Investing with the Godfather of Silicon Valley

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  • Ron Conway, Godfather of Angel Investing

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About Ron Conway

The soapbox talk with Ron Conway, the man who has placed more bets on Internet start-ups than anyone else in Silicon Valley, was packed with over 220 people and tons of excitement last Friday. It was the first time ever that we had people drive from as far as Santa Monica and fly over from Italy to meet Ron Conway!

We talked about Ron’s investing strategy, his due diligence process, his advice for entrepreneurs and his thoughts on integrity and value of investors. Feel free to listen to the podcast as you read through our summary of takeaways below.

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How do you define angel investing?

Angel Investing started in the 1930’s with people investing in movies in Hollywood. Today it’s about investing into technology. Angel investors are a group of people who invest in raw startups. A raw startup is defined as four people or less who have started a company.

When should entrepreneurs seek angel funding?

Before you want angel funding, you'll want to bootstrap. Bootstrapping as long as you can is the best thing for the company because you own the entire company. My favorite example of a bootstrap startup that was never funded is Michael Arrington's TechCrunch. When he sold the company to AOL, since he was the biggest share holder of it, he got most of the income from the sale.
Don’t go right into angel funding. Use your credit cards, do anything you can so that by the time you go to angels you have built a working prototype and have some users. You'll likely be valued higher and will suffer less dilution.

Give us the stats: How many deals do you get? How many fail/succeed?

We see 5 deals per day, 30 per week. All these deals are quality referrals from people we already know; we already either know the referrer or the entrepreneur. We’ll invest into 1 company out of those 30 per week.
Out of the 5 we see per day, we turn down 2-3 via email, without phone call. On average, only 10% of entrepreneurs looking for funding will actually get funded.
In terms of failure rate, today 1/3 of the companies we invest in fail, 1/3 of he companies return the money, and 1/3 of the companies return 4 or 5 times the investment. It’s a hits business. In 1999 when the bubble burst, 80% of our portfolio went out of business. Thank God for Google. That one hit paid for the rest of the companies in the portfolio.
Also, let me clarify something - I consider the 1/3 of companies that return our money as success. I get irritated with entrepreneurs who comes to me saying, ‘Sorry I only returned your money to you.’ I say, ‘You’ve got an attitude problem,’ there is nothing wrong with getting your money back.

What’s your evaluation process?

We have 6 other people at SVAngel. We invest out of a fund that is about $30 million dollars. This is our third fund at SVAngel. Due diligence usually gets assigned to the other 6 people, I don’t do any due diligence, I help companies at inflection points.
The way it goes usually is that at our meeting someone says, ‘I have a company that looks good. I like what I see on the paper.’ We say, ‘Okay, make the phone call.’ That person goes and makes a phone call. He comes back says that he loves them even more after the call and wants to setup a meeting. We vote on whether or not to have a meeting.
A little secret here: what entrepreneurs should realize is that by the time we meet face-to-face with them we’re much further along into deciding to invest in them then they know because we have this process.

What do you look for in a pitch?

We invest in people first, idea second, market size third. It’s our belief that the idea that we’re seeing is going to morph so much that we should not get wedded to the idea, we should get wed to the individuals. The traits we look for: Can this person be a leader? Can this person lead a team?
90% of the time it’s a group of three founders. We always looks for the dynamic between the three people. Will there be any problems along the way? Will they realize that their idea is not working and have a solution to fix it?

TechCrunch published your email concerning the integrity and values of other angels. Can you elaborate a bit on that?

The email from Ron Conway was sent to the group of super angels who were likely involved in the Bin 38 “AngelGate” meeting that Michael Arrington stumbled into back in September 2010. The following is the quote from the email:

I wish the Angel community could have the same integrity and values of the entrepenuer community, but unfortunately I now believe that is hopeless and your actions prove that.

Here is Ron’s answer to the question:

I don’t want to speak about that group too much. I’d say that all investors should care about is adding value to the entrepreneurs. Making money is a bi-product of adding value to entrepreneurs. Since there were no entrepreneurs in that meeting, and none of [the investors] were trying add value to entrepreneurs, it was a waste of air.

We opened up the floor to questions after the interview, and got several great ones.We talked about conflicts of interest within the same investment portfolio, the ownership percentage angels typically get from their investments, dealing with management upheavals and some of the best and worst entrepreneurs Ron has dealt with. Many people stuck around after the event chatting with Ron and connecting with others. As always, we’d like to thank Ron for such an engaging and insightful talk!

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Interviewer: I'm super excited to have so many shining faces here today. Welcome to ZURBsoapbox. I'm super excited to introduce Ron to ZURB Soapbox. Ron has been named the Godfather of Angel Investing. He has invested in over 500 companies. He has invested in companies such as Google, Twitter, PayPal, many, many others.

Ron: Facebook.

Ryan: Facebook, of course, that little company.

Ron: The new web.

Ryan: I'm just really excited to have you here, Ron. Let's welcome, Ron, to ZURB Soapbox.

Ron: Thank you.

Ryan: I'd like to get started and talk a little bit about the term "angel investing." It started out back in the '30s or so, but I'd like you to define what angel investing is and what does an angel investor do for an entrepreneur.

Ron: Sure. If I'm right, the term "angel investing" did start in the '30s in the movie industry down in L.A. The movie industry, I think, is similar to the tech investing environment because the movie business is a hits business, and I believe that the investing business is also a hits business.

Over my career, each investment cycle, we have had a hit in each investment cycle that paid for all the rest of the portfolio companies, including all the failures, and the failure rate in startups, unfortunately, is pretty high. But in the movie industry they got individuals to invest in the '30s, and those individuals, if they invested in "Butch Cassidy and the Sundance Kid" or something, they made a hit. So it's an old term.

In tech, it's what I equate it to is angel investing is the group of investors who invest in raw startups, and raw startups are easy to define. I define them as four or less people who have started a company. So, angel investing is the group of individuals who invest in raw startups.

Ryan: So, why would I want angel investing? Why would I want angel funding?

Ron: Well, before you want angel funding, you want to bootstrap. Bootstrapping your company as long as you possibly can is the best thing you could ever do because then you own the whole company. My favorite example of a bootstrapped startup that never got funded is TechCrunch by Michael Arrington. When Michael Arrington sold TechCrunch to AOL, because he owned the company basically, he was by far the largest shareholder; he got all the income from that. That's the best outcome ever. Now, I would have liked to have been an angel investor in TechCrunch, but the outcome for Michael Arrington was much, much better that he took no angel funding from anybody.

I just don't want to say you go right into angel investing. Use your credit card credit. Do whatever you can to get the company as far as you can so that by the time you do go for angel investment, you've accomplished enough and have a working prototype, hopefully with users. Then, you get a higher valuation and therefore suffer less dilution.

One thing about me is I always speak from the point of view of the entrepreneur. We are very respectful of entrepreneurs. I think anyone who has the guts to start a company should get it funded, and my estimate is probably 10% of you who want to start a company will actually get it funded. There aren't enough angels out there, and in my opinion the more the merrier, because we keep the innovation in the Bay Area if we fund more startups.

Ryan: Tell us the stats. How many deals do you get a day? How many of those do you actually look at seriously? Out of those, how many return your money? How many fail? How many succeed?

Ron: Great. This is a crash course, an MBA at lunch. So, SV Angel is six people. So it's, by far, not just me. It's a team of six people. We invest out of a fund that's like a $30 million fund, and we're on the SV3 Fund right now. So, there was SV1, SV2. We're now investing out of a fund called SV3. So there's six people sifting through this deal flow.

We see five new deals a day. Because I've been doing this since 1994, the five deals we get a day, all via email, are all from people that we know already. So we don't really see deals that come across the transom. Because our network is so huge, since I've been doing this since 1994, these are all people that we know. We either know the entrepreneur or the referral source.

As awful as this sounds, we see 5 a day, which is 30 a week, and we invest in 1 company out of 30 that we see. So, we invest in one company a week. Of the five a day that we get, we turn down at least two to three via email without even a phone call. So that says how competitive this market is. That's why I know that only about 10% of the entrepreneurs who want to get funded, get funded, just from our own stats.

At our weekly investment committee meeting, if a company looks interesting … so the due diligence gets assigned among the six people. I actually don't do any due diligence. I help companies at inflection points. So I help companies that have much bigger issues that need my expertise. So we dole the work out based on expertise.

At our investment committee meeting, we vote whether or not we're going to make a phone call to that company. Whoever is doing the due diligence says, "I think I've got one that I think is interesting. I like what I see on paper." We say, "Okay, make a phone call." That's how valuable a phone call is.

Then that person calls the company. If he likes that, the next week he says, "Guess what? The phone call was so good I want a meeting," and we vote whether or not to have a meeting. Sometimes we say, "No, cluttered space. We can't do a meeting." That's how brutal it is. So we vote for the meeting.

What the entrepreneur should realize, and this is a little secret, by the time we meet face-to-face with you, we're actually a lot further along to investing than the entrepreneur normally thinks we are because we have this process. Then, if that meeting goes well, then we invest. If there's not an urgency, over the course of five weeks, three to five weeks, we will make the investment, and that's 1 out of 30 that we look at.

Now, you asked something else, and I already forgot it.

Ryan: The pitch. What do you look for in the pitch when you invest?

Ron: We invest in people first, the idea second, and the market size third. There are other investors that invest only if they think the market size is big. There are other investors who only invest if they like the idea. We happen to invest if we like the entrepreneur. It's our belief that the idea that we're seeing is going to morph so much that we shouldn't get wedded to the idea. We'd rather get wedded to the individual, and as that company morphs, we're perfectly happy because we invest in the person.

The traits that we look for are: Can this person be a leader? Can this person build a team? By the time we see them, there are very few single entrepreneur startups. So, 90% of the time it's a group of three, three founders. So we always watch for the dynamic between the three founders because whoever's the CEO selected the other two founders. We watch for their dynamic and we want to make sure that the CEO is a leader and can attract a team, is flexible enough that they can admit six months into it that, "Hey, this isn't getting traction, and this is all about building traction. We're going to change the idea."

Lots of entrepreneurs come to us after six months and say, "I've got bad news. Don't shoot me, but I don't think my idea works" That's something we actually love. That's when we pat the entrepreneur on the back and say, "Awesome. We didn't have to tell you weren't getting traction. You saw it, and you're fixing it yourself." That's what we call a flexible entrepreneur.

We try and predict all these traits as we're talking. Most of the successful companies out there … you asked for failure rate, so I'll answer that, too. Well, why don't I answer that right now?

I've been doing this since 1994, and the best decision I ever made in my life was, in 1994, to only invest in this thing called the Internet. In 1994, Marc Andreessen was still a student at the University of Illinois, just to give you a perspective. So, in '94, I decided Internet software only. Today, I only invest in Internet software. We think it's the most exciting growth market there could ever be. But in '99, when the bubble burst, 80% of our portfolio went out of business.

Thank God for Google because we had Google in both of our active portfolios, and like I say, it's a hits business. Google paid for 80% of the companies that didn't return a nickel plus a bucket of money on top of that. The failure rate in this market has lowered, in our portfolio, all the way down to 30%, and a lot of that is because starting a company today doesn't cost as much and, therefore, more companies are getting started, which I think is awesome for innovation. But the failure rate is about 30% today.

So, back to the hits business. I keep saying it's a hits business. So today about a third of the companies fail. About a third of the companies are what I call base hits. We get one or two, maybe three times our money back, and that's great. If you're an entrepreneur and you get one, two, three X your money back, that is success. I get very irritated with entrepreneurs who come to me and say, "I'm sorry. I only got you two X your money back." I say, "You've got an attitude problem." You're not part of the third that went out of business. Those are the ones, and they shouldn't be sorry, these are brave entrepreneurs who started a company. But those are the ones, that if you can't return the money, that is something that you want to have regrets about. I define any entrepreneur that returns money back as a success, and I truly believe that. So, that's a third of the portfolio.

Then, the top third of the portfolio are the companies that we get four, five or Google times our money back. It's basically, a third, a third, a third is how it works.

That one big winner, the Google, the Facebook, the Twitter, the PayPal, they pay for everything. It's really the needle in the haystack that kills it.

Ryan: Do you ever invest in failures afterward if they have another idea, say an entrepreneur has another idea?

Ron: Oh, yeah. Yeah. The founders of Napster would be an awesome example. We invested in Shawn Fanning. Napster failed. It was not his fault, of course. Then Shawn and I founded a company called Snowcap where we wanted to solve the rights management issues. That failed, and then Shawn founded Rupture, which we later sold to EA, and that was Shawn Fanning's first hit. So we had two failures together before the hit. We just, like I say, invest in the individual, not their track record. So we think Shawn Fanning was born to be an entrepreneur, and so we wanted to keep backing him. Sure enough, he came up with a hit.

I do think entrepreneurship is genetic. I think it's in people's blood. So once you start one company, you're going to start two, three, four, five. It's very rare that I see an entrepreneur start a company and then go work for Hewlett-Packard. I do believe it's genetic. I have no proof, but once an entrepreneur always an entrepreneur is what we see, and we love that. Shawn Fanning is on his fifth company. I think he's got, at least, three or four more left. In his career, he'll start at least nine or ten companies.

Ryan: Who's like the Michael Jordan of all the entrepreneurs you've ever invested in? That's a lot of people over . . .

Ron: Wow. I think Shawn Fanning is a Michael Jordan. I think Sean Parker is a Michael Jordan. I think Larry Page is a Michael Jordan. I think Jack Dorsey is a Michael Jordan. There is no one answer to that.

Ryan: Okay.

Ron: Mark Zuckerberg, for sure.

Ryan: Okay.

Ron: For sure, Michael Jordan. So, Silicon Valley and the Bay Area have produced . . . keep in mind every name I just called out is from the Bay Area. Now, I think Andrew Mason at Groupon, which is in Chicago . . . you say Michael Jordan. What I say about entrepreneurs instead of Michael Jordan, I say that's a defining entrepreneur. A defining entrepreneur in my mind is someone who creates a market and is a product visionary.

So, all of the names I just named - Jack Dorsey, Zuck, Fanning - you think about them. These are product visionaries who own the mind of their consumer. Zuckerberg owns the mind of the Facebook user. He knows more about what those 700 million people are thinking than any of them, and that's the gift of Mark Zuckerberg.

The Michael Jordans, I rattled off five. I could rattle off more. Yeah, don't forget Andrew Mason. I think Dennis Crowley at Foursquare. So, there's one in New York too. New York has a Michael Jordan.

Ryan: I want to move on to September 2010. There was an email that Michael Arrington published on TechCrunch that was sent from you. In the email, you mentioned something to the extent of, "I wish that the angel investor community had the same integrity and values as entrepreneurs." It's always been in my mind since I read it then.

Ron: This is like a year ago.

Ryan: Yeah, a year ago or so.

Ron: It seems like five years ago.

Ryan: Can you go into details? What did you mean by that?

Ron: Well, I think all angel investors should care about is adding value to the entrepreneur. Making money is a byproduct of adding value to an entrepreneur, and I don't want to talk about that group of people, but there are some people that I think angels invest because they think they are going to make a quick hit. There are no quick hits. You get what you give.

Our methodology at SV Angel is that we invest, and we want to add value to that company at inflection points. We don't take board seats. We don't look over the entrepreneur's shoulder. By the way, our average investment is 50K to 200K is roughly the amount we invest. We give the entrepreneur the money and we say, "We're giving you the money because we trust you. You passed all of our screening process. You tell us when you need help. We're like a law firm. When you need us, you call us. But when you don't need us, we're not going to bother you. But when you do need us, watch how quickly we will perform and solve whatever it is you need."

Examples of these inflection points are once a site gets up and running, then it's all about traffic. So we will introduce the company to Yahoo, Google, Facebook, Twitter, AOL, IAC, and get traffic deals, get distribution deals so that the company keeps building momentum. When it comes time for the VC round, we do the introductions to the VC community. This is when the company is raising five million. The typical angel round is half a million to a million.

The next step is the VC round of five million, but we do all of those intros. We sit down with the entrepreneur and say, "Here's the three VCs we think should see this first, based on the value they add, based on the value of that particular partner at the VC for that company." And then, like it or not, every single startup has a management upheaval where the founders don't like each other any more, or they hired somebody that one doesn't like and the other does.

Because of our pattern recognition, I've been doing this for so long, we've invested in over 600 companies, when that management upheaval happens, we can come in and be the marriage counselor. Literally, every company we're in, I've played the marriage counselor role at least once. That's valuable just because I have a learning curve, and I can say, "Hey, here's what you ought to do, and here's how … eight out of ten times I've recommended this, there's been a good outcome."

Then we help with liquidity when it's time to sell the company. Most of these companies, the ones that are successful, are going to get sold. The IPO is the needle in the haystack now. So we do all the intros to the M&A candidates, and if it's under $100 million, we don't use a banker. We set the price, turn it over to the lawyers, and the company is sold.

Ryan: I just wanted to come back to that meeting that took place September 2010.

Ron: You don't want to let go of that.

Ryan: I wanted to ask you. Dave McClure published another post, and I remember it really well. He was saying, basically, there was no colluding, there was no kind of deals. The angels just got together at that meeting to shoot the shit, I think he said in his post. So I was weighing those two things back and forth. What would you say to that argument?

Ron: My attitude about that was, hey, if there wasn't an entrepreneur there and you weren't saying to the entrepreneur, "Help us make you successful," it was a waste of air. That's the only point I'm making. I'm not in favor of having meetings with other investors. I'd rather meet with an entrepreneur and say, "How do we get you to the next step?" That's adding value.

Ryan: Okay. Do you do handoffs to venture capitalists? Do you meet with venture capitalists?

Ron: We do. We do meet with venture capitalists because they're an important part of the food chain for all of our portfolio, because the next step is the venture capital round. So, yes, we try and maintain very positive relations with all the top VCs so that when we do the intro, they get a meeting really quick and get a fair hearing.

Ryan: Right. Right. Well, I'd like to open it up to the audience here. We've got ten minutes or so. Questions? Go ahead, right there and I'll repeat the question, too.

Audience question: What percentage of the company do you usually take?

Ron: We invest 50K to 200K. Valuations let's say today are roughly three to five million. Two years ago, they could have been half that. There has been a creeping up in valuations. We typically will own one or two percent of the company when we invest in the angel round. By the time the company goes public, we own way, or whenever there's liquidity, we own way under half a percent. But a half a percent of Google or Facebook is still very, very significant. We rarely do follow on rounds. We're just happy being the angel. We're happy where we're at.

Audience question: Is that typical? I thought angel rounds were much higher than that, in fact, 10%, 15%.

Ron: Well, I'm talking about what our 50K to 200K buys. The typical angel round will be half a million to a million. So it will take 10% to 15% of the company, for all the angels.

Ryan: Let's go right here.

Audience question: What kind of a focus do you have in terms of the type of ideas or companies that you invest in, B2C, B2B, platform, Cloud, mobile?

Ron: That's what this chart is.

Ryan: The question is: What kind of focus does Ron have in terms of investment?

Ron: SV Angel is thematic in its investing, and two and a half year ago we picked a theme of real time data, so any company where data is being spontaneously entered on the Web. You have the users building the content, and that is what is causing the explosion on the Web that we're seeing today. We call all of that real time data. Twitter and Facebook are perfect examples of real time data.

We have this overarching mega trend that we call real time data, and then we break it into seven buckets: social, real time, big data, mobile. Mobile also overlaps everything now. Many companies are being started on a mobile platform, not a web platform, which we think is very smart. Then social commerce, online to offline, and then collaborative consumption.

What we try and do is find 20 companies in each of these seven sectors and hope that one of those 20 is the breakout company in that sector. But keep in mind for every one of those, there was 29 that we said no to.

Ryan: All right. That lady right there?

So the question is about management and having a lot of management, and how can an entrepreneur … management upheaval and what to do to mediate that?

Ron: That's a great question.

Ryan: That's two different things.

Ron: I would say it's not like founders are careless in packing the other founders. I actually, from a realistic point of view, I don't think there is anything you can do to prevent it. The only thing you could do is if when you were putting the founding team together is put a little more thought to, "Hey, are we really the right three founders?" But usually at that point, the three individuals are so excited about the idea and working together and the fact that they're going to get funded, those issues don't crop up until later. It would be hard. But if you thought about it more in the beginning, maybe some groups would admit, "Hey, we really don't get along. It would be better if we didn't do this together."

Ryan: Go ahead, sir, right there with the red shirt.

Audience question: You said invest and bootstrap as long as you can, maybe even all the way. At what point do you decide you're a developer, I'm a great business guy, but we never really know how to hire, how to network, how to break into a market, so we want to go to an incubator or find some angels to help us? Is that a good strategy and basically sort of hope that you can get investors to help you out?

Ryan: So the question is: At what point, when you're bootstrapping, do you decide that you need some help and go to an incubator or an investor or an advisor?

Ron: Even though I'm advising people to bootstrap as long as they can, the number of companies that have been bootstrapped to liquidity is tiny. I use TechCrunch as the example. What I'm really saying is bootstrap as long as you can, and then it is smart to say, "Wait a minute. Now we could use some mentoring, and we have enough traction that we're proud of what we have. And maybe, we should go to an accelerator or do an angel round."

There are accelerators springing up everywhere. The most prestigious, which I call the Harvard of accelerators, is Y Combinator. I could not recommend them more. There are other accelerators out there as well. They give you a small amount of money and a lot of mentoring. If you don't think you need as much mentoring, then do an angel round where you know the mentoring is going to be less. The vast majority of startups do graduate from bootstrap and go the accelerator or funding route.

Ryan: One more question, sir, back there.

Audience question: Now, entrepreneurs, we put so much passion into what we do. As we evaluate investors, how much concern do you think we should have over the size of the portfolio and the companies in the portfolio that investors may have, particularly in the space we're in?

Ryan: So, as entrepreneurs evaluate angel investors, how much concern should you have as far as the size of the portfolio goes? That's the question.

Ron: I think it's all about the quality of the individual angels. If it's one angel, how much value can they add? If it's like us, where it's a group of six, how much value can that group add? What is the power of that person's Rolodex?

SV Angel, since I've been doing it since 1994, we can get to the management of any Internet company. When I say management, I mean the CEO and the five people that report to the CEO. When there's an order change at Google, like there was recently, we go make sure that we know whoever the new people are because our portfolio companies need access to that even though our portfolio right now is 300 companies.

So you could look at that and say, "Well, that's stupid We'll never get any time out of them." The fact of the matter is when you're at an inflection point and you need that intro, that is what we spend our time on. So we're very incident driven.

Audience question:My question before is do we need to be concerned and protective of our ideas?

Ron: Oh, conflict. You asked that. I knew I didn't answer the whole question, but I couldn't remember what it was. Conflict of interest is a big issue, but now I'm going to tell you it's not, because in our portfolio many companies have morphed into the space of one of the existing companies unwittingly. No matter what, you're going to deal with conflict if your investor has a portfolio of over 30 companies, which is most of them.

We actually have a conflict policy that when we know there . . . we actually show the conflict policy to every company. We invested in Gowalla when we had already invested in Foursquare. At the first meeting with Gowalla, I said, "Do you know we're an investor in Foursquare?" "Yes" "Do you want to continue this meeting?" And he said, "Yes." Now I think he made the right decision because we do not get into product strategy.

With a portfolio of 300 companies, the last thing I have time to do is go dig into one company's product strategy. I have no idea what the product strategy of Twitter, Facebook, Foursquare and then the 50 companies that no one knows the name of we just invested in, and we don't want to get into the product strategy. But our conflict policy actually says that.

Our conflict policy also says we think we're decent people. You have to trust us. This word "trust" is a big word, and you either trust somebody or you don't. By the way, there are like 50 traits I am evaluating when I'm talking to an entrepreneur, and it's takes ten minutes to do it. One of them is, hey, is this entrepreneur going to trust me? Is this entrepreneur, like they're not answering every question directly. I say, "Who are the other angels you're talking to?" Some entrepreneurs say, "I'm not going to tell you that." Kaboom! I'm probably not investing in that company even if I think it's the next Google. That's not a trusting person.

So, you have to trust people. There are not that many cases of corporate espionage where somebody actually stole somebody else's idea. I kind of think it's a non-issue is my answer. It should be covered though.

Ryan: Unfortunately we're out of time, but people can come up to Ron and ask questions for another ten minutes or so. I'd like to thank Ron for such an awesome talk!

Ron: It's a pleasure.

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