Get Inside the Mind of an Angel Investor

Posted on Feb 10, 2011 | 25 comments


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.

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.

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).

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)

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).

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)

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

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.

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.

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

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

–  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

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


  • http://www.brekiri.com/ Greg4

    The golden rule about simplicity and explaining it to your girlfriend is great. The specifics are a little different for hardware or B2B, but the general principle about boiling it down to a clear benefit remains the same. It's like the (Twain?) quote: “I would have written you a shorter letter, but I didn't have enough time.”

    I think the investors that really get it want to be sold on simplicity, but I worry about the ones who want to be sold on complexity. I can imagine a lot of investors getting pitched on the next Twitter or GroupOn and thinking it sounds too trivial. “So you send out an email with an offer to a bunch of people?” But being “trivial” is never really the problem for most early-stage companies. I think some entrepreneurs lose clarity on the value proposition in trying to tell investors what they think they want to hear.

    A similar risk exists in product development. I find myself thinking, “What if feature X turns out crappy, and no one cares about my product? Maybe the product should do Y, too.” The problem is that you usually just end up with two crappy features instead of one. I'm constantly reminding myself that I have to do one thing well, and that's really it.

  • http://20minus.com Thanasis Polychronakis

    That was indeed one of the most great and juicy interviews for TWIVC!! I listened more than 3 times to it, more than deserves the time you took to transcript it Mark, Great post!

  • http://bothsidesofthetable.com msuster

    Thank you. Yeah, Tom's great. When I was there I remember thinking, “I wish we could run 2 hours”

  • http://bothsidesofthetable.com msuster

    The problem with new Twitter-like products is that it's nearly impossible to tell what's going to take off. So in a way you need a bit of customer traction to excite investors.

  • http://www.brekiri.com/ Greg4

    True. It's a butterfly effect kind of product. But I think Twitter is

    actually a great example of the right way to do it. Instead of building in

    picture sharing and an ad platform and God knows what, they went to SXSW,

    showed the value, and got adoption. In other people's hands, Twitter could

    have become a bloated and confusing product quickly (not that it's not

    confusing to a lot of people anyway, but for different reasons).

  • http://fashioningchange.com/ Kevin Ball

    This is a great interview, with lots of great things to learn.

    I'm wondering though, it seems like everyone in the LA area is looking around them and north. Do you have any advice for the startup community down south in San Diego to start getting more attention? We're working on getting more organized and trying to draw more attention; any ideas would be greatly appreciated.

    Thanks

  • OSU_Matt

    Great interview! I particularly love the re-emphasis on explaining your product in 1-2 sentences. This particulalry pertains to the company/idea I am trying to work on. Also, Tom's advice on having one leader and brining on 4-5 other technology guys vs. co-founders was an interesting persepctive. Thanks for the great interview Mark.

    Also Mark, I sent you an email about doing the transcript for another interview, with one other short related question. I hope you got the email.

    Again, thanks for the best VC start-up blog and for your insights.

    Matt

  • John

    Here is a video of a talk given by Basil Peters to a group of angel investors in Boston sponsored by the Angel Capital Association on best practices of investing in early stage technology companies by angels and VCs.

    http://www.angelblog.net/Early

  • http://twitter.com/rkillgo Russell Killgo

    Mark, I loved this interview. Very insightful as to how to approach the angel investment time period. I posted the other day on your basecamp blog post. Hopefully you will find a minute to check it out. Big news today for my company… It looks like we will be bringing a front line sports athlete on board with us from day 1. He has almost 1 million Twitter followers, is in the prime of his career, and one of the best in the world in his sport. I'm super excited about this, but this now opens up a lot more questions I have. One last thing… Do you think Instagram would be as popular as it is if it had charged a fee for the app from the beginning? I would love to talk a little about my startup with you if you ever have time. — Russell
    russellsiffter@gmail.com

  • gouravs

    Mark
    I saw this video a couple of days back on TWIC
    absolutely loved it
    I became a fan of Tom's clarity of thought!
    interesting comment on simplicity – the requirement that his girlfriend should get it in a minute

    as an entrepreneur, i think the intersection of clarity of purpose, simplicity of use and degree of fun makes a great pitch to investors.
    do you agree?

  • http://twitter.com/starttowonder S Jain

    Mark,

    One quick question, How open are Angels to be on board of a startup because of their experience but not for money. I guess it wouldnt take so much money to build a product before worrying about scaling for a technical person himself. But having insights from people like you or Tom would be so much more valuable right from the beginning.

    One thing that you guys did discuss was twitter and ecosystem and I have very different views on it. Especially after seeing the demise of big giant social networks like Myspace.
    I am going to stick my neck out and say, I believe either twitter is going to add on many services and change significantly and will be fairly complex or its going to vanish same way as Myspace did in next three years or so. Other than social graph there is no compelling reason for me to use twitter.I can just tweet from other platform and read it there. I dont see any retention value, stickiness in twitter. The day there is a better product to tweet or maybe comparable product thats able to generate enough hype, twitter should be worried.

    Also, I think totally opposite from Tom in terms of twitter being open and no privacy makes twitter what it is. Because there is so less privacy I do not tweet so many things that I could. Hence twitter looses on the extra data I can be adding to it. And me not adding that data thats important to me makes me less loyal to twitter.

  • http://www.darrenherman.com dherman76

    Mark, great interview. I totally agree with being able to explain to your gf/wife. Love it.

  • kristy1212

    i just came by your article and it get my attention. i thought i'ld leave my first comment just to appreciate the hard work you done.
    Small Business Loans

  • David Beyer

    Great interview. Can you explain the product risk versus market risk difference? I'm an angel and won't invest in the most beautiful of products if I don't see a market for it. In fact, even at the earliest of stages, I'll invest in a market over a product (as long as the team's there).

  • http://www.monicasellsflorida.com Monica Nielsen

    Hello Mr. Suster, I am not a techie, However an end user. I have been following your blogs for almost 18 months, Both Sides of the Table. I am new at blogging, Monica Nielsen's Blog is about the end user wanting to learn and Beta test products. Blog is just over a week.

    Also, you can read more info. on who I am by googling Monica Sells Florida or Monica Nielsen. I would love to provide feedback to start-ups looking to excite investors. Pass my contact info. around if anyone is interested in me testing there product or services.

    Keep up the great work!
    Monica Nielsen
    Celebration, Florida

  • http://bothsidesofthetable.com msuster

    “looking around them and north” not sure what you mean?

    re: san diego – there is huge engineering talent in San Diego coming out of UCSD (my alma mater) and mobile skills given the success of Qualcomm. There are also several successful entrepreneurs who live down there including the people who build MP3.com (Michael Robertson), Active and several others. The best thing for any community is to get these experienced people working with new startups and attracting VCs to spend more time down there.

    I know I will be.

  • http://bothsidesofthetable.com msuster

    Thanks, Matt. Yeah, sorry, I get so many emails some slip through the cracks. I don't think anybody has done Michael Robertson yet so that might be a good one to do.

  • http://bothsidesofthetable.com msuster

    I responded over there.

  • http://bothsidesofthetable.com msuster

    yes, I agree. and a “narrative” can be important.

  • http://bothsidesofthetable.com msuster

    Most angels don't join boards because
    - they often have other jobs
    - they invest at higher volumes and can't be on 15-20 boards

    But
    - if you find one angel to write a larger check or show more interest that could change. For example, Tom spends A LOT of time at Klout. He's super passionate about it. That happens.

  • http://bothsidesofthetable.com msuster

    product risk = product isn't complete so you are taking a risk when you invest that they can't build a good product.

    market risk = product is built but you don't yet know whether the market will adopt it en masse

  • http://twitter.com/rkillgo Russell Killgo

    Thank you. I will use my resources and creativeness. Hopefully, I'll be seeing you soon.

  • gouravs

    hmm, so another question.
    how much 'drama' do angels/VCs like?
    do they like story-telling (of course with an embedded logical idea flow)?
    or do you suggest keeping the “DQ” as low as possible?

    (*drama quotient; sorry! couldn't resist :-)

  • http://twitter.com/#!/wamatt Matthew Tagg

    Great interview Mark and I found myself nodding along quite often. You have excellent people skills and knack for a explaining things clearly in a relaxing manner.

    From Tom's side I took away one thing which I'm wondering whether is true:

    He believes matching capital to ideas is more efficient than executing himself.

    This is curious to me. Surely angels (the ex-entrepreneurs types) can do better than +-30% IRR as predicted by angel market returns, by managing the enterprises themselves? For example my personal IRR over a 10 year period on invested capital into the business (excluding sweat equity of course) is 200%+

  • http://goteamspark.com Chris Patton

    Mark – just want to say thanks for posting the writeups of the talks. Super helpful – I don't always have time to watch the whole show, but to be able to skim through the talk to see what might be interesting to me is wonderful. For example, I'm a single founder….so was interested to listen to your discussion at 14min about cofounders, 50/50, etc. Keep it up!