Your first act is school, your second act is work, but have you thought about what you’re going to do in your third act? Join host Liz Tinkham, a former Accenture Senior Managing Director, as she talks to guests who are happily “pretired” – enjoying their time, treasure, and talent to pursue their purpose and passion in the third act of their life.
Inspire others to get more and to do more later in life.
Athena helps women achieve executive-level leadership expertise, polish their boardroom and executive knowledge, get closer to board seats, and make leaps in their careers.
In part one of a two-part series, Erica Duignan Minnihan—founder of 1000 Angels—begins her master class on the fundamentals of Venture Investing. This series covers the basics you need to know to build a solid portfolio as an angel investor.
Dive into this primer on startup valuations, and what to look for in due diligence materials like investor decks, financial models, and the company’s cap table. Whether you’re a founder seeking funding or an investor who wants to add early-stage private equity to her portfolio, this informative podcast will get you up to speed on understanding the exciting opportunities in startup investing and how it can launch your own third act.
1:26 What is venture investing and what are the different categories within it?
5:09 Risks of venture investing
8:00 The fun reasons to get into venture investing
9:18 Why do companies go to 1000 Angels
16:04 Diversification in venture investing
18:58 Understanding portfolio returns
23:05 How to think about investing $100,000
28:47 Industry or sector differentiation?
32:20 What makes a company investable?
38:45 Evaluating the management team
40:20 Looking at addressable market
42:09 Why do women-led companies get less funding than their male counterparts?
45:43 Evaluating product market fit
To learn more about Erica Duignan Minnihan, click here. To find more information about 1000 Angels, click here.
If you enjoyed the podcast, please subscribe and share a review. Engage with more stories of those finding fulfillment in the third act of their lives on Liz Tinkham’s Third Act podcast at thirdactpodcast.com.
Liz Tinkham (00:18):
Hi, this is Liz Tinkham and welcome to Third Act, a podcast about people embracing the third act of their lives with a new sense of purpose and direction. The third act begins when your script ends, but your show’s not finished.
Liz Tinkham (00:34):
On today’s show, Erica Minnihan, founder and managing partner of 1,000 Angels, a private venture and investment network, and Coco Brown, founder and CEO of the Athena Alliance, talk about the fundamentals of venture investing. Erica provides a primer on venture investing, what it is, the different categories of investing, how to get started, how to develop a portfolio approach to investing, and what makes companies investible.
Liz Tinkham (00:56):
If you’ve thought about getting into this asset class, this is a great podcast on what you need to know, or if you’re like me and barreled into a few friend and family investments without the benefits of Erica’s wisdom, listen as well, so you can understand how to think about your potential future investments and your role as an angel investor.
Liz Tinkham (01:14):
Today we’re playing part one of the two-part series. Part two will air in a few weeks. Enjoy this great conversation with Erica and Coco.
Erica Minnihan (01:26):
We’ll get started with what we can cover today. Some basics on what is venture investing and what are the different categories within it? What are some of the risks and rewards of getting involved as an investor in this space? A little bit about how we use a portfolio approach to be successful, and, most importantly, what makes a deal investible? So how do we determine what companies are worth investing in as outsiders versus just what companies can be really great businesses for their founders, but might not make such sense to add to your portfolio?
Erica Minnihan (02:05):
So a big part of the reason why this whole category has gotten pretty interesting is that we’re seeing so much in the news around startup finance. As somebody who spent a long career in banking and has been in this space for the last 13 years, I’d say that over the last five years or so, there’s just a lot more information going around, and stories in the media about startup valuations and what SoftBank is doing and what WeWork is doing, and why is this company worth a billion, et cetera. So I think that for folks to have a better understanding of the details at the early stage can be really helpful and of a lot of interest.
Erica Minnihan (02:53):
So when we talk about venture investing, our first question is, of course, what is an angel investor? So the second question is why do people even become angel investors? So these are some of the big questions that folks have. And so, the main thing to realize, the main differentiator is that an angel investor is a person who makes a direct investment of personal funds into a venture. It’s typically an early-stage venture as opposed to a venture capitalist who’s investing what we call OPM or other people’s money.
Erica Minnihan (03:31):
So, really, what differentiates you isn’t necessarily what a lot of people think that, oh, well, angel investors are trying to be nicer or any of that stuff. But it’s really just about who has actual control over the money at the early stage? Is it on behalf of LPs or is it as an individual? There are certain differences from the founder perspective as to the alignment of interest between those two types of investors and where they come in.
Erica Minnihan (04:05):
So this chart here shows you a little bit about the different types of early-stage investors. If we look at the axis here, you’re going to see that there is a spectrum as far as dollars raised, as well as the quality of the deal terms. You’ll see, as the company grows, different types of investors coming in.
Erica Minnihan (04:31):
So on the smaller end of capital raise, you’re going to start off with your friends and family. You’re going to start off with investment clubs and smaller angels, moving on to seed funds, and then to VC firms as the dollar amounts get larger.
Erica Minnihan (04:47):
You’ll see that as the dollar amounts get larger, the types of securities that are used and the terms of the deals from the investor perspective become a little bit more attractive and a little bit more stringent. So we’ll see the types of companies change as you move up that spectrum.
Erica Minnihan (05:09):
As far as the risks and rewards of venture investing, there are some great reasons to start venture investing. So let’s first address some of the risks. I would say that the number one risk that everybody who gets involved at the early stage needs to be aware of is that there is actually a very high risk of total loss. We’ll dig into the numbers a little bit deeper as to what you can expect as an investor.
Erica Minnihan (05:39):
Of course, that risk is there. I think people are aware of it. It can be mitigated through various strategies that we’ll talk about. But really more importantly, I’d say that the one thing that people maybe are a little bit more uncertain about is just the complete lack of liquidity. So even in the best case scenario, you tend to end up with a five to 10-year horizon before you actually achieve liquidity, before the company has an exit.
Erica Minnihan (06:13):
So those are some risks to really take very seriously and to realize that even though this asset class can provide incredible returns and tremendous alpha, there is a huge liquidity premium, or really illiquidity premium, to the investor, a very long and uncertain holding period and an absolute chance that you can lose all of your money.
Erica Minnihan (06:38):
So given all of these risks, why do people bother doing this? So, really, I would say that we always want to focus on the main objective of getting into this asset class has to be really for above-market returns.
Erica Minnihan (06:57):
A lot of times you’ll hear people, particularly when you’re dealing with female investors, be like, “Well, I want to help somebody. I want to help. I want to invest in women.” All of those things are really wonderful, but in order to be successful and sustainable in this asset class, developing a portfolio that produces above-market returns really has to be paramount.
Erica Minnihan (07:25):
The reason for that is because due to the high risk of total loss, due to the complete lack of liquidity, due to the long investment horizons, as an early-stage investor, if you’re not building a portfolio to target quite high market returns, eventually we would all run out of money to invest and it would cripple the startup ecosystem. So we as investors have to be just as diligent with how we allocate capital as the founders have to be with how they spend it.
Erica Minnihan (08:00):
So once you’ve taken that as a primary concern, I think that, of course, the next three are the fun reasons that people get involved with angel investing. And so, the first is of course, meet cool people. I have to say as an investor, I mean it’s pretty amazing. Through my work in this arena, I now know lots of people that have started multibillion-dollar companies, and people who I’ve had a relationship with since they were unknown of, that nobody had ever heard their name, but their company was not around.
Erica Minnihan (08:41):
So you certainly do have a tremendous opportunity to build amazing relationships, to see a company become something out of nothing, to learn a lot about new technology, and to be on the cutting edge. There’s a lot of fun in that. There’s a lot of excitement.
Erica Minnihan (08:59):
So there are some really great reasons for why we start that help to overcome some of the risks. I can see we have a question from Lilia that says, “How does 1,000 Angels get higher preference than professional seed funds or other large angel groups?”
Erica Minnihan (09:18):
So it’s really not so much about that we … I guess the word isn’t necessarily that you’re getting higher preference. A lot of it has to do with, let’s see, the way that an angel group or a fund might be structured. So you’ll see that a vast majority of angel groups across the country are set up a little bit more as clubs. They’re looking to do investment in companies that are local to them so you know if it’s a group in Connecticut or Westchester. They want to invest in companies that are growing around them, or in Texas, same thing.
Erica Minnihan (10:08):
Whereas with 1,000 Angels, we are pretty much 100% acting as a global network to co-invest in venture-led deals that have already had terms negotiated by a venture fund and have already had a first close and are looking to fill out a smaller amount of their round.
Erica Minnihan (10:31):
I think another part of the reason that we’re able to operate where we operate is that we just have a lot more of a streamlined process for founders. So there is actually a cost to the social element of a lot of angel networks, which is that founders are pretty aware that a lot of time they end up being used as entertainment for the group. Obviously there’s a potential for investment, but it becomes very time-consuming and the value per dollar is less.
Erica Minnihan (11:07):
So I think that’s why we’ve been able to have an advantage. We also operate a lot more like a venture fund. So even though checks are coming directly from individuals, the founders deal with us directly and the diligence process is a lot more streamlined. We’re able to bring, I think, relationships more closely to what a fund would bring.
Erica Minnihan (11:35):
So if we look at the risk profile of various asset classes, you see this chart takes us all the way from the lowest risk, treasuries, which is supposedly zero risk technically, all the way to where we’re operating at seed-stage equity for non-derivative based assets. This is pretty as far out as you can get on the risk curve.
Erica Minnihan (12:02):
So to a lot of people, that would seem somewhat scary, but if you understand portfolio theory, you can see that there can be a lot of advantages to adding a small amount of very high-risk, high-return potential assets to a portfolio. So it has to be in combination with a lot of other asset classes. But at the end of the day, this is an asset class like any other. It’s just not quite as regulated as some of the things that are lower on the risk spectrum.
Erica Minnihan (12:39):
So as you get out there, you have to be a little bit more careful about how you participate in it and get a little bit more, I would say, professional guidance, or dig in deeper with a little bit more experience in order to be able to perform well.
Erica Minnihan (12:55):
But, in theory, as far as risk adjusted returns go, we’ve seen over the last few decades that this asset class can perform incredibly well, and particularly as companies not only wait longer to go public. So it’s much longer before you even have a chance to purchase equity in some of these most successful startups. The markets also started to value things differently, not only between just the way companies are valued. In the olden days, it was like, okay, multiple on EBITDA. All that stuff is out the window. But also as there’s more M&A activity, that allows those private company investors to basically capture a good deal of returns that public market companies want to own for innovation and growth.
Erica Minnihan (13:49):
So it’s almost like a part of the economy that’s shifted off to the side to launch businesses, grow them, and capture the return on investors completely outside of the public markets. So that’s why I think it’s also been very financially successful for many of the investors.
Erica Minnihan (14:12):
But at the same time, there’s a lot of risk. So what we want to talk about today is what are some of the ways that you can reduce risk if you do want to start playing in this asset class? So, number one, we’re going to talk about diversification and its extreme importance for people who are coming into this sector, the benefits of co-investing, of course, performing due diligence. So, really, that’s why we make sure we’ve gone through the financial models, that we get to know the founders very well, that we’ve really researched the markets and the opportunity for each of the companies that we invest in.
Erica Minnihan (14:52):
Then, of course, post-investment. Investors are able to reduce some of the risk by staying engaged with the companies that they’ve invested in. So continuing to be a resource and support to them as they grow, helping them through challenges.
Erica Minnihan (15:07):
That’s another thing that some folks really like about early-stage investing is that you’re obviously women with a lot of amazing experience in networks. If a founder needs those resources or that help, you could actually be there and have an impact on the success of the company. Then just good old good record keeping. So a lot of people will make an investment and forget about it, really staying on top of, okay, what’s in my portfolio, what do I own? Were there warrants in there? Are they doing a follow-on round? Do I need to exercise pro rata rights? Just keeping on top of all that stuff helps to mitigate risk.
Erica Minnihan (15:49):
That’s another thing that we really help with at 1,000 Angels is helping our companies understand that we’re doing some portfolio management for them as a group, so they don’t need to think about it as so much individually.
Erica Minnihan (16:04):
So as far as diversification, I mean I’m sure that you guys mostly understand this. This is also very applicable to the stock market, which is that a single concentrated investment is a big gamble. But we have slightly different numbers that we have to deal with that I think make this an even more serious consideration for getting into this asset class.
Erica Minnihan (16:29):
So this is a little bit of an older study, but I think probably the most recent study that’s been done on the angel investment asset class period. But my guess would be that the numbers are still fairly the same. And that’s that for this asset class, you’re going to see somewhere between 30% and 40% of companies that successfully raise money end up in a total loss somewhere between around 30% to 40%, end up breaking even. It’s only around 20% to 30% of the companies that actually provide a positive return.
Erica Minnihan (17:06):
So for this reason, diversification becomes really key because there’s basically an 80% chance that any individual company that you invest in is either going to go to zero or, if you’re lucky, return your capital. It’s only that 20-ish percent that are the ones that are going to provide the 10, 20, 30X returns.
Erica Minnihan (17:31):
So making sure that we end up with one of those, one or two or more of those, in the portfolio is really critical to success and longevity of investing, but also to actually achieving those above-market returns. So we want to … Rather than putting a large amount of capital into a single company to spread smaller amount of capitals, a smaller amounts of investment among a more diverse group of companies.
Erica Minnihan (18:05):
So I see in this space a lot of people get really excited. “Oh, I heard this great idea. I think it’s the next big winner.” They treat it with like a lottery ticket approach. It’s just not a good thing to do. So rather than putting $100 grand into a single company, the better rule of thumb is do $25,000 investments over four companies and hedge your bets.
Erica Minnihan (18:30):
I know this seems like a really simple, obvious thing, but with startups, people end up sometimes getting a little too excited, a little too personally connected to the company, a little too wanting to put their eggs in one basket because they really love the founder. They really love the concept. But we still have to treat it a little bit more like an asset class and maintain a commitment to diversification.
Erica Minnihan (18:58):
So this chart is used for pretty much every asset class, that as you increase the number of investments, you’re able to actually minimize the risk of the overall portfolio. If we look at the numbers here, we’re using examples of three different portfolios that are comprised of companies that either end up in a total loss, a breakeven, a double. So you’ve got 2X your investment, a great exit, which would be 10X, or a home run, which would be 20X or more.
Erica Minnihan (19:35):
For this asset class, our target portfolio, overall portfolio, return really needs to be around 25% in order to be competitive with the market on a risk-adjusted basis. If you look at the example here, we can see that for investor A, if they had 40% of their portfolio in companies that ended up in a total loss, 40% in breakeven, one, they got a double and, oh, look, one they actually got a 10X.
Erica Minnihan (20:10):
So if you were at a cocktail party, this person who got a 10X would be sitting there probably just bragging about what an amazing investor they are, because, look, I had one company that was a 2X and I had one company that was a 10X, but we can see that that doesn’t even get your overall portfolio to … That gets you to almost what you would expect from the stock market on a good year.
Erica Minnihan (20:41):
So, in theory, it’s really not getting you there. So when we are looking at investments, a lot of folks think like, “Oh, well, the company says that they can double my money,” or, “This will be worth 5X in a few years,” but because of the effect of compounding and just the risk of the asset class, we really need to be looking for 10X minimum expected returns all the way up to 20 or 30X.
Erica Minnihan (21:15):
So the rate of return that you really need to demand from a startup when you invest in order for your portfolio to perform at an acceptable level is quite high. So even in portfolio B, this person had two 10X investments in the portfolio, or had 20% of their portfolio that moved into the 10X, and they still only got to a 20% IRR. This is assuming a five-year time horizon, which is not even as long as probably … Like you’d be very lucky to be on five years.
Erica Minnihan (21:47):
And so, if you look at portfolio C, this person had 40% in total loss, 30% in breakeven, one double, one 10X, and one home run. Now they’re clearing that hurdle to get to a 29% IRR.
Erica Minnihan (22:04):
So these companies actually need to perform spectacularly well on exit for you to be able to reach the IRR hurdle that makes it an appropriate addition to your portfolio to do what it needs to do. So we need to be very cognizant of the fact that the expectation when you go in, particularly for something that’s even at an A stage, has to be at least that the company has an expectation that the value of whatever security you’re purchasing should be worth 10X within the next five years, and sometimes even should be more, 20 or 30. So the cost of capital is high. As investors, we need to really think about that.
Coco Brown (22:51):
Erica Minnihan (22:52):
So I just want to break and see if there are any questions so far.
Coco Brown (22:56):
Erica, I have a question for you. Can you hear me? This is Coco.
Erica Minnihan (23:00):
I can. Hey, Coco.
Coco Brown (23:01):
Erica Minnihan (23:01):
Hear you and see you.
Coco Brown (23:05):
Hello. So, interestingly, so if you’re joining an angel investment group that has a minimum of, say, $25K investments, or another one that has a $10,000 minimum on investments, and then you also factor in follow-on rounds and participating in follow-on rounds to try to help the company along, is it then your position, if you’re going to hold 10 to 20 companies, that coming into angel investing, one should anticipate that they’re going to put in a minimum of $250,000 to maybe $1 million over that portfolio of 10 to 20 companies in order to actually be able to play the game with the odds that you’re saying?
Coco Brown (23:55):
The reason I ask that question is because I see people dabbling in angel investing going, “Well, I’m thinking about putting $10,000 in portfolio,” and you wonder, should they be doing this or should they walk into it first saying, “I am going to invest $250,000 to $1 million in a portion of my overarching portfolio that is angel investing?” It just is sort of a-
Erica Minnihan (24:20):
Yeah. I mean I love that question. It’s a really good question. I tend to say I think that what makes sense for a person who’s interested in angel investing, the … What I would say is like a really good, sane approach would be, “Hey, I’m going to invest $100,000 a year for the next four or five years to build up my portfolio.” So you’re adding four companies a year over the course of five years. That gets you to your 20.
Erica Minnihan (25:06):
It was really reflected even in the way you said it, which is that a lot of angel groups have this sense of like, oh, and we need to reserve some for follow-on so that we can help the companies. Realistically, the way that the ecosystem works, and we’ll get into some slides that describe it a little bit better, is that a company does $250,000 to $500,000 friends and family raise. So the friends and family raise will come, some from their own money, some from people who are actually family, some from high net worth individuals that they know and have a relationship with.
Erica Minnihan (25:54):
Then if they deploy that money intelligently, they’ll be a million-dollar pre-seed round, is what people would probably call that now. That million-dollar pre-seed round is really where angels would come in and angel groups should come in, where there’s been a significant amount of de-risking that it makes sense. You could put your $25,000 in there.
Erica Minnihan (26:20):
But this whole idea that, like, reserve some more money for their follow-on rounds is that, realistically, once they’ve done that million, if the company’s going on a good path, they’ll be doing a $3 million seed round, or they’ll be getting to a series A.
Erica Minnihan (26:39):
Other types of firms are going to take over at that point. You’ll probably have an opportunity to put more money in, but where I see people getting into trouble is they fund these startups a little too early and then the startups just run out of money. Then they come back to angels like, “Oh, do a bridge round. Give me more.” That’s where people end up losing a lot.
Erica Minnihan (27:03):
So I think you have to be a little bit dispassionate, that you took a flier and this happened. You have to analyze each opportunity individually, but that when you come in and you’re fulfilling that role that an angel investor should fulfill, it should not really totally be your obligation to continue capitalizing the company as they grow and become more successful.
Erica Minnihan (27:36):
So it’s great if a company’s doing really well, like we’ve seen … When we see companies where we’re like, okay, we were in their seed round and the pre-money was five. Then they knew they were getting a series A done with this fund. They did another small bridge with $7 million. Oh, maybe people want to add to their position because they know it’s going up. Now the company’s doing a series A and the valuation’s 35. Do you want to put more into exercise your pro rata alongside of a venture fund? Probably yes.
Erica Minnihan (28:12):
So you will have opportunities to re-up and add more. But I do think the strategy should really be that hopefully over the next five or six years, I can get to my 20-company portfolio target. But to very much realize that it does not need to happen overnight. It’s going to take you a while to select those companies. If you’re adding four really great investments per year, that is fine. You’re on the path to get there.
Speaker 5 (28:47):
Well, I’m curious, when you talk about building a portfolio for an individual investor, would you advise sticking to a set of companies in an industry or a sector that they understand and can potentially even get engaged and assist the company, or would you say diversify into sectors that they may not know, but that an angel group might enable them to access because other people are experts? So how diverse would you make the portfolio?
Erica Minnihan (29:26):
Okay. I mean that’s a great question. So I’m not big on sector focus. And so, we’ll look at what makes a company investible? I think the things that make a company investible are outside of the sector. So I would advise people to … It’s fine to have a more diversified approach and probably beneficial because it’d be like, oh, what if somebody decided I only want to do things that are crypto or I only want to do things that are cannabis? Now you’re bringing in a more concentrated risk factor if something happens within those industries. So I think that it’s probably smart to diversify a little bit.
Erica Minnihan (30:13):
I do think it’s important to invest in things that you can understand. But I will say from experience, I have noticed that sometimes people who have too much expertise in a certain industry can actually make not great investment decisions on things that are in their own industry. Because they know the industry so well, they tend to be overly critical of the companies that come through in that space.
Erica Minnihan (30:49):
So just based on what I’ve seen over my 13 years doing it, I would say that when people are presented with something that’s actually in a space that they have a lot of overwhelming expertise, they tend to pass on things that end up being successful because they just knew too much about it. So I don’t think it’s actually helpful to you to even do something in your space.
Erica Minnihan (31:09):
Now if we’re talking about things that are like deep technology, life sciences-heavy, biotech-heavy, most people do not look at those sectors because it’s very hard for them to actually validate the underlying product. So for things that are wet medical, where it’s not something where you can say, okay, I could understand why somebody would need this, or you don’t know if the product actually works, most people just stay out of those realms completely.
Erica Minnihan (31:44):
But as far as being able to understand enterprise technology, consumer technology, what you’re going to see a large number of opportunities in, I think it’s fine to go in a variety of sectors.
Erica Minnihan (31:59):
The number one thing that we’re betting on in this stage is not so much the sector, but it’s really that founder and the opportunity. So we want to keep our eyes open for a wide variety of those.
Erica Minnihan (32:20):
So let’s just talk a little bit about what actually makes a company investible. So what are some of the things that we’re looking for? So whether you’re an investor or a founder looking to raise money, these are really important considerations. They’re almost in order of what actually drives value in investment.
Erica Minnihan (32:41):
So we have to really separate the concept. This is so important as an investor. This is like, probably my number one takeaway that I’ve learned, investing in hundreds of companies and having the experience that I have, is that an investment is an investment. It’s not about a product or an idea. So we have to separate all of those things completely.
Erica Minnihan (33:13):
You’ll notice as I’m talking, I almost never talk about what the idea is or what the product is. We look to other things that are much better indicators of whether or not a company is investible.
Erica Minnihan (33:26):
So the number one thing, and I would say the strongest driver of value, is the management team. So it is absolutely the most valuable thing in a company. Founders that are the right founders that are able to bring a team around them, and really we’re investing in the people.
Erica Minnihan (33:45):
So at this stage, there’s usually not a lot there’s there. So you’re really just not only counting on them to be able to build a company, which is extraordinarily hard, but also to be able to bring in people around them that are trustworthy and hardworking and can build something. That’s really the absolute hardest challenge in building a company.
Erica Minnihan (34:08):
So this is why they say solo founders almost never get funded, and it’s not because anybody has something against that founder. But it’s just that the number one most valuable trait in somebody who’s starting a company is the ability to sell other people on their vision and bring them around them. So that’s going to be a huge driver of value.
Erica Minnihan (34:36):
The next, of course, is the size of the addressable market. So you guys might know the minimum total addressable market that you really need a company to be going after is at least a billion dollars. We’ll get into why that’s a high bar.
Erica Minnihan (34:53):
Then thirdly is product market fit. So we’ll talk about what product market fit is. But I always say I don’t care if you’re selling bags of dog doo doo, as long as there’s a customer for them and they’re willing to pay for it. It really doesn’t matter what your product is, as long as there’s a market that really wants it and they’re able to pay for it.
Erica Minnihan (35:15):
Next is really understanding the company’s customer acquisition channels and the scalability of those channels, why or where they have a competitive advantage, whether that’s intellectual property or some other competitive advantage. This is really important. I get a lot of people who get very obsessed with this idea of patents, patent, patents. Well, patents are okay, but 99% of the time we want to see a company that has a competitive advantage for reasons outside of the fact that they have some patented technology.
Erica Minnihan (35:53):
That’s simply because patents are a pain to get and they’re also a pain to enforce. A lot of times they don’t even protect you that much. So it’s much better that the company has some sort of competitive advantage or just general intellectual property that can be protected for other reasons.
Erica Minnihan (36:14):
So there are some barriers to entry, or at least that they have some sort of a very solid first mover advantage. You would see that with a company like Uber had a very strong first mover advantage in the beginning, as it took them quite a long time to even build up the ecosystem before other competitors could come in.
Erica Minnihan (36:34):
Then, lastly, we’re looking for evidence of traction, as well as tremendous growth potential, and, of course, exit opportunities. So whether or not a company is creating value, building a great product, has traction, its value is really going to largely be driven by, okay, what are the exit opportunities? Are there some really large potential acquirers with a lot of cash that are going to pay a premium for this?
Erica Minnihan (37:08):
A great example of that is a company like Honey. So Honey, awesome company, they do the Chrome extension, browser extension that helps aggregate all of your discount codes and coupons. They only raised $40 million, I think, in total and they sold to PayPal for $4 billion. So even though it was a great company independently, the fact that there was this big potential acquirer that has a lot of cash and value to bring to the table provided for a fantastic exit opportunity for the original investors.
Erica Minnihan (37:47):
FYI, they did not have an easy time raising capital. I’m actually good friends with one of the seed funds that was one of their first investors, like completely sort of relatively unknown fund in Detroit. So it wasn’t like everyone in Silicon Valley was fighting over this deal. It took them a few years to actually raise money.
Erica Minnihan (38:08):
But that’s a perfect example of the way a company should operate. They should be able to get to some breakeven or whatever on hopefully less than $50 million in capital, and then be able to provide a big exit. I mean $4 billion is amazing. But even if it was $1 billion, that would’ve been really, really great.
Erica Minnihan (38:30):
So that’s what we’re looking for. All of those elements make a company investible. As you can see, none of these elements necessarily have to do with a specific sector or a specific product.
Erica Minnihan (38:45):
So as far as the management team, which is the first thing that we look for, number one, experienced or serial founders. That adds value. Is it necessary? Not always. So I’ve had companies in my portfolio that have had a serial founder who had no previous big exits, but he had experience, grew his company to a billion-dollar valuation, and that’s wonderful. But we’ve also had companies we invested in where the founder was dropping out of college in 19, still grew his company to several times what we invested.
Erica Minnihan (39:24):
So this is just a point of value. It’s not a necessity. But we’re just talking about what improves value versus detracts from it. So having several co-founders versus a solo founder drives value within the company. Having a team in place, that means a CEO, a COO, and either a CTO or CMO, depending on the type of business, help to add value to the potential investment.
Erica Minnihan (39:52):
Then to really be able to answer the question why this team, relevant expertise. You’ll very often see people starting businesses that they have no particular expertise in. They’re just like, “Oh, I thought this would be a good idea.” It can work, but actually knowing why these people strategically are bringing value to the table is really critical and an important part of the diligence process.
Erica Minnihan (40:20):
Then, of course, whatever sweat equity they’ve put into the company so far. So what have they been able to build so far? What value have they created? All of these components go to actually drive value within the current company. Then as far as addressable market, as I mentioned earlier, you really have got to look at companies that have at least a billion dollars or more, total addressable market. The reason for that is that it will really largely dictate how large the company can grow.
Erica Minnihan (40:52):
So in order to have a viable exit opportunity through M&A, you really need to get to at least $100 million or more in revenue. So for you to get to $100 million or more in revenue, that means even if your market opportunity was $10 billion, you have to capture 10% of the market, which is no small feat.
Erica Minnihan (41:13):
So not only do you need to get to at least $100 million or more generally to be viable for exit, but then whoever’s acquiring you is acquiring you because they feel that there’s more growth potential. So they’re usually acquiring the company so that they can then take the inner workings and cause growth within their business.
Erica Minnihan (41:33):
So you’ve got to be able to get to scale and then you’ve got to have extra room for growth. That’s why people love markets that have a growing addressable market. That’s why cannabis has been so hot. That’s why video is so hot right now. That’s why meditation has been really hot in the last couple of years, Internet of Things. All of these are sectors that are already fairly large, but are expected to grow considerably over the next few years. So it’s this rising tide lifts all boats theory.
Erica Minnihan (42:09):
So Karen has a great question. “Do you have some insights as to why women-led companies get less funds than male companies?” Yeah. So I spend a lot of time talking on this because it’s a relevant question.
Erica Minnihan (42:23):
I’d say it’s pretty simple. So we live in a society that has just inherent biases towards the ability of women to accomplish certain things. Why is it hard for women in positions of power for everything? So there’s that number one that’s an inherent disadvantage.
Erica Minnihan (42:46):
Then, number two, the venture capital space is very insular. Basically, there’s no career path for it. So the only way that you become a venture capitalist is because some very rich people thought that they should give you money to manage. It’s not like you work your way up from analysts and now all of a sudden you’re the partner. No. You basically have to go out and raise the money yourself.
Erica Minnihan (43:13):
For whatever reason, women have always been, I think, a little bit more cautious in investing. A lot of the women that I have known over the years that are ultra high net worth individuals, they will be totally fine donating millions of dollars to charity, but the idea that they would give it to a female emerging fund manager, they’re too cautious for that. Whereas men just don’t view things the same way.
Erica Minnihan (43:44):
And so, for that reason, we’ve seen an industry in which I think less than 10% of investment managers are female or people of color. So it’s largely dominated by white men. It’s very natural that if I’m a white male investment manager and I look at things through a certain lens, when I’m being pitched, I’m going to view somebody who’s more similar to me as being more competent than probably somebody who’s different.
Erica Minnihan (44:19):
So that’s the main reason why I think it’s been that way. We’re working really hard to shift that thinking and to get more females and people of color in investment manager roles to help get to the root of the problem there and to get more of those companies funded.
Erica Minnihan (44:42):
But it’s a very good question. There’s a really great research piece written by Dana, D-A-N-A, Kanze, K-A-N-Z-E. She is a Columbia business school or PhD at Columbia. She did an entire research project on how were female founders treated differently.
Erica Minnihan (45:06):
And so, the key takeaway was that when a woman was pitching a business, the main focus was on what could go wrong with the business. Whereas when a man was pitching a business, the main focus was on what the big picture potential of the business was. That led to people feeling that the female-led business was a lot riskier and that the male-led business had a lot more upside potential.
Erica Minnihan (45:36):
So I hope that answers the question in a nutshell. I know it’s a complex and thorny topic. Thank you for bringing it up, Karen.
Erica Minnihan (45:43):
So we have a few more minutes, and I just want to dive into what I think is the most crucial thing to look at in investing, and that is product market fit. So we want to talk about why it’s so important and why it is so misunderstood.
Erica Minnihan (45:57):
So when people talk about product market fit, it’s really the holy grail of what you’re looking for in an investment. It’s so hard to achieve because, really, if you’ve ever gotten one of these surveys that says how would you feel if you could no longer use product X? It says very disappointed, somewhat disappointed, not disappointed, or I don’t use it anymore. The reason you’re getting it is because they’re trying to assess their level of product market fit.
Erica Minnihan (46:27):
And so, as you can see here with some of the results that are really successful, a SaaS company like Slack has gotten … They basically had 90% of their users feel pretty disappointed. So they had over 50% saying that they were very disappointed and 40% saying somewhat disappointed.
Erica Minnihan (46:51):
And so, to actually have customers that are at this level where they would feel very disappointed or some pain if they can no longer have access to your product is incredibly difficult to achieve, but also puts you in a position of extreme value within the market.
Erica Minnihan (47:10):
So rather than evaluating the product on what do we think of the product, would we like it, do we want to use it, really, this kind of data that a startup gets back from customers around product market fit, around engagement, around a low level of churn are some of the best indicators to creating value within a company and to make a company actually investible.
Erica Minnihan (47:37):
So product market fit is basically validation that the customers place monetary value on the product. It establishes a possibility for monetization and, really, if they don’t have it, you get into that very bad position where the company that you’ve invested in will start investing in customer acquisition for people who don’t really care that much about their product and they churn out, which essentially destroys all the value and uses up the money that you’ve given them.
Liz Tinkham (48:09):
Thanks for joining me today to listen to the Third Act Podcast. You can find show notes, guest bios, and more at thirdactpodcast.com. If you enjoyed our show today, please subscribe and write a review on your favorite podcast platform. I’m your host, Liz Tinkham. I’ll be back next week with another guest who’s found new meaning and fulfillment in the third act of their life.
Want to share the story of your own Third Act on our podcast? We welcome stories from executives who pivoted their careers to find their passion and purpose later in their lives. Tell us more about yourself to be considered as a guest.