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Things I wish someone had told me before I started angel investing (rongarret.info)
602 points by lisper on July 16, 2017 | hide | past | web | favorite | 205 comments

> But the cool kids don't beg. The cool kids — the ones who really know what they're doing and have the best chances of succeeding — decide who they allow to invest in their companies.

The company I was an early employee of (that ended up being a "unicorn") was not a cool kid, and we certainly were begging people to invest both at the angel stage and (especially) the series A stage. And those people got a really really good return on their money.

This isn't to say there aren't valuable signals perhaps involving "cool kids" status, but there are a lot of diamonds in the rough.

> I figured it would be more fun to be the beggee than the beggor for a change, and I was right about that.

As a much smaller time angel investor myself than the author, I'm still the beggor. You are only the beggee if you are writing 25k+ checks (and more like 50k-100k to really be the beggee). If you are writing 5k or 10k checks, you are going to be begging people to take your money, cool kids or not cool kids. So if you are looking to get into angel investing today without allocating 6-figure amounts to your hobby, I wouldn't advise doing it for ego reasons :)

How is it that a $10k check even gets a startup to take your call? That pays like one engineer for a month, if that. (Genuinely curious)

A $5k check will give a super-early-stage "startup" (two or three college kids) with no salaries and about $1000/month burn rate ("living expenses" in the right market outside of SV) about four months of runway. You'd have to approach at a sufficiently early stage (like so: http://velocity.uwaterloo.ca/funding/velocity-fund/).

What share of the company would you expect for that kind of investment? If the amount would be trivial then why would you bother (little reward for so much risk), but if it's non-trivial then why would they accept your money, given how small the amount is compared to the value of their sweat equity?

If they really believe in what they're doing, they won't want to give chunks of it away so cheaply. Conversely, if they're willing to sell on those terms, wouldn't you be concerned that they aren't serious?

>If they really believe in what they're doing, they won't want to give chunks of it away so cheaply. Conversely, if they're willing to sell on those terms, wouldn't you be concerned that they aren't serious?

If they're college kids or new college hires, you'd probably banking on them not knowing how valuable whatever they're making is.


Angel Investors get huge stakes for their small high-risk outlays.


> We have a new standard deal at YC—we’ll invest $120k for 7%.

> This replaces our previous standard deal of on average $17k for 7%, plus a SAFE that converted at the terms of the next money raised for another $80k.

Originally, before they invented the SAFE, there was no SAFE in the deal

In my experience founders taking a 5-10k check often do it as a favor to an advisor they like and who can't afford to invest more. Maybe the advisor helped them out in the past, or their personal brand or connection are relevant to the startup.

Considering that "cool kid" founders do engineering themselves and that they typically don't pay salary to themselves, 10k could cover their initial hosting or say hardware prototyping costs.

"Cool kids" should not be taking 10k checks except as a favor, every investor they take on and have to maintain a relationship with is a potential distraction to the business. I'm lucky to have more than enough capital to run my business until we're done prototyping and ready to start growing.

Or it pays one skilled non-tech employee for a YEAR here in China. I'd gladly take $10k in exchange for 0.5-1% at this stage.


...says Madeline44 and Nathalie45. Your username generator algorithm is lacking.

Group investment clubs. Get a group of 20 guys each putting 10k in and you get 200k. These exist in B.F. Indiana so they must be elsewhere too.

10k pays for ten months of an engineer in Turkey and many developing countries.

It's either part of the entire round, or it's gonna go to a founder, one of whom is an engineer if it's a tech biz, and it'll feed them for 2-3 months while they get the prototype together.

There are usually several of these $10K ones, especially from angels the founders like and want to have a longer term relationships with. Also, most initial development is either outsourced or done by the founders.

For someone who needs to support a family and with a fancy office it's nothing. But for some kids in a garage it will come a long way.

> This isn't to say there aren't valuable signals perhaps involving "cool kids" status, but there are a lot of diamonds in the rough.

Yeah, it entirely depends on where you're positioned as an investor. If you have great deal flow, then you can limit yourself to cool kids. But if you're more obscure, it makes sense to seek a comparative advantage with undervalued companies.

> we certainly were begging people to invest both at the angel stage and (especially) the series A stage.

Oh, sure, but angels typically don't lead series A.

And yes, finding needles in haystacks does happen. But for any founder who really has the knack, it only happens once :-)

OP didn't claim that the cool kids always succeed, or that the uncool kids never succeed.

Just that they have higher odds.

the article-writer OP claimed "There is a small cadre of people who actually have what it takes to successfully build an NBT [next big thing], and experienced investors are pretty good at recognizing them." which is hilariously and demonstrably wrong.

we already have one person chime in with a counterexample (the person you replied to) and that is a very common experience. No, experienced investors are not pretty good at recognizing them. It's hilariously wrong to claim they are.

Benchmark Capital has a pretty small number of bets, and a pretty high hit rate, from my perspective. They certainly seem better at picking than most.

Though I'd say a lot of that is of course positive selection - the best founders self-select to Benchmark/Sequoia/A16Z, and to Greylock/Accel.

They could be awful at recognizing them and only invest when founders show up with a box pooping out bars of gold already, and not at any point before then, since they're so awful at recognizing them.

so you can have a 100% success rate (investing only in founders that show up with a box already pooping bars of gold) while having a 0% ability to identify successful founders.

a high hit rate does not mean you can evaluate founders correctly.

If they keep growing into bigger boxes pooping gold, then you've done a pretty good job as an investor. It's all about IRR; if you invest and your investment grows, it doesn't matter what stage you invest at.

Keep in mind that for every Series C company that's pooping gold bars still 90% will fail, and a lot of investors are gonna lose money investing at that stage.

of course, I said "100% success rate", under the scenario I sketched they're great investors. I just showed that this doesn't mean they can recognize the cadre of people who have what it takes. They could be 100% successful while having 0% ability to recognize anyone whose boxes aren't pooping gold yet.

> investing only in founders that show up with a box already pooping bars of gold

will get you a 100% success rate at getting conned, btw.

Genuinely curious if your choice to group those investment firms is intended to imply something about them - such as they generally work together/compete with each other, belong to the same tier, etc.

Yes, due to tier.

>Benchmark Capital has a pretty small number of bets, and a pretty high hit rate, from my perspective. They certainly seem better at picking than most.

Of course some investors have better results than others. That would happen if they were all choosing to invest or not at random.

And numbers backing the claim would help. A lot. I'm inclined to believe it is all a craps shot.

There is a small cadre of people who actually have what it takes to successfully build an NBT, and experienced investors are pretty good at recognizing them.

I really do question this. The "problem of induction"[1] comes into play when you start talking about pattern matching and learning from "experience". That is, there's no guarantee that the future will look like the past.

Before Zuckerberg was Zuckerberg, I wonder how many people would have said "Hey, I recognize in this kid the innate capacity to be an NBT"? Of course they got funded, but I believe most of it was after they already had demonstrable traction.

On that note, one of the things that makes fund-raising such a drag, is that so many angels (at least in this area) want to see "traction" before investing. Even though, typically, you would thing that angels are investing at such an early stage that nobody would really have traction yet. Maybe it's just that the angels here on the East Coast are more risk averse.

[1]: https://plato.stanford.edu/entries/induction-problem/

And also memory is very tricky. I imagine there are lots of people who met Zuckerberg thought he didn't have it took, but now believe they always thought we was going to succeed. That's why I suggest angel investors write down everything they thought about an encounter with someone immediately after the meeting. Why you think they'd succeed and fail? Then when you follow them in the future you can compare your notes to what happened and learn. Otherwise it's really easy for your brain to put together a completely unrealistic view of what happened in the past based on what's happened since.

I remember an article where someone said they were doing this in the Army, writing / saying "this guy has the potential to be great" or "this guy will wash out quickly", and discovering 20 years later that their predictions had no relationship to reality. (Can't find that article anymore though.)

I think you're talking about this, which was cited in the book Grit: https://www.ncbi.nlm.nih.gov/pmc/articles/PMC3910317/

I believe that was a mention of something like that in Thinking, Fast and Slow.

In Facebook's amazing case, Zuck got $500K from Thiel almost immediately out of the gate, after a little traction and a bunch of backstabbing as to who at Harvard college controlled the company.

I totally agree. In not so many words, the author explained how implicit bias works. It's not so different from the processes that shape the incoming classes of prestigious universities.

Want to know why these people can be recognized by experienced investors? At least part of the reason is that they know who looks like an NBT builder to other experienced investors. I would assert that this makes a massive difference in a founder's ability to close rounds and continue executing.

There's tons of companies like Clinkle, where the founder literally and figuratively looked just like Zuckerberg. Looking the part doesn't guarantee success, but it often does guarantee a few huge rounds of funding, at very impressive valuations.

Clinkle got $25million before they even built a product, from the tsunami of money raining down all over Silicon Valley post-Facebook IPO. Very different from Facebook which actually had traction.

Well Sean Parker and Peter Thiel seem to have picked up on it in the very early days. Not to mention the fact that the two biggest/best VC funds co-investing for the first time, letting them take money off the table.

It's fair to say those weren't average reactions.

Every successful company will have a list of early investors. But not only is the list of those successful investors inconsistent (some startups were backed by Founders Fund, some by Sequoia, some by KLCB, some by Benchmark), the list of companies within the portfolio of a single investor (Founders Fund, to pick your example) is far from being 100% homeruns.

I recall seeing a comment by Paul Graham somewhere to the effect that Zuckerberg set off his "founder detector" very strongly. This was after Zuckerberg was successful, admittedly, but it at least gives some suggestion that someone skilled at recognizing founders would have seen his potential.

Unless you saw something else, he was making a joke about having his own biases, not that he could identify Zuckerberg due to keen founder detection instincts:

> And Graham knew that he had his own biases. “I can be tricked by anyone who looks like Mark Zuckerberg. There was a guy once who we funded who was terrible. I said: ‘How could he be bad? He looks like Zuckerberg!’ ”


No, it wasn't that. I don't see it on paulgraham.com. It was probably an HN comment.

You're probably thinking of this interview at startup school: https://youtu.be/MGsalg2f9js (7:40)

It wasn't a comment on HN, but during an interview (video) he did with MZ on YC. I don't have a link, but that may help.

Zuckerburg was telling a story of how he built a "social" website to share notes for an art history class, except he didn't have any notes himself but got everyone to share theirs so he could pass his exam. This supposedly was an early experience that started him thinking about social websites and sharing online.

PG then commented how his internal alarm was going off saying "fund him. Fund him", and how even though it was too late he can't shut off his brains instinct to sniff out good founders.

> Zuckerburg was telling a story[...]PG then commented how his internal alarm was going off saying "fund him.

Is this a story about PG's amazing "founder detector" or perhaps one about the learnable skill of telling a good story to potential investors?

It's a story of how PG loves people who are "naughty" and know how to combine technical chops with an "screw over everyone around me to get ahead" attitude. AirBnB is the quintessential YC story.

Video is https://youtu.be/MGsalg2f9js at 7:40

The author makes good points here. While it's true that YC and other venture investors invest in many companies to increase the chances of large returns on the best of their portfolio companies, there is another significant advantage to YC having a bunch of companies in each batch - the teams that are not doing so well are a source of talent for the teams that are doing well. At some point YC can and has encouraged teams they think aren't making enough progress to join teams that are. A friend in one batch described his batch consisting of: 1/3 working on great ideas/products that could be big, 1/3 working on mediocre ideas/products and 1/3 working on bad ideas/products, and those in the bottom 1/3-2/3 still had good team members that could be sourced for talent for the best 1/3 and for previous YC companies doing well.

YC also basically does a lot of training, mentoring, etc. I don't know how much of that most angel investors provide. But YC is not merely rolling the dice. They are also doing a lot of weeding, watering, making introductions, sharing wisdom, etc.

So, pro tip: If you want to successfully invest, treat it like gardening rather than gambling.

The YC network effect is the secret sauce. Most YC companies would not even be able to bootstrap if it wasn't for YC alums like AirBnB.

Definitely. For an organization that spent a decade teaching startup the importance of building moats, it's no surprise that they've built their own.

If they hadn't built such a moat it would surely be irony but wouldn't have unusual to do what they preach

This is a really interesting point about YC. I've heard before that in markets some companies need to fail, their talent and assets act as "fertilizer" for helping the other companies grow.

That's how STARS are born!

Ron was one of our investors in FathomDB, and that turned out to be a bad financial investment, much to my personal dismay & regret.

However, something that I think the essay modestly overlooks is the non-financial elements. The investors made a huge difference in my life & that of the others that worked for FathomDB. I like to think that we moved the industry forward a little bit in terms of thinking about modular services (vs a monolithic platform-as-a-service) although it turned out that the spoils went mostly to the cloud vendors. Many of the ideas developed live on in open-source today.

Of course, this all serves Ron's point in that it doesn't make for a good investment. But that doesn't mean that no good came of it - and it makes me want to work harder next time so that it is both a good outcome and a good investment.

So: thank you to Ron and all our investors. It is no accident that you are called angels.

Every single word in this article burns clear and bright and true. Every word. Every paragraph. Every penny paid for every hard lesson learned.

If you want to get into the angel game in 2017, and you want to do it to make money, then I'd sincerely advise you to go take out $5-10k for a weekend in Vegas, and try to get really good at a game of complete chance, like roulette.

"Good" at roulette, you're thinking? What can that possibly mean?

It means having a large bankroll and knowing your tolerance for burning through it. It means understanding how to pace yourself, so that you're not blowing through your bankroll in the span of a few minutes. It means getting the itch out of your system, if, indeed, this is merely an itch.

Can't afford to fly to Vegas and blow 10 grand in a weekend? Don't get into angel investing. You can't afford it. I say this not as a snobby rich asshole, but rather, as the sort of nouveau-riche asshole who lost quite a bit of money many years back, doing exactly what the author did, and losing money I learned in retrospect I didn't really want to lose.

I still make the occasional investment, but as part of a group. By and large, those investments go to founders we've worked with before, or who come highly regarded. We invest super early, we eat a fuckton of risk, and we expect to lose 99.999% of the time. We're too small-time to play the game any other way at the moment.

Angel investing is about bankroll and access, and if you're wondering whether you've got the right access, you don't. So you're left with bankroll. Have fun, and try to get lucky if you can help it. :)

Yeah angel investing seems to be a wealthy mans game. You probably need to make at least 10 bets to have a chance at earning your money back. I did a little research and it looks like the first YC batch was comprised of 9 companies. Two of those companies, Reddit and Loopt, likely generated all the returns for that batch.

PG agrees you, he wrote a whole essay about the subject in 2012 [1]. At that point in time, he wrote that "just two companies, Dropbox and Airbnb, account for about three quarters of [YC's value]."

[1] http://www.paulgraham.com/swan.html

Well written post, especially the first paragraph.

Thanks for using the term "nouveau riche". Don't know why, I haven't heard it since college, but made me laugh.

My 2 cents - As an investor or potential employee when analyzing a startup, pay close attention to how scrappy and capital efficient they are. Do they have excessively nice office space? Are the founders making too much in salary? Does it seem like the executives are working like animals, or do they have the big company mindset where they take it easy? Startups are nothing like established, revenue-generating companies and the mindset should be entirely different.

The #1 thing a startup can do to survive is to be as stingy as possible with their capital.

It’s all a balance act. My last startup went bust in part due to the fact that we avoided hiring as long as possible in order to save money. In doing so we missed our inertia when we first started and we’re hot, and as we dragged on we didn’t have the diversity of talent to help do the things we were bad at (and didn’t want to do) ourselves.

Obviously super fancy offices, lavish meals, etc should be red flags, but you can’t generically say “be stingy” – it’s more like find the most efficient way to use your capital (which may include seemingly inefficient things that are actually required).

> My last startup went bust in part due to the fact that we avoided hiring as long as possible in order to save money.

While not going bust, I had a similar experience. In the early stages, you think you can do everything yourself, and you can. Network, hardware, software back and front, systems, the lot.

So once we had a little success I found it very hard to get my cofounders to spend a bit of money on some relief. Ended up paying up for some guy who wasn't compatible, and let him go soon after, which soured their taste for hiring entirely.

Lean, not stingy. It's about reducing waste. I'm on my third company, stingy would kill us, waste would kill us. But, gotta buy the things you gotta buy, when you gotta buy them. Critical difference between Lean and stingy. Maybe frugal is the right word.

> gotta buy the things you gotta buy, when you gotta buy them

I would add, I think it's usually best to wait until the need is crystal clear. "We think we're going to need this in a few months" is not generally a good reason to spend money now, even if the case seems airtight. Circumstances can change. Of course the exception is when the purchase is needed to start a chain of events that you need to initiate, even though it won't come to fruition for a while.

i have been lucky - multiple exits, 1 unicorn (and more importantly half a dozen fails)...and in that experience stingy always wins in hindsight. if it doesn't feel painfully stingy, be more stingy. the future You will thank you every single time, regardless of outcome.

I was part of a startup where the founders were older and the team was older. The technical competence and the competence of the team were amazing but I wouldn't characterize the team as "working like animals." However, the founders were pretty loaded and put in the initial 1-2M. We had a pretty good exit after less than 2 years.

Surely you can succeed without working like an animal? You probably can't take it easy like with a larger established company, but it doesn't mean you have to run yourself to into the ground in order to be successful.

Normal employees should work hard but not ridiculous amounts. Executives, whose compensation is highly tied to stock value, should be animals, at least in the early pre-revenue stages. That is my opinion.

Well, it's a marathon, not a sprint. A CEO that isn't taking care of him/herself isn't taking the long view. Sacrificing your health and not making time for thinking big thoughts is a bad way to lead a company.

There is a small subset of people who are able to work 80+ hours weeks without end (and are also intelligent, conscientious etc.). I think a significant portion of highly successful people belong to this group.

There's a big difference between working super hard and working so hard that your health fails. If you aren't pushing 60 hours a week, you aren't even trying. At a startup, so many things are out of your control, but one thing you can control is working hard. All that time and effort, and failing because some other company out-hustled you is the worst reason to fail of all.

Burn-out is a thing. A CEO that isn't making time for focussed reflection can very easily get stuck in 24x7 fire-fighting mode. A tired, burnt-out CEO won't be finding creative solutions to problems.

The game of international capitalism is one where if you aren't working both smart and hard then somebody else is going to eat your lunch and leave your company's corpse on the side of the road.

Most ideas don't exist in a vacuum and until you get your name associated with your market you're running the risk of someone faster stealing the buyers' hearts.

When you see startups blow millions a year on AWS spend because its "easy", when you could do the same on dedicated hardware for 1/10th or even 1/100th the price, it always shocks me.

Yes, queue the comments about "Total cost of ownership", past the point where you cant afford an OPs person(s) (which you will eventually need for AWS anyways) AWS is a money-sucking black hole.

It's not about the hardware. It's about what happens when it breaks--which it will--and when you need stuff you can't reliably build off the top of your head--which you will.

The axe you're grinding is profoundly weird, and indeed a large part of my business is because the stuff we build is extremely cost-competitive with dedicated hardware. Difference being that I can open up the console and start shooting servers and nothing breaks. You're not saying the same with the overwhelming majority of naive "dedicated hardware" deploys, especially at the levels of skill and expenditure that small companies can employ.

I don't see anything "profoundly weird" about it (a bit specific, maybe, given the rest of the conversation).

You're right, of course, about naive deployments. But it just isn't that hard to build reliable systems, assuming some experience. And if you're doing anything more interesting than pretty CRUD forms (say, atypical storage or bandwidth requirements), DYI becomes much cheaper, fast.

To reiterate, yes, you need someone who knows what they're doing on the systems end. But you will anyway at some point, and making that hire earlier can pay for itself.

I am a huge proponent of self-hosting, but there's other considerations when it comes to doing something like cloud - namely, CAPEX vs OPEX (Capital Expense vs. Operating Expense).

Having your own equipment is a CAPEX and investors don't like to see those on a balance sheet at all due to various accounting reasons. Mostly its seen as a burden. Cloud is an OPEX and investors seem to prefer renting to owning.

Personally I don't understand why spending 3x more is more attractive to investors, but often the technical reason being right is superseded by the business logic.

For RDB? Sure. For EC2? Depends on many factors. Storage per safe, backed up and versioned gigabyte? Can't see anyone competing there.

Hahaha. Work like an animal for some guy who is semi-retired. Pass on that deal.

Do you have the money to fund it yourself? Do you have the network you need to greatly increase your chances of success at each stage? If so, definitely take that option. If not, the semi-retired guy isn't semi-retired because he gives his money to people that aren't highly motivated and hungry for success.

If you don't want to found a billion dollar company from scratch, you don't have to. Someone else will.

Are any of those things issues at Angel stage?

It's pretty much the same issue as with FizzBuzz: You'd be completely shocked at the insane ratio of people passing already the very basic smoke tests of good due diligence.

I was hoping for a fact like

"And this is how I made 42 investments in my first 3 years. All are now bust, and I am out 1.4 million dollars"

Obviously not fun to tell the world how much money you lost, but it would help to add color to the people behind the VCs, that developers love to see as the frenemy (terrible people out to screw you, but man their money is nice sometimes).

Looking at what other people did and how that turned out is completely useless because the things that matter are the day-to-day details which you can only get by immersing yourself in the process full-time for a long time. So sharing that data would be worse than useless. At best it would serve to satisfy some prurient interests, and at worst it would cause someone to act on what cannot be anything other than hopelessly incomplete data.

But there is one detail I will share with you: I decided to start not in high tech because I thought it was too risky, but to get my feet wet by starting with less risky investments. So I decided to invest in a real estate development in 2006, thinking that even in a worst case scenario there's an asset there that will be worth something no matter how badly things go wrong.

Like I said in the OP, you will be shocked at how things can fail. (And this is far from my only horror story.)

FWIW, I've also had some winners along the way. I'm not poor, just poorER than I would have been if I'd just put the money in VTI.

Are most angel investors focused on finding the 1000x companies (i.e. the NBT) that VCs are?

I guess my question is what's a practical, good outcome for an angel investor when a company exits? Or what rate of return do the most successful angel investors have?

I was in denial about this for a long time, but the fact of the matter is that your overall outcome is almost entirely determined by your outliers. If you take all of the investments I've ever made, including going to work as an early hire at Google, the I've won. If I leave out Google, then I've lost. If I leave out my single biggest loss, then I've won again. If I leave out my next biggest win, then I've broken even.

Did "not spending 1 more year as an employee at Google" cost you more or less than all of your later wins?

More. And by a huge margin. Leaving Google early was by far the most costly financial decision I've ever made in my life. But I don't regret it. You have to focus on the money you made and not the money you didn't make or you'll be miserable no matter what happens because no matter how well you do you could have always done better in hindsight.

Very interesting, thanks for responding.

You bet.

With hindsight would you take the same path with your career and funds? I find myself at this crossroad right now, both financially and professionally, so found your article useful - thank you.

If you're asking me this question because you hope my answer will inform your decision that's the wrong reason to ask. This is an intensely personal choice, and what you want out of life is very unlikely to be the same as what I do (that's what makes trade possible!) I'm glad I did it despite the fact that it cost me a lot of money because I know that if I hadn't tried I would have regretted it more than I regret the lost money. But that's just me.

> Like I said in the OP, you will be shocked at how things can fail. (And this is far from my only horror story.)

Did I miss the story, did you talk about it somewhere?

Paragraph 6 (but no, I did not get into specifics)

I prefer the phrase philanthropy to angel investing. As I understand it philanthropy is using your own hard earned money for lost causes of one's own choosing. This is different to fundraising or giving money to charity. With a modest philanthropy budget you can change lives and be able to support others achieve their dreams. Everything can be on an individual basis with no formal framework. For instance, what happens if you pay someone's way so they can finish their degree? What is the potential return? Or, more radically, what happens if you find a homeless person a place to live? Do they get a job and return to society? These things can be found out with radical personal philanthropy. I would say there is good value in this if you do want to learn about society and the human condition. I also think that financial and time losses are an investment. This type of work where you really do invest in individuals should help anyone angel investing to have the chops to do it well.

Yes, a failed business is called a hobby.

So fundamentally as an angel you're in early. That usually means that you face dilution. I also wouldn't think it would be that unusual for the business to make a pretty dramatic pivot or two and that initial angel investment may have been for something else entirely by the time the company finds its legs. There are basically 3 things you can do in that dilution situation: 1) Do nothing and go from basically owning the business to not. (You still get to watch and be part of the ride) 2) Pony up more money to match the big investors, assuming the terms allow it, or 3) Fight it or any change every step of the way.

A VC once told me that there were "good angels and bad angels" Too many bad ones and he wouldn't invest. A couple specific bad ones and he wouldn't invest. To that, there are also good angels that will make introductions, spend time coaching, and really help beyond what I'd call a "hobby." It seems like there are good people out there with money and knowledge and they really want to help out others in an angelic sort of way knowing full well they will likely lose their investment.

> As an angel you're in early. That usually means that you face dilution.

I've always wondered why early investors don't include an anti-dilution clause in the contract? It could be structured in many ways, but it could be simple as "my share of the company will always be 18% (or whatever), no matter what, until I sell". Then when the company takes on more investment, it'll be up to the new investors and the company's accountants to do whatever share adjustments to keep you at 18%.

There must be some really good reason(s) why this isn't done and I hoping someone can explain.

Makes it much harder to raise future financing, which is bad for everyone.

A company who has given away equity with anti-dilution is much less attractive for a new investor. If 30% of the company is allocated on anti-dilution, that means everyone else without anti-dilution is fighting for the remaining 70%. ALL future dilution comes out of their share. It acts like a dilutive multiplier.

So any new investor is going to want anti-dilution also. But there's only ever 100 percent. So you end up with new investors trying to force old investors to sell (or tasking the founders/board with doing so). This is not uncommon in reality.

BTW, most anti-dilution works by allowing existing investors the option to put in more money with each new round. I.e. they can "top off" their equity to X%, but only by investing more. So as an angel, you might have invested $100k for a few points, but to stay topped off in future rounds, you start having to invest a lot more as the valuation goes up. Not everyone has the desire or liquidity to do that.

If you are going to take on follow up money someone is going to get diluted. So where is it going to be? Squash the founders until they have no upside? Then why would they stay? When the money is this early, it has to be the existing investors. Some come in on the next round for a smaller number to keep their percentage fixed.

From working in a lot of very early stage companies, the two things I have seen is that some of these angels don't understand that the 10K they put in will probably need two more fundings of the same size before things get to an A round. Also, too much funding isn't tied to the right kind of metrics from the start. It is mostly about being cool and disruptive with no plan for the early customer and measuring everything from the beginning to truly know the health of the startup. ymmv

Why should you get free money from later investors?

While the points Ron raises are really good, there is another source of investing error which is "generals fighting the last war" effect. As an Angel investor you are drawn towards founders and companies that resemble you and your experiences. This is almost certainly going to lead you astray as conditions will have changed and everyone's experiences are so limited.

I was actually thinking of mentioning this, but there is a very strong counter-example: Google. One of the reasons Google went unnoticed for as long as it did (both Excite and Yahoo passed on opportunities to buy it for <1M) was that everyone thought that the search engine market was mature.

In fact, I think this is one of the reasons so many people are trying to re-invent Facebook. If Google could re-invent Excite and Facebook could re-invent MySpace (and Reddit could re-invent Digg) then why can't someone re-invent Facebook? And maybe someone can. (I sure hope so!)

Actually the "fighting the last war” effect was the reason everyone passed on Google. Almost all the VCs (and other companies) thought the search war and been fought and won five years before. Rather than looking at Google from an unbiased viewpoint (that Google was the first to solve search), they saw it as the 17th competitor in a mature market.

I think the difference with Facebook is the network effect and that it is run by Zuckerberg. What ever failings Mark has a CEO he has one amazing strength which is a single minded focus to let no competitor to Facebook rise. As he has shown time and time again he will buy you out or outspend if you have any possibility of being a competitor.

> Actually the "fighting the last war” effect was the reason everyone passed on Google.

Yes, that was exactly the point I was trying to make: Google is a counter-example to the theory that you should not fight the last war. (On the other hand, it is also a positive example, because no one has been able to displace Google despite there being no shortage of attempts.)

> What ever failings Mark has a CEO he has one amazing strength which is a single minded focus to let no competitor to Facebook rise.

In the world of business, this is well illustrated by the market dominance of SAP. They have, and will buy out, or compete out startups that encroach on their market. This is why they are still the top pick for the biggest companies in the world.

Successfactor comes to mind as an example.

when you look at MS, Apple, Amazon, Oracle, Google, Facebook, what really sticks out is that all except Google had incredibly ruthless founder/CEOs. Google somehow made it big on a few good hosting deals, amazing software engineering + math, inventing the online advertising economy

Summary: beginners almost never invest well.

And it is the same for stocks, many people think they will make money by investing in a specific company because their logic says it is good idea.

Investment is a job, and to win you need experience

> Summary: beginners almost never invest well.

Investing in startups is closer to betting on horse races than stuff like the S&P 500 or buying bonds.

There're a lot of people who will sell you systems. There's a lot of form guides. In a booming economy more people take a flutter on the fillies. And every once a while a thoroughbred emerges that is simply unstoppable.

But in general, only the bookies win.

The main difference is that in horse racing you can bet on a single horse and in the course of a few races, you'll probably bet correctly and make a little scratch.

In startups you can only bet the trifecta: you'll probably never hit it in your entire life, but the payoff is much higher if you do.

>And it is the same for stocks, many people think they will make money by investing in a specific company because their logic says it is good idea.

Probably like FizzBuzz, we'd probably be shocked at the amount of people that wouldn't default to lazy-3 or an index fund based portfolio.

I don't know of a good metric someone should study fundamentals before they'd be considered "ready" to invest in individual companies or options.

Depends on what kind of investment. If you want to win, but don't care how, just buy a broad index.

This blog post is also showing, however, that it is possible to make experiences without learning much. He doesn't seem to have figured out how it works, because that part is still rather unclear in his text.

and, must like gambling, the winnings are very skewed towards the top small percentile. so, even if you know more than 90% of participants, you will probably get owned.

>There are a myriad ways to make a company fail, but only two ways to make one succeed. One of those is to make a product that fills a heretofore unmet market need, and to do it better, faster, and cheaper than the competition. That is incredibly hard to do. (I'll leave figuring out the second one as an exercise.)

Is he implying some sort of unethical behavior as the second way?


[UPDATE: before you downvote this answer you should know that I am the OP.]

Oh, I have totally missed that part. Happy to see that you didn't lose the money without learning something.

What decision have you made? Howling with the wolves or getting back to being a sheep? I'm still unclear in this part and actually hoped for some suggestions in one or the other direction.

Bah ah ah ah ah. ;-)

Seriously though, I do have a strong preference for erring on the side of being ethical and respectful of others. (But that could be the reason none of my companies have succeeded.)

Something specific, or just unethical behavior in general?

Not "in general", but there is a long list of unethical behaviors that, sadly, can contribute to success. Selling snake oil. Abusing monopolies. Flat-out lying.

However, it's not good to go to the other extreme. I've seen companies fail because the CEO bent over too far backwards to be ethical and as a result let people walk all over him. One of the qualities that seems to be required in a successful founder is a willingness to be an asshole when circumstances demand it (and being able to tell what those circumstances are!)

You have to be willing to drive a hard bargain, but that's not unethical, nor does it make you an asshole. I'm not sure being an outright asshole is ever required. Do you think it is?

Yes. Mainly when dealing with other assholes.

Okay, I can see that :-)

Bill Gates, Steve Jobs, Larry Ellison, Jeff Bezos, and Mark Zuckerberg agree that being an outright backstabbing asshole is required.

Larry Page and Sergey Brin do not.

Anyone who defends Uber's behavior is shouted down. Are Uber's actions an example of necessary assholish behavior? In particular their Hell application for tracking Lyfts, which required using Lyft's APIs?

The problem with this vague advice is it leaves it to the reader to interpret what is and isn't ok. And readers are notoriously bad at this.

> Are Uber's actions an example of necessary assholish behavior?

No, I don't think so. But I have a conflict of interest here because in 2008 I made my own attempt at starting an Uber-like thing (I called it iCab). It failed before launch because we were unable to get any of the local cab companies to work with us. The idea of using black cars never occurred to us, so Travis gets props for that. I think he's gone way too far towards the dark side. But on the other hand, he succeeded where I failed so take that into account when deciding how much weight to give my opinion.

> The problem with this vague advice

Well, the problem is more fundamental than that: it's a judgement call, one which always depends on a totality of the circumstances at the time. I can't give you a formula for how to decide how ass-holey to be, just as I can't give you a formula for making any of the other myriad decisions it takes to successfully build a successful company. If I could do that, I'd be running my own successful company instead of wasting time hobnobbing on HN.

I would argue that you were simply too early to market, now that Uber succeeded there are a ton of cab hailing apps trying to keep cabs relevant.

Anyone can say they were too early to market as the main reason for their failure.

The idea of hailing cabs electronically is not new. A confluence of factors helped Uber figure out how the idea could work, in hindsight.

> "The idea of using black cars never occurred to us, so Travis gets props for that."

lisper is right: using blacks cars was a much better strategy than trying to negotiate with local cabs in trying to gain traction

iCab started almost a year after Uber (it was called Ubercab back then). And there were half a dozen other also-rans that started about the same time.

You seem to be contradicting yourself then if you say "iCab started almost a year after Uber" when you wrote above that: " But I have a conflict of interest here because in 2008 I made my own attempt at starting an Uber-like thing (I called it iCab).

Uber was not yet a thing until 2009.

Yeah, sorry, my mistake. iCab started in late 2009.

Let's not forget stealing. Letting someone else do the hard work of figuring out the Next Big Thing and then taking over is very profitable.

It's not _required_ to be unethical, it's just really tempting when you see others get rewarded for their unethical behavior. "When circumstances demand it" is of course the excuse of all unethical people throughout history. Total weak sauce.

Try being the only one without a pile of patents on important tech in a patent war. Offensive use of patents + piles of money from market share and their own lock-in are among the reasons newer, big players are holding off older ones in the patent suits designed to eliminate competition with older ones. Originally, I thought I could just avoid what was patented until I learned how vague and ridiculous they are. Plus, there's said to be 200,000+ patents that could cover smartphones alone. Where would I start if doing legal, due diligence? Then, maybe I'd license them for a fair amount. I found NDA'd offers, high-balling, and even I.P. holders suing people w/ Oracle demanding $25 per Android phone for its tiny slice of smartphone patents, Java, or whatever. So much more honest licensing.

So, status quo for tech companies is to not read on patents (avoid knowing infringement), grow as fast as they can no matter what patent laws they violate, accumulate their own patents where possible for use in self-defense, and build up lawyer money. One day, when the attacks come, the company will be ready for a solid defense where it claims it didn't know about the patents, they're void, or they're overpriced. This might also be leverage for a better deal during an acquisition.

The operating environment is unethical in its very nature with certain things such as patents, trademarks, copyright, lock-in w/ formats/protocols (eg walled gardens) and so on. So, those that can use them will get a financial advantage. Those that don't might get so much less of the market they get squashed or denied a fortune they could be doing a lot of good with. Lots of grey areas to think through in these sorts of things.

> Lots of grey areas to think through in these sorts of things.

Smart people can come up with elaborate justifications for anything, if they take the time to "think it through". Arguments that "they could be doing a lot of good" is basically "the end justifies the means". That's the opposite of morality.

Maybe an executive is doing a lot of good and so it would be bad for society if he went to prison for a hit-and-run. Better cover up the crime so the good guy can keep doing the good things he so goodly does. All for the benefit of society, of course.

You have an unusual set of ethics there. What you're describing for patents is not violating patent law, and I doubt you'd find many people in the tech industry who would equate potentially infringing someone's patent to adopting source code you don't own into your product in a copyright-infringing way.

" What you're describing for patents is not violating patent law"

The law says I can't reproduce what's in a patent without permission/license from the patent-holder. The law also says that your intent doesn't matter: unknowingly infringing is also a violation but with less penalties. The big players defining markets or entering mature ones file patents on as much of them as possible to maximize chance new competition will infringe on one of their claims. They also acquire companies for their patents. So, newcomers often have to violate patent law or pay some large amount to a bunch of companies just to get their product in the market if keeping it legal.

Or they just build, grab market share, and pretend patents don't exist. That's how almost all of them make it. The alternative is endlessly Googling patent databases about almost everything your business is doing in tech. I say good luck to a startup or SME trying to do that.

"You have an unusual set of ethics there."

The above advice was given to me by people who create patents for big companies. They said it's what their employers do. It's not my ethics so much as the only option that works without putting one player in a defensive, weak situation. That player still might get hit by NPE's, though. Whatever isn't deterred will involve a big payout to patent-holder or a bigger payout to lawyers that, if defense fails, results in an even bigger payout to patent holder.

"I doubt you'd find many people in the tech industry who would equate potentially infringing someone's patent to adopting source code you don't own into your product in a copyright-infringing way."

In their minds, that might be true. It wouldn't surprise me given that patent provisions aren't in a number of FOSS licenses. In legal reality, they're both a monopoly on a something that require a license to legally use. Thanks to bribery of politicians, the game is also rigged in favor of patent-holders and big incumbents most of the time.

You're explaining patents to someone who has a bunch of them! "Breaking the law" or "violating the law" is generally used to indicate a criminal case; patent lawsuits are not criminal cases.

By the way, my patent lawyers (both in startups and at a big tech company I worked at) tell me that patent cases are crapshoots and there's no good way to predict what's going to happen in them. This also means that I really don't have any idea if I'm actually infringing someone's patent, even if I knew about it. Which I don't, because that advice to never read anyone else's patents is good advice for any inventor.

I agree, but there is also subtle difference between unethical and asshole. You can be ethical asshole.

"Asshole" was used in contrast to being "too ethical", so from the context it cannot mean anything except for "unethical". If the parent meant "asshole" in the conventional sense (e.g. parking in two spots) it would make no sense to bring up in this discussion.

The parent is rationalizing unethical behavior by classifying it as merely assholish. If you read the post carefully you can see the point where the cognitive dissonance takes place. The parent even said "the other extreme" is being too ethical, so he's clearing arguing that acting too ethical is undesirable.

If you are not unethical _and a competitor is_, the competitor will have an edge.

Most unethical behavior doesn't pay. Some unethical behavior is staggeringly profitable. I don't want to go into detail, because the less known these things are the better.

I think there are two main cases:

1) business models based on the exploitation of others, and

2) low margin businesses where ethical players get crushed by those willing to take unethical/illegal shortcuts.

Luckily you _can_ become successful even if you rigidly adhere to the highest ethical standards, you just have to choose your business model carefully.

My immediate thought was more along the lines of companies that were built for acquisition -- either for the team or a technology (without business model).

Good point. I've only spent a limited amount of time in startup space but it seems this intention is usually considered more as a possible path rather than an intention. It's a common accusation but seems outlandish and unnecessary to me.

If anyone thinks this is wrong, please say so. I'm interested.

This is reasonable -- I think companies that get a solid team together and then look for a quick acquisition is a way for top players to capture something closer to their market value. Or as a way to develop good tech that a big player is interested in, without having to deal with the specifics of profitably monetizing that tech.

I don't understand why he'd be cagey about telling us that, though.

Isn't that basically one of two possible paths for a startup? It seems like these days, most people aim for an "exit", ie. either an IPO or acquisition by one of the big companies. You don't often see people talking as if their endgame is to keep running and growing their company indefinitely.

All of the focus seems to be on getting to the next series of funding. The survivability metric used is not income over burn rate, it's investment dollars over burn rate. The whole goal is to get as big as possible then exit.

You can keep running and growing your company indefinitely after an IPO, the liquidity provided just helps you grow faster by also leveraging the business' equity.

My two cents, heavily influenced by Blank's book :)

While any sentence-long description will be an oversimplification, I think fitting everything under the sun in a "1st way" is counterproductive. If all we're talking about is how they succeed with Ron's components in mind, then there are at least a few ways.

I see the the need-being-met thing as a spectrum. The more unmet the need is, the less likely competition is a problem at that moment, so just solving it is sufficient (who knew having a car was actually a 'problem' versus purchasing transit from 'a' to 'b'?)

I've also seen that sometimes a product that focuses on a niche and does it REALLY well is better (for that niche) and NOT cheaper, but they succeed too (e.g. Veeva).

Sometimes a product that focuses on the lower end of the market is cheaper and not better (i.e. functionality) but ppl underestimate the long-tail of non-users. (maybe like Gusto vs. traditional payroll providers or RelateIQ vs. Salesforce)

On acquisitions, I've heard that acquihires usually make little-to-no money for the investors. But as beambot also mentioned, the business could be acquired for hard tech that, even if no customers/bizmodel, some other business would find value in having (maybe like Facebook>Friendfeed or Linkedin>RunHop). But to reverse engineer that from day 1 I imagine would be even harder than building a product to an unmet need haha. You don't know if the bigger co is working on it internally or if they'd scoop up somebody else. Wonder if this was Meerkat's plan, gone awry <-- speculation. ¯\_(ツ)_/¯.

One of those is to make a product that fills a heretofore unmet market need, and to do it better, faster, and cheaper than the competition

That's note quite true. You might choose to compete on, say, price, but that certainly isn't required. Likewise, you don't necessarily have to have a better product, if you are so much more operationally efficient that you can sell you product cheaper than the competition. It would be better to say that you need to be better than your competition in some combination of "better, faster and/or cheaper".

For more on this topic, I recommend The Discipline of Market Leaders by Fred Wiersema and Michael Treacy.

It's the "do something illegal that people really want, then force politicians to rewrite laws or face the ire of their constituents" business model. Not sure if that's unethical or bold. When it comes to taxi laws, I view the laws as unethical, and challenging them as bold. OTOH, I see hotel laws as providing a necessary constraint on the cost of housing.

It worked as the foundation for several now big startups, but was the perhaps ethical breaking of said rules some kind of gateway drug to unethical behavior? Kinda looks that way in Uber and AirBNB's case.

And then again breaking perceived rules, ideas like Big Oil will be here forever or you have to be a defense firm to get a rocket launch contract, is bold and lucrative (or apparently future-lucrative). There is a fine line between bold and foolish.

My guess is the second consists of pretending to do the first, so 'dishonesty'.


I wonder how often VCs/angels are conned out of money (and I don't mean by delusional entrepreneurs, but by genuine con-artists). I assume it must happen, and with all the money sloshing around may be common.

I would say it's extremely common. Fake it till you make it is almost expected. Even the cons don't think they're lying.

I'm of the opinion that a lot of VC's are like money managers. Index funds regularly beat their returns but that doesn't stop them from think they're God's Gift.

VC's seem to be much the same. There's a lot of "black magic" to the funding process. In my experience, something that can't be logically understood usually has no logic behind it. Some of the VC's probably have real metrics but it becomes statistically impossible to find success using logic when you only fund a handful of companies a year. There's not enough data.

I think the most common instance is the middle ground, where an entrepreneur can clearly see systemic issues with his/her company, but still raises funds to keep the gravy train going.

Being a good investor takes a certain kind of temperament. Can't really teach this. For most, as Buffet says, stick with the index fund.

Thank you to the author for sharing your experience and insights. Some tips for being a better angel investor and reducing risk: 1) I can't stress this enough - learn the ABC's of private investments. I have seen a ridiculous number of angel investors as well as founders who don't understand the fundamentals of private equity investments and returns - even people who have been working at a startup for several years. 2) Limiting yourself to meeting with and investing in startups an industry in which you've worked, so that you understand their industry, better evaluate them and add value 3) Limiting yourself to meeting with and investing in startups in industries in which you or close colleagues and friends have worked so that you can consult with them regarding the potential investments 4) Joining an angel group, such as Band of Angels, so that you have a group of fellow angels to learn from and discuss investments with 5) Meeting with successful serial entrepreneurs who make angel investments to ask what they look for 6) If you have not founded a company or worked at an early stage startup, learn Lean Startup methodologies 7) Make sure you understand how a startup achieves product-market fit 8) Put together a list of good people and companies who can help startups you invest in, with everything from operations to tech to growth There's much more, but this is a start.

> There are a myriad ways to make a company fail, but only two ways to make one succeed. One of those is to make a product that fills a heretofore unmet market need, and to do it better, faster, and cheaper than the competition. That is incredibly hard to do. (I'll leave figuring out the second one as an exercise.)

Any guesses on the second way?

The best I could think of was: find dumb investors to pump it full of money and hype it. Then rely on all the hype to get it sold.

I'm hoping for a less cynical answer!

Cap table economics are an equally-important reason to fear angel investing. Unless the company is very successful, angels tend to get diluted-out of the money by VC rounds. In the baseball vernacular, angel investors must pick triples and homeruns to make money. Singles and outs will result in total loss. Doubles may break even. It's a tough way to get ahead. Impossible without some insider edge (YC, pundits, stars, etc.).

Seems to me acting as a lone Angel investor is not very efficient and quite limiting to the kinds of opportunities that are open to you. It's analogous to the constraints you face with as a lone founder of a startup. Maybe better to team up and benefit from each other's insight and capital. And totally agree you have to do this seriously as a job unless you don't care about the money.

> There is a small cadre of people who actually have what it takes to successfully build an NBT, and experienced investors are pretty good at recognizing them. Because of this, they don't have trouble raising money.

That's a pretty specious statement. I don't know how he came up with that; it certainly doesn't match with a lot of reality.

> I don't know how he came up with that

By looking at history. If you look lists of the most valuable startups the vast majority of them didn't have any trouble raising money. In fact, I can only think of a single recent (last 10 years) counterexample.

Alternatively, this just shows that it's hard to build the NBT without funding.

The causality definitely runs both ways. If a company is perceived as an NBT, and that results in investors piling on, then the company is that much more likely to actually become an NBT. That's one of the reasons investors like to pile on: just because a prophecy is self-fulfilling doesn't make it any less accurate (just the opposite in fact).

You can't point to funding at a later stage (everyone sees that something's a hit a pile on) and work back to say that those were the only founders who could pull that off. You can't prove a negative.

You're saying, "Only a few seeds 'have what it takes'. Experienced gardeners see that and so they give those seeds water."

What lesson should this teach founders; don't discount the importance of `looking like` the NBT?

Or it could show how most investors are still very unsophisticated and insecure. They don't want it to be the NBT, they need for it to be. If the music industry was this bad, you would mainly be hearing variations of Taylor Swift and Justin Bieber on the radio.

The lesson for founders, therefore, should be to avoid investors for as long as possible.

Just because you have a different experience than the writer doesn't mean that either experience is invalid.

This post reminds me of "the war of art" where you're encourage to make the decision right off the bat of whether or not you're a professional or an amateur.

I'm somewhat biased when it comes to angels because most of the experiences I heard (http://etl.stanford.edu/) were almost always homeruns. Sure there's the down in the gutter claims every investor tries to sob about where they lose money but let's be honest wouldn't it be great if someone gave a talk and said how much they lost (and how much they're continuing to lose) by attempting to get rich quick.

So far bootstrapping appears to best way of weeding out the shitty angels who haven't been in the game for a minute.....it's a pleasure to not deal with someone wanting to give you a check while telling you what their expectations are for YOUR business not their 10k+ check.

>One of those is to make a product that fills a heretofore unmet market need, and to do it better, faster, and cheaper than the competition. That is incredibly hard to do. (I'll leave figuring out the second one as an exercise.)

Anyone figured this out?

I am realising that a weekly exercise on 'inversion' should be a must-do for founders/investors.

Inversion essentially means think hard about: "What factors can cause my venture to fail?, How to avoid those factors?"

This sounds simple but it could be a very powerful idea. https://www.farnamstreetblog.com/2013/10/inversion/

Off-topic, but lisper, congrats on your neat HN karma points!

  It's 222-2222
  I gotta answering machine that can talk to you

Interesting read.

I'd love to hear from other angel investors with (perhaps) different experiences and opinions.

my experience is that good deals are only available/viable/mutually beneficial when you have direct personal, close connections (please stop sending LinkedIn messages!) to the team. "retail" investing doesn't succeed in this arena.

my opinion is that you should only invest as a lone/lead angel in what you know from your long history in a super niche space where you know all the important cognoscenti from a career full of personal interactions...anything else is a guaranteed loss. fine if you use it as the OP says to learn about a market. though would be better IMO to just volunteer to work at a startup in a new area and learn by doing...which I have done and found highly educational and ultimately rewarding.

The author has mentioned "random shit that markets do, like completely ignore clearly superior products..."

Can anyone give me such examples?? I am curious.

Most obvious example is when an enterprise software / hardware startup will have superior product than bigco in their space. However, bigco sales & marketing budget and status quo stop the startup from gaining enough traction for success.

Betamax (vs VHS) comes to mind. As does Microsoft (vs Apple).

Prices played a critical role in both examples, but one can put forward that the product was evidently superior than the alternative that ultimately prevailed.

Perhaps the key is to invest in what you know?

Not if you want to get in on the NEXT new thing. By definition, you don't know that.

Good news: I can agree with some of the OP.

Much better news: I do believe that it's fairly obvious that there are good solutions to the most important problem mentioned in the OP.

First a remark on scope: I'm talking about information technology (IT) startups based heavily on Moore's law, the Internet, other related hardware, available infrastructure software, etc., and I'm not talking about bio-medical technology which I suspect is quite different.

Second, a remark on methodology: When the OP says "almost certainly" and similar statements about probability, sure, (A) in practice he might be quite correct but (B), still the statement is nearly always just irrelevant.

Why irrelevant? Because what matters is not the probability, say, estimated across all or nearly all the population, or all of business, or all of startups, or even all of IT startups. Instead, what is important, really crucial, really close to sufficient for accurate investment decision making, is the conditional probability given what else we know. When the probability is quite low, still the conditional probability -- of success or failure -- given suitable additional events, can be quite high, thus, giving accurate decision making. So, net, what's key is not the probability but what else is known so that the conditional probability of the event we are trying to evaluate, project success or failure, given what else we know is quite high.

So, back to the OP. We can start with the statement:

> The absolute minimum to play the game even once is about $5-10k, and if that's all you have then you will almost certainly lose it.

Here for the "almost certainly" to be true needs to depend on what else is known. Sure, if not much more is known, then "almost certainly lose it" is correct. But with enough more known, the first investment can still likely be a big success.

The big, huge point, first investment or 101, is what else is known.

> There is a small cadre of people who actually have what it takes to successfully build an NBT, and experienced investors are pretty good at recognizing them.

I agree with the first but not with the second. From all I can see, there is hardly a single IT investor in the US who knows more than even dip squat about how to evaluate an IT investment. E.g., commonly the investors were history or economics majors and got MBA degrees. Since I've been a prof in an MBA program, I have to conclude that a history or economics major with an MBA has no start at all evaluating IT projects.

Here is huge point:

We can outline a simple recipe in just three steps for success as an IT startup:

(1) Find a problem where the first good or a much better solution will be enough nearly to guarantee a great business, e.g., the next big thing.

(2) For the first good or much better solution, exploit IT. Also exploit original research in high quality, at least partly original, pure/applied mathematics. Why math? Because the IT solution will be manipulating data; all data manipulations are necessarily mathematically something; for more powerful manipulations for more valuable results, by far the best approach is to proceed mathematically, right, typically with original work based on some advanced pure/applied math prerequisites.

(3) Write the corresponding software, get publicity, go live, get users/customers, get revenue, and grow the revenue to a significant business.

So, right: Step (2) is a bottleneck: The fraction of IT entrepreneurs who can do the math research is tiny. The fraction of startup investors who could do an evaluation of that research or even competently direct such an evaluation is so small as to be essentially zero.

So, net, the investors in IT are condemned to miss the power of step (2) and, thus, flounder around in nearly hopeless mud wrestling in a swamp of disasters. And, net, that's much of why angel investors lose money.

So, the main problem in the OP was losing money on IT projects. The main solution, as both an investor and an entrepreneur, is to proceed as in steps (1)-(3).

For IT venture capitalists (VCs), they can't use step (2) either, e.g., can't do such work, can't evaluate such work, and can't even competently direct evaluations of such work, but they have a partial solution: Likely enforced by their LPs, in evaluating projects they concentrate on cases of traction and want it to be significantly high and growing rapidly.

So, with this traction criterion, and some additional judgment and luck, some of the VCs get good return on investment (RoI), but they are condemned to miss out on step (2).

So, what is the power of step (2)? As we will see right away, clearly it's fantastic: Clearly with step (2) we can do world changing projects relatively quickly with relatively low risk.

The easiest examples to see of the power of step (2) are from the US DoD for US national security. Some of the best examples are the Manhattan Project, the SR-71, GPS, the M1A1 tank, and laser guided rockets and bombs, all relatively low risk projects with world changing results. Each of these projects, and many more, was heavily dependent on step (2) and met a military version of steps (1) and (3).

More generally, lots of people and parts of our society are quite good at evaluating work such as in step (2) and proposals for such work, just on paper. We can commonly find such people as professors in our best research universities and editors of leading journals of original research in the more mathematical fields.

I started some risky projects, e.g., an applied math Ph.D. from one of the world's best research universities. From some good history, only about one in 15 entering students successfully completes such a program. The completion rate of applied math Ph.D. programs makes the Navy Seals and the Army Rangers look like fuzzy, bunny play time. With much of my Ph.D. program at risk, I took on a research project. Two weeks later I had a good solution, with some surprising results, quite publishable. Later I did publish in a good journal. I could have used that for my Ph.D. research, but I had another project I'd pursued independently in my first summer -- did the original research then, in six weeks. The rest of that work was routine and my dissertation. While working part time, the Navy wanted an evaluation of the survivability of the US SSBN fleet under a special scenario of global nuclear war limited to sea, all in two weeks. I did the original applied math and computing, passed a severe technical review, and was done in the two weeks. Later I took on a project to improve on some of our work in AI for detection of problems never seen before in server farms and networks. In two days I had the main ideas, and a few weeks later I had prototype software, nice results on both real and simulated data, and a paper that was publishable -- and was published. My work made the AI work look silly; it was. Once in a software house, we were in a competitive bidding situation. I looked at what the engineers wanted and saw some flaws. Mostly on my own, I took out a week, got good on the J. Tukey work in power spectral estimation, wrote some software, and showed the engineers how to measure power spectra and how to generate stochastic process sample paths with that power spectrum. As a result, my company won sole source on the contract. So, before I did these projects, they all were risky, but I completed all of them without difficulty.

Lesson: Under some circumstances, it's possible to complete such risky projects, given the circumstances, with low risk.

But IT VCs can't evaluate the risk before the projects are attacked or even evaluate the results after the projects are successfully done. So IT VCs fall back on traction.

I confess: It appears that the IT VCs are not missing out on a lot of really successful projects. Well, there aren't many IT startups following steps (1)-(3).

So, for IT success, just borrow from what the US military has done with steps (1)-(3).

The problem and the opportunity is that nearly no IT entrepreneurs and nearly no IT investors are able to work effectively with steps (1)-(3), especially with step (2).

The IT VCs have another problem: The know that for the next big thing -- Microsoft, Apple, Cisco, Google, Facebook -- they are looking for something exceptional. And they know that those for examples have very little significant in common. Still the IT VCs look for patterns for hot topics at the present or recent past. That's no way to find the desired exceptional projects. E.g., when the US DoD wanted the Manhattan Project, they didn't go to the best bomb designers of the previous 20 years; doing so would not have resulted in the two atomic bombs that ended WWII. Instead, the US DoD listened to Einstein, Szilard, Wigner, Fermi, Teller, etc., none of whom had any experience in bomb design.

> We can outline a simple recipe in just three steps for success as an IT startup:

You might as well put a sticker on your forehead that says, "SUCKER."

Four of my investments (including a startup of my own) were absolute slam-dunks according to your process: large, well-established markets, orders of magnitude price-performance improvement over the competition, good IP protection. They all failed.

Like I said: unless you are very, very lucky, you will be absolutely be shocked by the creative ways the universe will come up with to screw you.

Fill us in; why did they fail?

I've seen a lot in business, and I never saw anything as challenging and perverse as your "creative ways the universe will come up with to screw you".

The worst I heard of was law suits by patent trolls.

For "secret sauce" in IT, that's in software locked up in the internals in a secure server farm. Tough to know just what is in that. Tough to get a judge to force you to present all your software to some troll without a lot of good reason.

There can be collusion in restraint of trade, but that's much harder to do now than 100 years ago.

There can be nuisance law suits, but the usual response is that those are too much work and trouble if the defendant is small and too little chance of winning if the defendant is big enough to defend themselves.

I saw a lot of how FedEx grew; some Teamsters were angry, but all they wanted was the usual, just money. Your statement of the perverse universe was not the case at FedEx.

I've seen some families do well with life style businesses. They commonly had problems, e.g., union problems, but they didn't have anything line your perverse universe claims.

Somehow I doubt that IT startups will have union problems anything like what was common in some old US businesses and industries some decades ago.

1) key employee has an old discounted investment make them independent and they take flight (didn't see that coming.. they seemed all in)

2) dot-com bubble and crash. Simultaneously freezes investment and convinces everyone that internet related startups are hokum. We survived and exited at less than a quarter what we would have had. It didn't matter that we had positive cash flow and gazillions of thrilled customers.

3) major media company quietly puts copyrighted material onto your system, sues you for copyright infringement based on that same material and spends years in discovery. You win, but lose.

4) the very clever marketing guy your investees just hired turns out to be a plant by the giant competitor who leaks your marketing plans like a sieve back to self-same giant competitor.

There are gazillions of other things the universe can do to you.

1) Yup, employees can leave. We know that. If have a "key" employee, then need some strong reasons they will stay, and even with those reasons they may leave because of something about their marriage, children, health, etc. If you promised them stock and are 18 months late, then they may get pissed, not trust you, and leave. They may get run over by a truck, etc.

We know that.

That's why the founder should be the main key employee. Or, if have a key employee, then maybe they should have a deputy that can fill in in case of an emergency. That's why there are carefully thought out compensation plans for key employees, e.g., unvested stock options.

Once I was in a little company. Since there was some question about my status, I circulated some resume copies. In that little company, some instances of good work I'd recently done made me essential to our business with one potentially good customer and with our main customer. One of the resume copies got me a better job offer, and I took it. As I submitted my resignation letter, soon late at night I got a phone call from the CEO of the little company: He told me that he would accept my resignation "with prejudice" which didn't really mean anything. He was also drunk at the time.

Part of the job of a CEO is to keep key employees happy. That CEO had been treating me as excess baggage, with the mushroom treatment (keep the employee in the dark and feed them BS) until I became important. Then at one point, in the hall, as apparently an off hand comment, with some resentment and no details, elaboration, or discussion, he said "You are becoming an important person around here". Actually I'd just done some work for a week I'd never told the CEO about, work that thrilled our main customer and in effect got us sole source on a competitive software contract. I didn't yet know how important my work was, and I didn't know that my CEO knew anything about it. But apparently some high up guy at our main customer (the US Navy) called my CEO and had a chat about my work. So, as of the mushroom treatment, not letting an employee know they were doing well, etc., my CEO didn't discuss my exceptional work with me. So, all he did was just make the resentful remark in the hall. He was happy as a clam until he got my resignation letter which suddenly put his future with the two customers at risk. He was CEO of the little company, but that little company was just a subsidiary of a much bigger company; so, no doubt, from losing two big chunks of business, the CEO's job was also at risk. He was a dumb CEO.

2) Yup, the year 2000 bubble and crash hurt a lot of startups. But for a startup, the flow of more equity capital is always a really bad crap shoot that can be affected by anything including the hemlines of skirts of teen girls, sun spots, and a war in central Africa, or a drought in the Amazon valley. A startup just CANNOT depend or count on (count chickens before they hatch) on future equity capital. Similarly for future M&A deals.

Instead, if the customers are still happy and the revenue is still there, then that's about the best can hope for; in bad times, commonly anything more than that can be just a red cherry on top of whipped cream on top of ice cream on top of a waffle. Until the bad times pass, what's real is just the waffle. For the going business, just keep that going, be glad there's no second Great Depression, be glad some one customer, the source of 75% of the revenue, doesn't go bust, etc., keep the revenue going, please the existing customers, try to improve the business in promising, incremental ways, accumulate the after tax earnings, keep watching for better times, and be thankful for what do have.

3) Sure, there are lots of ways some lawyers can look for billings. One way is nuisance law suits. So, sure, maybe start your business as a sole proprietorship. As soon as have any decent revenue look into business insurance to protect you from nuisance law suits and pay a lawyer to set you up as an LLC. Then get to relax for a while. If are small, then filing a nuisance law suit against you is not worth the time, expense, and effort. But if are small and some lawyers do file, then -- IANAL but just thinking out loud about what I'd consider doing -- let them sue the LLC. Shutdown the LLC and restart the business under another name; contact the old customers, etc. and keep going under the new name. Also patch the legal hole the lawyers used to attack you. Also, as soon as have any decent revenue, talk to some lawyers and get some protection against nuisance law suits. E.g., I just saw a disclaimer by a major company saying that they don't accept, look at, or use unsolicited ideas from outside -- right away I kept and indexed a copy of that disclaimer and will be sure to use it when and if appropriate. Generally, need some protection against law suits from unsolicited outside contributions -- IANAL, but likely YouTube has some legal walls against such attacks.

Once are a significant company, do check with more than one high end business law firm and business insurance firm on being protected.

4) Sure, can have spies, worms, saboteurs, agents of competitors or unions, thieves, etc. So, use some standard precautions, e.g., the standard rule in security, "need to know". Maybe have some bonded employees. Look into some security firm checking the security of your organization, say, something like a white hat hacker would check the security of your server farm or other computers. Keep the intellectual property crown jewels nicely locked up. When still small, for the daily incremental backup data, maybe have the CEO take those home and store them in a box in his den; have multiple copies of full backups stored with great safety, off site, etc. Make good use of encryption. Etc. Nothing here is new; we're not the first to consider such things; so, there should be some good advice readily available.

> Fill us in; why did they fail?

That would take a book. Or at least a lot more blog posts.

If there could be a book, then there's enough for a blog post for the four cases you mentioned.

As it is, you are telling me that during the night aliens will attack my business, leave without a trace, but have my business in ruins by 8 AM in the morning. Your claim is the first I ever heard of such a thing.

Having orders of magnitude better price/performance is amazing. An "order of magnitude" is usually a factor of 10; those are not easy to come by. Leading examples include Moore's law, hard disk drive capacities, solid state disk drive capacities, optical fiber data rates, wireless data rates, and floating point operation rates in GPUs. In any market of any major size, typically customers just LOVE some factors of 10 better price/performance, and any company that is the sole source of such an advantage should have nearly a license to print money. What went wrong? Anxious readers are eager to know! You have an attentive audience waiting!

> you are telling me that during the night aliens will attack my business

That's right. That is exactly what I am telling you. Aliens. Definitely aliens.

> Your claim is the first I ever heard of such a thing.

What can I say? You heard it here first.

> Having orders of magnitude better price/performance is amazing.

Yes. It was.

> those are not easy to come by

Indeed not.

> What went wrong?

That's a long story. But the TL;DR is that we underestimated the difficulty of launching new infrastructure.

Here's some background:


> You have an attentive audience waiting!

And I also have a lot of other demands on my time.

The Flownet article was nice. I got reminded of lots of old networking stuff, e.g., ATM.

From about 1980 to about 2000, LAN technology was a chaotic war. The war part was from all the competitive battles. The chaos was from all the different technologies, often to address some of the issues in the link you gave. There was no cheap, easy, perfect solution.

So, there were the various versions of Ethernet. Also there was token ring. And of course ATM, really intended for voice and video streams. And I forget some of the clever addressing ideas.

The problem was, year by year, all the ideas that looked good one year were swamped just by much faster data rates the next year. Finally, TCP/IP let the lower levels be sloppy, e.g., have dropped packets, out of order packets, goofy packet timing, etc. For streaming (not conversational) video over TCP/IP, just have a lot of data rate (that is, a network with much more data rate than might think would be needed) and buffer at the receiving end.

Flownet looks like a nice solution for a problem that, however, was well on the way to going away due mostly just to much faster data rates.

It's nice that Flownet was developed so nicely on Linux, so quickly, and for so little cash.

But for making a business out of Flownet, I wouldn't have tried: Basically would have to go to some big office buildings with some big LANs running Linux (so that your device driver development would work) and have them convert over to Flownet. But mostly those offices would have been running Windows for which there were no Flownet device drivers. And mostly those offices were busy, at each computer upgrade, riding the Windows, Ethernet, Cisco LAN switch and/or TCP/IP router horses. Flownet would have been a tough sale.

I know; that's easy to see with 20/20 hindsight. But those years, I was using first 4 Mpbs token ring and then 16 Mbps token ring and watching 10/100/1000 Ethernet rise. I could see that token ring was dying. Also dying was IBM Systems Network Architecture (SNA). In IBM Research, I went to lots of research presentations where the speakers were hinting how dumb it was for reliability not to go just end to end as in TCP/IP.

Flownet was a long way from "orders of magnitude" (factors of 10) better. Flownet was aimed at a market with a lot of big, powerful players -- IBM, Cisco, Juniper, and more -- and where the market was in chaos due to the rapid speed increases of Ethernet, the death of dial-up, AOL, Prodigy, and Compuserve, the use of the coaxial cable of cable TV to carry telephone and Internet traffic to SMBs and living rooms, all the legal stuff about sharing the last mile, ADSL, etc.

When the giants are in a chaotic war, looking for critical mass, setting de facto standards, and pushing data rates by 1-3 factors of 10, little guys stay out.

In broad terms, right now is a great opportunity: Get to use HTML as a great user interface well understood by 3+ billion people. Get to develop Web pages that will look good on anything from a smartphone to a work station with a Web browser up to date as of about 10 years ago. Get to exploit the Internet which for the more developed countries can easily supply 10+ Mbps data rates to everyone, fixed or mobile. Get to use Windows or Linux for Web servers, and using commodity motherboards and processors can build one heck of a Web server for $1500. Can put that Web server in nearly any room in the industrialized world that has a cable TV connection. Are just awash in powerful, often quite cheap or free infrastructure software from operating systems, data base managers, Web server and page tools, language processors, communications, etc. E.g., now the Ethernet, cable TV, ISP, Internet backbone connections and TCP/IP stack software are nearly universal and rock solid.

Now get just to build on these resources and get to avoid developing them.

Now, just think of something good to do with these resources, along the lines I outlined.

In particular, now get to stay the heck away from developing hardware, fighting industry standards, writing device drivers, hanging on by fingernails as processor clocks and data rates are increasing by more than an order of magnitude, developing your own user interface (as AOL tried/had to do), etc.

> Flownet was a long way from "orders of magnitude" (factors of 10) better.

That article was written towards the end of FlowNet, when we were already winding it down. The work started in 1990. We built our first (and only) prototypes in 1992 (self-funded). Fast Ethernet was not introduced until 1995, and at that point our BOM cost was 20 times lower because our NICs used 100% off-the-shelf commodity hardware, and we didn't need hubs or switches. So for about a year we were 5x faster and 20x cheaper. It took five years for Fast Ethernet to completely catch up with us.

And remind me to tell you the story of Tokutek some time.


You illustrated an old, back of the envelope standard for investing in new hardware: The new stuff has to be at least 10 times better than the old stuff.

I love the difference of tone between this article and the usual Silicon Valley pieces.

For me, the most important thing that Ron conveys is that being an entrepreneur is an incredibly foolish thing to do. Silicon Valley created myths of passionate geeks who worked in their mom's garages and went on to make billions. Who doesn't want that?

But the reality of Silicon Valley today is that because of these myths, most people work their twenties away for a chance to buy a lottery ticket...

I think I must agree with you on taking it as a full-time job!

TLDR; you will lose money because you don't know anything.

you can make money when you dont know anything.

correlation vs causation

you only always make money on 2/20 :o

Not an endorsement or evaluation, was simply summarizing the article. The tone was my way to indicate my disappointment with an article that failed to life up to the headline. For someone with years of experience he/she didnt share any of the details that would have made this interesting.

I remember Ron although I was unsure about the name. Fair winds and following seas.

Unless it's in your background and in your DNA, it seems that angel investing will end in tears.

Interesting perspective, but he assumes that everyone's experience will be his own. First of all, he was in LA. I don't know of many success angels down there.

It's impossible, with any certainty, for an investor to prove that his or her judgement is better than random chance. This is high schools stats.

What I take from this is that this person doesn't have a grasp if high school math or is not being honest.

Also if you listen closely to a lot of investors they'll basically tell you their metric is "can I sell this to a greater fool?". This is why there is so much investment in 'hot' areas when, in reality, those are the areas to stay away from as the unicorn shares are likely already over-priced.

"If you want to make money angel investing, you really have to treat it as a full time job, not because it makes you more likely to pick the winners, but because it makes it more likely that the winners will pick you."

plenty of good entrepreneurs have great angel investing track records doing it part time (Elad Gil, David Sacks, Aaron Levie)

The investor names only "one way" to succeed (though alluding to a second one that this investor does not name):

>To make a product that fills a heretofore unmet market need, and to do it better, faster, and cheaper than the competition.

This is an insane sentence. Let's make it only slightly more insane to throw it into starker relief:

>To make a product that fills a heretofore unmet market need that nobody has expressed or even thought about until the company announces it, and to do it absolutely perfectly, instantly without any development time, and make it free for the consumer, while getting money from a sustainable high-margin source and having a proprietary moat that makes it impossible for any other market players to enter even a similar market. Also I'll add that the company must have such strong network effect that the utility of any competitor's product is negative (people would regret getting it even for free) unless the competitor is able to get at least 98% market share.

That's pretty insane, and if you re-read what I quoted you will see it's the same kind of insanity.

Why do people even write stuff like this.



Downvoters don't understand my objection. I'm not going to edit this comment. If you don't get it, you don't get it. This investor literally named "good, fast, cheap" (except as: better, faster, cheaper) as three of four requirements that must be met. (The fourth named requirement being "heretofore unmet".) You cannot get more insane than this except in magical la-la land where there are no trade-offs of any kind. It's absurd.

It's not only a bit silly (I wouldn't say "insane"), it's trite even if it were true. It's the tech wold equivalent of "folksy wisdom" about working hard. There's sort of a truism about it, but it's not useful in the sense that anyone can use it meaningfully.

It is introduced with the sentence "There are a myriad ways to make a company fail, but only two ways to make one succeed" (where the second is left as an exercise for the reader.)

This introductory sentence does not permit the writer to follow up with folksy and false bullshit. This is like my saying "there is only one way to prove that a function will return the correct output for all input", then naming that one way (wrongly, but unironically) as "copy it verbatim from a StackOverflow answer".

The reader deserves more. Writers don't have the liberty to spread such nonsense.


Edit: I finished reading the article. It is outlandishly wrong. It says "There is a small cadre of people who actually have what it takes to successfully build an NBT (next big thing), and experienced investors are pretty good at recognizing them."

This is demonstrably false: investors are demonstrably bad at recognizing these people, who often go through hundreds of rejections (because investors are bad at recognizing them) before building the next big thing.

Really, this article could hardly be more wrong.

You know less about investing and the world than before you read it.

On the other hand, you learn more about what an angel thinks is happening, so I guess it's a wash.

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