at early stage. I can tell you definitely that there are differences. For example, there are terms that are just not appropriate at early stage but fine for later stage. You don’t want to burden at seed financing negotiating over these kinds of terms, or waste money doing so.
Interview your lawyer for their experience in early stage financings. Get referrals from other angels.
Board Seats
In the companies I’ve observed, I think that taking a board seat should only be done if the person taking it can add value beyond that of just watching over the investors’ money. I’ve seen some pretty ineffective board members and I’ve seen some that were amazing. The amazing part comes in when the company needs to be sold or needs business deals or needs additional funding. Board members with lots of industry experience and connections can make or break whether a company is going to die today or live on.
If you’re just there to watch over the money, then i’ve heard horror stories of board members whose only mission was to protect the investors and not care what happens to the company.
How Much of the Company Should I Get After an Angel Investment?
Assuming you’re not doing a note, I originally set my goal for getting about 1% of a company with a $50K investment. Before the current economic climate, I was seeing deals raising about $1MM on a $4MM pre-money valuation. This seemed like a reasonable benchmark at the time. But now times have changed a lot. The valuations have dropped quite a bit and now you can get more of the company for the same $50K. Still, I see many startups trying to raise money at pre-2008 valuations and I just pass on them because I know there are better deals around the corner. This where having a good finger on the pulse of seed financing can help greatly.
I Don’t Do Notes
Sorry all, too many misadventures with notes, even those with caps. Read about my misadventures here. It’s too risky and troublesome for me.
Assume You Lost the Money As Soon As You Invest It
Definitely you’ll sleep better if you think this way. If you can’t let go of your money, angel investing is truly not for you.
Matchmaking and Connections
Your job after you invest should be to go out and meet people who can help your startup. You should keep a rolodex of these connections and cultivate them, because you never know when any of your startups might need their help.
Don’t be a passive investor and not help. You want to increase the odds of your startups’ success, and not be dumb money.
Invest with Other Helpful Folks
When you have a group of well connected, motivated individuals you increase the chance that a company will succeed, as the other investors will apply their connections and expertise to the startup.
Never Invest By Yourself
Again, you can increase the odds of your startup’s success by having a pool of helpful investors. If you invest by yourself, you only have yourself to help and the startup may need more than you can give. Incent others by including them in the deal. Forcing the entrepreneur to find other investors can also lend some more validation to the business idea.
Don’t Invest in People You Don’t Want to Hang Out With
Like Naval says, why would you want to give money to people you don’t like or don’t care about? Once you invest, you’ll be involved for a long time. Remember that. You can’t just walk away from an angel investment. There is no cash out and washing of your hands of a deal afterwards.
Make Sure the Company Raises Enough Money Before Sending Your Money In
I’m guilty of doing this for sure. You need to make sure a company can get enough money to survive before you put your money in. You don’t want to just extend out when a startup will die by giving them a little extra money. You want to give them enough money to survive to a good place. So commit, but make sure the entrepreneur has other money committed and coming in before you give your money in.
Don’t get entranced by the excitement of the business idea and want to see it started NOW, so you put your money in now thinking that it’s going to be all right. It may not be all right. You may have just wasted your money on letting the company run a little longer and then it dies.
Angel Investing Return is Not About the Money
My return is not all economic. I find it extremely satisfying to work with young, smart entrepreneurs and sharing with them my experiences at Yahoo, and helping them with their businesses and products.
This also helps me to consider invested money as “already spent” and not stress about whether that money is coming back or not.
I also consider it a challenge to see if what I think will work for a company really works. Thus, I apply my expertise and advice to my companies and am gratified when they do work (and bummed, and learn a lot when they don’t).
This is partly why I started advising when I invest. I get part of my return from working with the entrepreneurs. But I also want to make sure they really want my help and are not just telling me, then get my money, and don’t bother to talk to me. By executing an advisor agreement, this really creates the commitment from the company that they do want my help and want to engage me in that way. I’ve also walked away from deals because they did not want my help like that. It’s OK; remember…discipline to stick to your plan!
It’s an Individual Thing
In listening to Angelconf, you’ll find that most angels are consistent with many operating strategies. But then you’ll see some who’ll say one thing and another say something completely different on the same topic. A lot of that goes to what experiences they’ve had in the past, whether they were VCs before, or got burned on something in the past.
The important thing is that you need to figure out how you want to work and then stick with it (unless shown that you should change of course). Don’t go and tell someone else that they should do something your way. Their way may work perfectly well with them and it can be dangerous to adopt a new way of operating if you’re not able or ready to make it work that way.
How do I compare to other angels out there? Or to your own operations if you’re an angel?

Information Architecture: Blueprints for the Web 2nd Edition

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My good friend Christina Wodtke (with Austin Govella) just finished the second edition of Information Architecture: Blueprints for the Web and I just finished reading it.
Most of the book is filled with very valuable, basic information about information design for websites, like basic principles, balancing users/technology/business, information organization, navigation and other really important details in designing today’s websites. However, the real gems of this edition are the two chapters on search and on social/community design.
Christina is a recognized expert in search. She ran the search UX team for a long time, during a period when Yahoo! feverishly tried to catch up to Google in search. I remember talking to her about all the things they tried and discovered about search, and uncovered about how Google deals with search. Really crazy stuff that is down to the pixel level on how it affects response and the amount of dollars generated. So she exposes some of what she discovered here in her new book; mostly it’s about the UX and UI of search which is very relevant and important. I guess you’ll have to hire her (and pay her tons of money) to really do a deep dive into how search is tweaked by the big boys.
The chapter on social/community design breaks down the various important aspects of this area of design nicely into parts so that a designer can understand everything easily. It dives into important topics like identity and relationships, and how to manage them. Then it discusses what kinds of activity take place in social applications and how to create a design that encourages activity and doesn’t stymie it. Usually we here bits and pieces about how to deal with social sites, but this book just gathers a lot of concepts into one place, which is really valuable.
I’d definitely say this is a “must read” for all information architects both new and old. If you’re new to IA for the web, read the whole thing; if you’re an old hat, take a look at the chapters on search and social spaces and you’ll find that your money is still well spent.