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Last night I attend the London Business Starters meetup Investing in Startups – For Entrepreneurs and Angel Investors.

There were two presentations. Michael Waschnig talked about the start-up life cycle. He used the model presented in the Startup Genome Report (register and download):

  1. Discovery
  2. Validation
  3. Efficiency
  4. Scale
  5. Profit maximization
  6. Renewal

With particular emphasis on the stages 1-4 which are those covered in the report. Key characteristics for these stages are

  • Discovery:
    • the goal is to discover a “product market fit”
    • funding from founders, friends and family
    • often supported by founders doing consultancy
    • typically just the founders
  • Validation:
    • the goal is to validate that the market likes the product
    • funding from founders, friends and family and possibly a little bit of seed capital from angels or government funds ~ £ 20k
    • typically the founders plus zero to 4 employees
  • Efficiency:
    • the goal is to build an efficient organisation capable of scaling
    • this is where angels like to come in with ~ £ 250k (500k USD)
    • typically 4-6 employees
  • Scale
    • Institutional Venture Capital funding ~ £ 1.5 M
    • the goal is to capture a large market share
    • > 6 employees

I found Michael’s presentation of the statistics very helpful and today I went to the Startup Genome website and completed their benchmark for my own start-up Keyapt. This gratifying told me that compared to our peers our progress was exactly average or as Chris said to me “50% of start-ups are doing worse than us!”.

Two particularly interesting observations are that product companies are much more likely to succeed when founded by techies than business people and that companies founded by 2 or more founders are much more likely to succeed than those with a single founder.

An important idea that has made it to the mainstream over the last couple of years is “pivoting” – that is to say that successful companies tend to change direction when they encounter the market. One or two pivots is good because you are responding to market demand but more than that tends to indicate that you don’t have a clue.

Michael’s presentation was followed by one from Colin Coghlan who is both an experienced angel investor and a chartered company director. This was very interesting as he gave us the “dark angel’s” view of investing. Much of the presentation was fairly technical and if you would like to learn more about it I suggest that you join the London Business Starters meet-up group and sign up for Colin’s next seminar (date to be confirmed).

The big take-aways for me were:

  • Fill in the form and become EIS registered. It cost nothing and will give great tax advantages to your investors.
  • EIS limits your investors to 30% equity so that is what they will take (in round 1)
  • They will invest ~ £ 250k because syndicates will typically have 6 investors putting in about £ 42k each
  • Your business plan must show a minimum of 10x gain at year 3, 30x is better.
  • There must be a clear exit by trade sale.

Year 3 valuation can be calculated simply from the price/earning ration for your industry sector. Simply put the value of your company is Profits x P/E ratio. A typical P/E is 5, therefore:

  • Investment = £ 250k for 30% implies
  • Return = 10x 250k = 2.5 M
  • £ 2.5 M = 30% therefore 100% = £ 8.3 M
  • Profits = £ 8.3 M/5 = £ 1.6 M

At this point I have to note that Colin was playing the part of the “dark angel”. The key point is that your business plan has to look like this if you are to be in the game – not that  he thinks this will be the actual outcome. The mean time to success is 6 years not 3 but you will never do better than you plan.

Colin pointed out that he is a professional investor who works with other professional investors to invest in companies with a reasonable likelihood of success (1 in 10) but that there are other investors with other investment strategies.

For example some VC funds will shotgun millions of dollars into hundreds of start-ups in hope of a 1 in 100 success rate and some investors are pure gamblers who will take a punt on something that catches their eye. He would point out that professional investor adds value to the company because they typically will only invest in markets where they have good knowledge.

I am a professional manager who provides services to early stage companies. I found this presentation very helpful because it gives me a model for targeting my services. I have found by experience that companies in the Discovery and Validation stages have no need for consultancy services. This is because the companies are simple to run; product strategy is “have a go” and if it does not work do something else, “pivot” and the maximum level of management sophistication required is JFDI “Just F****** Do It”.

I find my services are typically required by companies in the latter end of the Efficiency stage or entering the Scale stage. Colin noted that at this point there is normally a bloody exit of the original founders because they cannot cope with managing a bigger business. I interrupted to say that this does not need to be bloody and can be managed by the investors and founders.

JFDI fails to work in larger organisations because resource allocation is more complicated and effective coordination is required between different departments. In this case I can help put in simple processes that ensure that senior management have the information they need and middle management (team leaders) get clear consistent direction.

If your successful company is in this position and would like help with putting in the processes you need to support further growth please contact me and I will pleased to discuss this with you.

–update 02/02/2012–

You can find Michael and Colin at http://startupacademy.biz/