By Dan Rosen

The COVID-19 Pandemic has caused every startup to assess how to survive and plan to thrive in the “new normal.” No one knows what the new normal will look like, but based on other jolts to our economic system, we do know that life after this pandemic will be different than life before – at least for a while.  Just as there is no natural immunity to the Covid-19 virus, there will be no immunity to the economic disruption that results.

As I previously posted (see http://blog.drosenassoc.com/?p=140 and http://blog.drosenassoc.com/?p=145), startups need to act  while they can to survive, pivot (as appropriate), and figure out what unique things each business can do to solidify their future.

This is a test of leadership.

Most angels cite the team as number one thing they look for in their investments.  The critical role of dynamic leadership is more important in this time of unprecedented upheaval and startup survival threat.

Founders and CEOs must maintain team enthusiasm in the face of societal and personal hardships now more than ever.  While maintaining team cohesion, startup leaders also need to motivate their investors to stick with them and subscribe to their changing vision.  Both founders and their investors are in this to create great companies that lead to great exits.  Ultimately future investors and acquirers will judge and value the enterprise based on how well it adapts to this new normal.  But, of course, there is no company to value if it runs out of cash before it gets to an exit.

As I’ve spoken with many startup CEOs, I’m finding that they seem to fit into one or several of four categories.  These are:

1. Immediate action.  These CEOs (generally guided by either their own experience or that of an experienced CFO who has experienced previous downturns) see that cash must be conserved with a potential path to becoming cash flow positive.  They tend to involve their entire employee team into the conversation and take rapid action to conserve cash.  They often have a company that already has some cash flow, so balance the reduced cash flow with cuts to stay alive and potentially thrive.  Given that cash balance is finite, early cuts have a bigger impact than later ones; this is similar to the response to Covid-19, where earlier actions seem to have more effect in preventing widespread infection.
2. Benefit from the “New Normal”.  There truly are some business that will benefit from the disruption.  A clear example is Zoom, which is blossoming as we all need to move to videoconferencing.  Or, one of my portfolio companies, DocuSign that has enabled transactions to still be done virtually.  Some clever entrepreneurs have quickly pivoted to provide a piece of critical infrastructure for businesses to reopen safely.
3. Wait and see.  Some CEOs decide to wait to understand how bad their situation will be before taking action.  They might have considerable cash in the bank – they believe sufficient to weather the storm.  And, guided by their prior experience, believe that when cash get low, they will have achieved milestones that allow them to raise more cash.
4. Denial.  These CEOs believe that, while things look bad right now, their business will turn around and go back to the way things were before.  In some cases, they were in the middle of raising institutional money and believe that the money will come (it might).  In some cases, there is a logic that says if every one of my competitors cuts back, but I continue to move forward, then I will be the biggest winner when the market does turn.  There are probably some businesses that will do well in the “new normal” but I doubt that it is as many as think that they will do well.

The purpose of the above discourse is to point out that there are many different paths to leadership in this tumultuous time.  No one path is always correct, and most leaders will use some elements of more than one.

Over the next few weeks, I will talk with leaders who I believe, through their actions, have demonstrated exceptional leadership in the face of what could have been a company destruction.  I believe that their examples will serve to illustrate why we invest in startups and be a guidepost for others to adopt best practices.

Dan Rosen is the Chairman of the Alliance of Angels, former Director for the Angel Capital Association, and a Tech Coast Angels member. He has a Ph.D in Biophysics from UCSD.

By Dan Rosen

To: The Angel Community

After publishing my companion piece, “How Startups Survive the COVID-19 Economic Crisis,” I have received a number of comments about how this impacts angels and angel investing. Here are my thoughts.

Unlike VCs, who have a fund to invest and collect a management fee for investing their fund, Angel Investors invest their own money and are under no pressure to invest in any company or at any time. Our decisions to support a startup are totally our own. As in previous market downturns, there will be some themes that help us through our investment decisions during the COVID-19 pandemic and the resulting economic crisis.

Angels have limited funds. And many of us already have extensive portfolios. We quickly will be (or already are) in the position of getting funding requests from many of our portfolio companies for new rounds of funding. Some will make it, and some won’t – even great companies with fabulous ideas will fail when the cash dries up, and sometimes Angels alone can’t provide sufficient cash to carry them through.

For Angels, this is a good time for both investing and tough love. Great companies are often started in market downturns. I believe this is because only the most dedicated entrepreneurs (the ones that feel absolutely compelled to create their new company) will leave a stable, good-paying job in the middle of a downturn.

My friend and colleague, John Huston of Ohio TechAngels, commented on the last two recessions: “One strong recollection I have of those periods is that CEOs (with a strong BOD) who most effectively & frequently communicated their parsimonious plans to use the emergency funding were helped and survived.” An inexperienced entrepreneur might neither have the experience nor the tools to manage their impending company crisis; we as knowledgeable Angels and mentors and board members can draw on the experiences we have faced as investors in those previous cycles. It is our hour to shine and help our startups survive and thrive!

Here are my rules for Angels during this downturn:

Stay in the Game. I know that our public equity portfolio is way down, but, most likely, you aren’t bailing out while the stock market is down. Same is true of Angel investing. Stay in the game. Keep reviewing companies, meeting with entrepreneurs, etc. And be prepared to invest in both some of your existing companies and some new ones.

Be highly selective. Most Angel investors are always selective, but this is the time to turn your filter even higher. Funding is even more limited than it was a few weeks ago. There will be lots of great opportunities, both in your existing portfolio and new ones. So, take your time and invest with care. The funding requests will vastly exceed your ability to invest!

Work in a group or a team. Angel groups (or groups of Angels) can help a lot, both in terms of assessing deals and in making sure that there is a sufficient pool of capital and expertise to help companies succeed and thrive. In stressful times like these, this is even more important. The Alliance of Angels has survived the 2000 (dot com crash) and 2008 (mortgage crisis) downturns, with a group IRR of over 20%. Angels and the startups they support can really benefit from that institutional wisdom.

Be ruthless. All Angels investors have their favorite companies. We want them to succeed. This is the time to step back and realistically consider the probability of success with limited financing. Advise your existing companies to conserve cash and focus on how to help their customers. (See my companion piece.) You may think you are helping by keeping a portfolio company alive, but make sure that their plan is reasonable to actually survive – tough love. Some of your portfolio companies will not survive – even great companies will die from running out of cash and runway. But it is likely that some good ones will come through this crisis even stronger and give a better return than you expected.

Multiple financing rounds. This is a time to avoid companies whose plans require multiple rounds of financing with large cash needs before they can turn cash-flow positive. I’m not saying to sub-optimize the outcome of great companies. But for at least quite a while, it is likely that cash will be tight, and it will be difficult to raise money. Companies that are frugal and can make the most out of the Angel cash have a much higher probability of giving you a return.

Deal terms matter. This is a time for resets. Both Angels and entrepreneurs need to reset expectations. The world will recover, but it is likely to take a while, so make sure that the terms on which you invest are in synch with the market and the projected future. Resetting valuations to match today’s reality is a must. If you agree to too high a valuation, the company will have trouble both attracting enough investment now and, particularly, more investment at the high post-money valuation later. Watch for other terms, like liquidation preferences, that can lower your return. And, for a less experienced CEO, do not be afraid to have some protective provisions, e.g., the company can’t exceed its budget without the approval of the investors or investors’ rep.

Be careful, but not greedy. As Angel investors, we invest for the future and to give back. It is OK to be careful, ensuring that the return you get is commensurate with the now higher risk you are taking. But don’t be greedy and ask for large multiple liquidation preferences, too much of the company, or asking the entrepreneur to throw all their energy into the company without retaining a big enough stake. This is a time when we want a “rising tide to raise all ships.” We are in this together.

Exits. In the short term, not many exits are likely to occur. Unlike VCs, Angels can do well with modest exit valuations (provided that the initial valuation was in line with reality). Entrepreneurs can also do well with a modest exit. Make sure the entrepreneurs in which you invest are on the same page – look for early exits, even if they are more modest. You want entrepreneurs who want to be rich, rather than becoming a king!

We are in a challenging period. It is natural to want to pull back. As an Angel investor, this can be a good time to both maximize your current portfolio and find some new fantastic deals with fantastic teams at reasonable terms.

Reposted with permission from http://blog.drosenassoc.com/

Dan Rosen is the Chairman of the Alliance of Angels, former Director for the Angel Capital Association, and a Tech Coast Angels member. He has a Ph.D in Biophysics from UCSD.

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