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Angel Talks #7. Best deals and where to find them

Angel Talks #7. Best deals and where to find them

28 Dec 2020

Mindrock Capital fund has gathered an incredible portfolio: Space X, Udemy, Coursera and many more successful companies. It is not the first fund led by the entrepreneur Pavel Cherkashyn. He walked the path from angel investments to multimillion deals. Being a guest at Angel Talks, Pavel talked about how he reached such a level, where to start and how to get access to the best deals.

Startup Jedi

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The road to success

I’m a former entrepreneur; I’ve started in Russia, participated in the development of three successful companies in the sphere of Internet advertising and customer relationship management, I was a director in two of them.

I sold all the companies, and after that started launching Adobe and Microsoft products at the Russian market. In the process, I realized that the corporate world was not my cup of tea, but as an entrepreneur I had already lost interest. However, I’ve always been good at communicating with entrepreneurs and understanding the startup success chances.

For the next 10 years, I’ve been investing as a business angel, I’ve sharpened my skill, moved to California seven years ago, and started venture investing. Currently, I manage a portfolio of more than $250 million, 46 companies have been invested.

Thus, I started as an investor at the earliest stage, then in the process I became RVC’s Business Angel of the Year and made more than 50 angel investments.

Then I was managing a venture fund that was investing on the stages from the first prototype to the first revenue. With the income growth, I reached the stage of pre-IPO and IPO launch. I also managed three portfolio company placements and three more are planned in the near future. I advised dozens of companies on going public.
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Angel Talks #7. Best deals and where to find them — Pavel Cherkashin

Our niche are investments in B and C rounds

According to my experience, I found a niche, which I consider the most optimal regarding the balance of risk and income.

If you invest in a company at the earliest stage, then the check is about $100,000, and the chance of getting 10X at the exit equals from 1:10 000 to 1:1000. Out of the 300,000 active startups that appear every year, about 300 become unicorns. If you invest in the next step (round A), the chance of success equals to 1:100. At the same time, it becomes more difficult to find a company, an investment in which will give 10X, as usually, the growth will be more modest.

At the end of the chain, there is the pre-IPO and IPO market, where the risk of investment loss is almost zero. At this level, bankruptcies occur only once in 250 cases. These are stories like Theranos and such like.

One step below, we can see companies that are successfully developing, making a quality product and capturing a large new market. These businesses have very serious growth potential.

Here you can get the same 10X return on investment in two years as in the early stage, but the risk of failure is the same as in the pre-IPO. The market for investing in such companies is huge: $3 trillion a year in the United States, while there are not many players on it. Here we are talking about rounds B and C. At the earlier stages, there are enough corresponding funds, and at the later stages, large equity investors already enter. It is much more difficult to find money in the middle — and this is a window of opportunity for an investor.

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The growth driver in the niche

Over the past five years, the situation on the investment market at B and C stages has changed dramatically. A huge secondary stock market has grown. It used to be very difficult to acquire or sell shares of a non-public company — the entire chain from seller to buyer had to be built independently.

Beneath our eyes, this market has grown from almost zero to $3 trillion a year. Now there is a huge number of brokers, a legal framework, the practice of structuring such transactions, and it is very easy to sell the company’s shares at later stages.

Another important nuance: now, it is difficult to make money on the public market, and large private equity funds began to look at the venture capital market. However, they don’t understand anything about vc: they don’t see the valuation of the company in a billion according to PitchBook or Crunchbase and begin to buy up their shares on the secondary market — after all, unicorns rarely fail.

For investors like me, this is a great opportunity. We can decide whether to stay with the portfolio company until the IPO or sell it earlier.

In the case of Coursera and Udemy, the estimated value was already over a billion, but it is obvious: the education market has huge growth potential, and the pandemic has helped us all understand this.

I see a huge growth potential for SpaceX too: our fund began investing in this company at an estimated value of $30 billion, now it has grown to $50 billion and in a year it will be worth $100 billion by all metrics.

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Angel Talks #7. Best deals and where to find them — Pavel Cherkashin

Where to find cool deals

Usually, I invest in the companies that can show me at least a hypothetical possibility of a tenfold capitalization increase in two years. I choose those that haven’t yet reached the billion dollar estimation, or have already stepped over a little.

If companies aren’t on the radar of the large funds, and nobody asks about their shares, then you can invest and be with this company until it becomes popular and attractive for investment.

In this case, it is very important to know about the key events in the life of the company — when they happened, and not when they are written in the news. The delay is usually about six months, but it can also be from three to twelve months.

Companies and investors deliberately withhold important information about their success in order not to create the unnecessary hype. When Techcrunch writes that Company X has closed the investment round, in reality, the money has already arrived in the account at least three months ago.

To make an investment, I need to have such information in advance, preferably a couple of months in advance. Gathering such insights is the most important skill of an investor.

Imagine: you know that company X is going to attract an investment round at an estimate of 10 times more than in the previous round, but the company’s investors don’t know about it. And then you can come to them and offer to buy out their share with an X2 premium to the assessment of the previous round. On such conditions, they will gladly sell you a package and only then it turns out that they have sold the shares five times less of the original price.

Everything in our private market is built on insider trading. If we were governed by the same laws as the public market, fund managers would be in prison.

The second main problem arises immediately after the first. If the insight is received, then it needs to be implemented:somewhere, you need to get the shares of the companies. You can’t just go to the stock exchange and buy them — you need to go to brokers, talk with friends, with co-investors. It’s like selling over the phone half a century ago.

We take insights from our network and from the market. We have scouts — people, who constantly communicate with everyone in the market, go to specialized events and collect information.

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Angel Talks #7. Best deals and where to find them — Pavel Cherkashin

Cooperate or die

Co-investors are the most powerful source of insights. This is how information sharing works: we lead no more than one or two deals a year, and we bring this our great deal to a dozen co-investors and give them the insights they need. In the same way, they share classified information with us — and now I have 10–15 good deals a year!

There were times when an investor called and said: “Company X will close the round tomorrow, I left a slot for five million for you”. I quickly agree to such things, although I don’t know anything about the deal — everything is on trust. We’ve already worked together, I know the qualifications of this investor and I understand that his team has been preparing this deal for several months.

In such a way I acquired very successful investments to my portfolio. Likewise, I invite investors with whom I have worked before to my deals. In such situations, the level of trust is very high, because everyone cares about their reputation and doesn’t offer participation in unreasonably risky ventures.

It is statistically clear that such investments based on signals give significantly better results than investments based on fundamental analysis.

It often happens that there are no good signals from investors, and then our team begins an almost detective investigation: we look at the sources, find contacts of current and current employees of the company, go out with them on phone calls, and, bit by bit, we understand the real situation in business.

But we don’t always trust the sources. Sometimes you have to play “Believe it or not”. We sit down with the entire investment committee and decide whether to trust this insight, whether it matches with other information about the company.

When they say to me: “SpaceX will launch a man into space next spring and once he returns successfully, the company will open a new round at an estimated 30% more than the previous one.” You sit and think, is it possible, and if to assess it precisely, it is impossible. But our team assessed the risks and decided to believe, and then we are betting on growth.

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Serendipity/Intuition

Of course, the conjunction of circumstances plays a role. I have the word Serendipity written in big letters on the wall. The element of chance always exists and you need to understand that we are engaged in risky investments.

The best way to use Serendipity is to only invest 20% of your free capital in venture capital. Then, in case of an error, the drop will not be critical, and in case of success, the increase in the account will be quite noticeable.

Happy coincidences occur regularly in our business, as well as unlucky ones, of course. A portfolio is the only way to get around randomness. When you invest in 10 good companies, one of them will definitely grow by 10 times.

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Angel Talks #7. Best deals and where to find them — Pavel Cherkashin

After the deal

Venture business involves the active participation of the investor. But I deliberately made the decision to refuse seats on the boards of directors at all portfolio companies. I have more than 40 companies in my portfolio and only two people in the fund team. I just physically cannot participate in business.

My policy is to always be on the side of the founder. We don’t have time to understand the business, but if a startup comes for help (contacts, advice, etc.), then I will always help.

Founders need help almost always — and not only in the form of advice. The biggest problems for fast-growing companies arise from the psychological characteristics of the founders. People lose their nerves, they lose themselves and the connection with reality.

Not so long ago, you walked across the market and through humiliation looked for the first hundred thousand, and today investors send you a personalized cake to convince you to give them the opportunity to enter the estimated billion — this changes the perception a lot. And here it is necessary and important to be able to return the founder to the earth.

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Angel Talks #7. Best deals and where to find them — Pavel Cherkashin

What’s the point of syndicates

An investor needs to evaluate a person at the start and predict how he will cope with the rapid growth of the company and withstand this load. Much of due diligence is about assessing the founder’s potential. Sometimes, I have to refuse deals, because I look at the founder and just сan’t believe that he can pull the whole load.

Imagine a situation: you look at hundreds of projects, all of them have potential, but everyone has a “But”. And suddenly a project appears where everything is fine: a strong founder, who passed my internal strength test, and a great product that captures the market. At this moment, you are ready for anything: you don’t care about the assessment and conditions, it is important to get into this business.

For such a project, begin a real investor wars. A smart founder will be able to use this perfectly: “reconcile” investors, offer everyone the opportunity to enter at a higher rate than they initially offered. And then bump their heads together on the board of directors to reduce the influence of investors on the company.

This circumstance prompts to make syndicates. When several investors are involved in a deal, one of them will eventually be unable to take over as the head of the company. Other members of the syndicate will always be able to prevent him, and the company will have a better chance of surviving and growing.

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How to become an awesome investor

You have to be an awesome scout — that’s the main thing. You need to be able to find that very deal among hundreds and do it before other investors. If you have intuition and understanding of the market, then getting into the venture business is very easy.

The scouts’ “turnover” is very high, and not because they don’t like something and leave — that’s not the case. After a couple of great working years, a good scout will receive an offer from investors to become a fund manager. The scouts, who have worked with me, have already managed tens of millions of portfolios.

The easier option is to become a member of an investor syndicate. Now there are many of them and they are actively developing. Usually, participation in syndicates like ours starts at $50,000 per trade. You can find an opportunity to try with small checks of a couple thousands.

My advice to aspiring investors: Build a “virtual portfolio”. Look at the companies and see if you would invest in them. And then wait six months and evaluate your decision. Analyze what helped companies succeed and what led to failure. When you feel comfortable with your virtual portfolio, switch to real money.

If you want to get access to the best deals, then become a scout and try to find interesting projects yourself — this is the best school.

The full video version of the conversation can be viewed here:

 

28 Dec 2020

 

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