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Get Inside the Mind of an Angel Investor

In my ongoing quest to get you good transcripts of the wonderful interviews we’ve done in the past on This Week in VC, I present you with one amazing interview here with angel investor Tom McInerney.

In my ongoing quest to get you good transcripts of the wonderful interviews we’ve done in the past on This Week in VC, I present you with one amazing interview here with angel investor Tom McInerney. He’s a friend, co-investor, former entrepreneur turned angel investor and “wizard of Oz” behind the scenes at the uber hot startup Klout.

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What is wonderful about this interview is that I got Tom on the record on:

  • what angels look for and how they work?
  • lessons learned from his days as an entrepreneur
  • some fun, big tech issues like privacy, net neutrality, location-based services and real-time data

The interesting thing about working with angels (the tech founder kind) is that they’ve all run their own startups before so there is instant resonance with what you’re going through, the issues you’ll face and how to best help. When I meet with Tom offline it’s obvious that he immediately is thinking about product issues, technology trends, funding rounds, etc. at a level of specificity you don’t always find in VCs.

This is one reason I always suggest getting talented angels involved in deals — whether it’s exclusively an angel round or whether you combine them with VCs. I know that I always make room and certainly would do so for Tom. In fact, HAVE done so.

Within the past two years Tom has become one of the most prolific angel investors in Southern California. Prior to his career as an investor, Tom founded and spent eight years running the online video company GUBA.

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The video link is here. And on top of that, the notes below can be quickly skimmed and if any topic interests you the time in the video is noted so you can skip right to that section.

A very big thanks to Alexandra Harris, the founder of FanCause and to Jeff Black at Rush Hour Outdoor, who both submitted transcriptions.Hope you all enjoy. If so, please give thanks to Alex here and to Jeff here.

Interview with Tom McInerney

Part 1: Inside the mind of an angel investor and how it differs from professional seed investors and VC

What made you become an entrepreneur and how did you raise money for GUBA? (0:12:05)

Before GUBA, Thomas worked at Sony on the VAIO computer. At Sony, he didn’t feel like he could “steer the ship” and get his ideas heard so he left and started GUBA, GUBA had no seed funding. Thomas and his partner lived off of credit cards, and used crappy data centers and open source software (LAMP).

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Looking back, what did you learn and what would you have done differently? (0:14:15)

The #1 lesson learned: having a business partner (50/50) is just like a marriage (although Thomas has never been married). And it has to be a good marriage. Founders need to see eye-to-eye or things will be very difficult. Also, remember that the journey is the reward. It’s important to learn from your experiences and apply these lessons you learn to the future.

On the matter of founders, we agreed that having a sole founder (and then hiring the really smart people) creates a more stable environment than a 50/50 partnership. With a sole founder you always know who is ultimately in charge.

What made you decide to be an angel? (0:17:06)

Thomas said it was partially the lifestyle, but mostly that he had a lot of ideas but limited execution. The hard part is always the execution. Today, innovation is happening at an increasingly faster rate and , that being true, Thomas thought it was more efficient to match capital to ideas than execute the ideas himself.

Do you like to be the first angel and why? (0:18:52)

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Amongst the participants in a round it’s actually easiest to be the last person because all the terms have already been hammered out. But Thomas is comfortable being anywhere in the continuum from first to last and depending on the situation. He’ll usually go first because oftentimes he receives a deal flow through a friend who’s already committed. For angels, it’s important to know the first investor and have a relationship with them because ultimately it’s a team bet at that point in time. For funding, you’ll see a loose affiliation of early stage investors, something will start slow, and then gain momentum to eventually close the deal.

In the angel world you see soft circles a lot. Money gets soft circled all the time and rarely do we see angels back out unless the terms change. The best proof of a soft circle is whether an angel will email someone else (refer another investor) and start off that email with “I’m investing in…”. If they’re not willing to do this then you probably don’t have a real soft circle.

How investors’ risk differ (0:22:45)

Angels will largely take a product risk (they bet on the product or idea and your ability to build it). “A” round investors or late-stage seed investors will take a market risk (they want to see the product, vision and maybe even the first customers, and they bet on there being a big enough market). “B” round investors usually take a scale or product market fit risk (they bet that the company can scale and that this is going to be massive).

How does someone get you excited and willing to commit? (0:25:35)

Thomas ultimately wants to see a beautiful product (it does’t necessarily have to have traction). He looks for artists in their craft programmers, graphic designers and UI folks (tends not to do hardware). The team, of course, is just as important as the product or idea. In a team Thomas looks for a lot of different things: a history of doing something interesting, a grasp on the big idea, a vision and a passion for the product, and a track record (all cliche but cliche for a reason).

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Are there warning signs? (0:26:44)

Yes! Thomas’ golden rule: if my girlfriend can’t understand what a product does in 1-2 sentences I don’t invest. The idea needs to be simple and easy to understand. A simple idea also allows for clarity. Clarity for the team that is building the product, clarity for the customer who’s using the product, and clarity when you’re marketing the product. The iPhone is a great example of simplicity and clarity. It’s so easy to use that a two year old baby who doesn’t know how to speak can pick it up and play with it.

How do entrepreneurs contact angel investors they don’t know? (0:28:00) & (0:31:27)

As a former entrepreneur, Thomas knows how hard it can be to get in front of investors and he appreciates that this process can be tough. However, if you’re going to start a company and be an entrepreneur, you need to network and you have to hustle. If you think its hard to get a meeting with Thomas or Mark, it’s even harder to build something that’s going to work. And if you don’t have the persistence to follow up and pursue an investor, than you probably shouldn’t be an entrepreneur.

We agree that one of the best ways of contacting an angel is contacting a company that they’ve invested in, ask for advice, network, and eventually get a meeting with the investor. Entrepreneurs should also use social media (Facebook, Twitter, LinkedIn, etc.) to find someone they know who knows an investor, network and get an intro.

What do you look for in a team? (0:34:00)

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We’re not looking for business development people, we’re looking for product guys. An ideal team would be a CEO and 4-5 developers. Angels are always looking for technical people on the founding team and many don’t invest if there isn’t one. If you’re not a developer, find someone who is. You can give them 20% of the company with a vesting schedule over four years (this way if things don’t work out you don’t lose too much), and you add infinite value to your team. But you need to be picky with who you bring on, you need to treat them as an equal, and you need to inspire them.

What are the attributes of an entrepreneur? (0:35:28)

Someone who inspires others. If you’re looking to bring people on, a real entrepreneur will inspire people to leave their jobs and join the company even before you get funding. An entrepreneur works all hours of the day, is scrappy, hustles all day long and can execute an idea (it always comes down to cold hard execution). If we didn’t describe you, than watch out because you’ll be pushed out of the market before you’re even in.

As an angel, do you reserve money for follow-on investments? what is your ratio? (0:37:35)

A typical VC (A round) will reserve at least 100-200% of initial investment. For an angel, investment and reserve are more personal because you’re investing your own money. There are personal factors that come into play like real estate value, stock market activity, etc. But for angels, fundamentally, since you’re the first money in it buys you time to become familiar with the team and see the track record and progress. This gives you a better idea of how the company is doing so you can adjust your follow-up reserve (increase or decrease it).

Part 2: Lessons for Entrepreneurs

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Advice from an angel (0:43:00)

Clarity (0:43:07): you really need to know what you’re doing and be able to explain it in 1-2 sentences. For a team, there’s a lot of effort required to keep people on the same page, so for any company you need a really clear sense of your mission that is understood by everyone (from the CEO to the coders). If you succeed in this than everyone on the team will understand how their work contributes to that mission.

Co-founders/employees (0:43:47): Pick a co-founder who is better than you and pick employees who are better than you. Take your time and be picky because getting the right person is always better in the long run. A good founder will put in the time and effort to find the right people and will have a hand in choosing their employees.

Speak human! (0:46:20): As the entrepreneur and founder, you’re very familiar with your idea and product, but an investor isn’t. You should approach all investors as if they literally have no information or inkling about your idea. Instead of being overly intellectual, for your first meeting you need to speak in “human terms” that anyone can understand. Once you have the audience interested and engaged, you can be more intellectual.

“If you’ve got 150 IQ points, sell 30 because you just don’t need them” — Warren Buffett

Patience (0:50:30): You’ll have a lot of highs and lows, being an entrepreneur is very emotional. But at the end of the day, success is related to being a good human being. You can write an angry email to get your emotions out but you shouldn’t necessarily send it (or wait 1 hour and then make a decision). Patience is also important for market and customers. Don’t obsess over your competition because most times competition will implode on their own, pivot in a different direction, or you’ll learn to coexist. You need to focus on what you can control (rather than what you can’t) and understand what value you’re providing in the world.

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Ultimately running a company is about connecting with human beings: your employees, customers, investors. If you can do that effectively, you’ll win.

Topics of the day

Macro trends (0:57:00)

We talk about the proliferation of data and the openness of information in terms of the data and the Twitter “ecosystem” and also in terms of the expectation of users. We compare Twitter with Facebook and its current privacy situation with users, and discuss how Twitter avoided this issue by starting out saying “this content is public”.

Net neutrality (1:09:00)

We discuss Googles plan to pay more to Verizon in order to be on a higher speed connection and get its mobile content to users faster. We also talk about the issue of net neutrality, how we believe the issue isn’t as black and white as some people believe, and the implications of government intervention even if they do so with the best intentions.

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Location-based services, realtime & personalization (1:12:25)

Location-based services and realtime are adding another dimension to computing however we haven’t seen a service that ties it all together. Something that uses a weak AI to make inferences about what we want or would like to see, kind of like the recommendations on Pandora but related to my location and current time. We also discuss how there is an abundance of inefficient applications and how we believe communication trumps commerce. Companies need to remember that the most successful apps (at least to us) are the ones around connecting people and communication.

3 things that excite Mark (1:18:06)

1) People/companies with a consumer proposition that will resonate with consumers and engage people to use it on a frequent basis

2) People/companies who are solving the merchant problem of managing the influx of location-based services, increasing sales and repeat business

3) People/companies building open APIs and the “pipes” to support all these apps

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What start ups currently raising money should contact Thomas? (1:21:41)

Companies on the west coast ideally located in Los Angeles or San Francisco. And companies that have a beautiful product or idea, somewhere between a prototype (only it it’s really cool) and a MVP. Thomas says the maximum size of an angel round he’ll invest in is $2.5M.

Thomas’ Stats

– angel investor in Southern California

– been investing for 3 years, more actively in the past 12 — 18 months

– successful entrepreneur: founded GUBA (sold to his partner) and ShareYourWorld

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– studied CS in college, interned at Apple

– typical investment size: $25 — $100k

– typically investment geography: west coast (LA and SF)

– total investments: 15

Terms for less technical people

soft circle: when an angel gives a verbal commitment to invest but hasn’t actually signed any legal documents or written a check

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follow-up reserve: money that an angel hasn’t yet invested, that they don’t have a legal obligation to invest, but that they might invest over over the lifecycle of the company. Every investor keeps a list of their reserves and adjusts over time based on performance, progress, etc.

TCP/IP (Transmission Control Protocol/Internet Protocol): network transfer protocol, basically it defines requirements for network communications.

net neutrality: all data should be carried at the same rate and carriers shouldn’t be able to charge more or limit access to certain types of data transfer

geo: your location (as in geo-based marketing, ads relative to your location)

AI: artificial intelligence

API: application programming interface, a way of accessing structured data for additional uses by other people

MVP: minimum viable product

Reprinted from Both Sides of the Table

Mark Suster is a 2x entrepreneur who has gone to the Dark Side of VC. He joined GRP Partners in 2007 as a General Partner after selling his company to Salesforce.com. He focuses on early-stage technology companies. Follow him at twitter.com/msuster.

About the author

I grew up in Northern California and was fortunate enough to have computers around my house and school from a young age. In fact, in high school in the mid-eighties I sold computer software and taught advanced computers.

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