4 TH ANNUAL TEXAS ANGEL DAY

1. 4TH ANNUAL TEXAS ANGEL DAY Who Makes More Money… One Check Willie or Follow-on Freddie? John O. Huston, Ohio TechAngel Funds

2. WILLIE’S ADVANTAGES • Step One: “One & Done” • Avoid taking Board seats • Don’t review financial statements • Don’t track your portfolio • Return entrepreneurs’ calls (if ever called) • Step Two: Provide wire transfer instructions into his checking account!

3. FREDDIES’ DISADVANTAGES • Might write more checks so: • Reviews financial statements • Tracks portfolio • Helps investees (intros to customers/investors) • Take BOD seat • Confronted with “Sequential decision making” • Angst & animus when declines Question:Does Willie or Freddie more frequently provide wire transfer instructions?

4. “For every problem there is one solutionwhich is simple, neat, and wrong.”H. L. Mencken (1880-1956)

5. Designing Your Angel Portfolio • Decisions • How much $ in this alternative asset class? • Max/Min per deal? • Martingale or Kelly Betting System? • Seek a BOD seat? • To VC or not to VC? • Chasing ROI or IRR? (10X or 58% IRR?) • Building entrepreneurial wealth or your wealth? • Dope Slap Avoidance?

6. Designing Your Angel Portfolio • What do you believe? • You can pick winners? • You are a gifted wizard in one industry? • Placing a few big bets beats “Spray & Pray”? • If you drive the exit, it will be highly lucrative? • Does Willie One Check make more $$$ than Follow-on Freddie? Question: Can this business be figured out, or is it a complex adaptive system?

7. Homework • James Weatherall: The Physics of Wall Street: A brief history of predicting the unpredictable (2013) • Michael Mauboussin: The Success Equation: Untangling skill and luck in business, sports, and investing (2012) Think Twice: Harnessing the power of counterintuition More Than You Know: Finding financial wisdom in unconventional places • Nassim Nicholas Taleb: Anti-Fragile: Things that gain from disorder (2012) The Black Swan: The impact of the highly improbable Fooled By Randomness: The hidden role of chance in life and in the markets

8. Let’s Look at the Research • “Throwing Good Money After Bad: “Political and Institutional Influences on Sequential Decision Making in the Venture Capital Industry” 2007 article by IsinGuler published in Administrative Science Quarterly • “Returns to Angels in Groups” November 2007 study by Rob Wiltbank and Warren Boeker for the Angel Capital Education Foundation (now the Angel Resource Institute) 3) “Siding with the Angels” May 2009 study by Rob Wiltbank for the BBAA (British Business Angels Association) and NESTA (National Endowment for Science, Technology and the Arts)

9. “No question is so difficult to answer as that to which the answer is obvious”G. B. Shaw (1856 – 1950)

10. “Throwing Good Money After Bad” • 2007 article by IsinGuler of UNC published in the Administrative Science Quarterly, 2007 • Subtitle: “Political and Institutional Influences on Sequential Decision Making in the Venture Capital Industry” • Studied 364 VC firms’ decisions re: 1,862 financing rounds in 796 ventures from 1989 – 1993 ($9.4 B)

11. “Throwing Good Money After Bad” • “Results show that VC firms become less likely to terminate investments as they participate in more rounds of financing, despite evidence that expected returns are declining over rounds.” • VCs would be better off investing fewer rounds into each venture

12. “Throwing Good Money After Bad” • VCs use the Kelly System, placing larger bets when they are convinced the odds are in their favor • The more VCs in a deal, the better the odds?

13. BUT………… • 2012 #1 VC deal was Fisker • Raised >$1B and will be sold to DongFeng for $425 MM Question: Are VCs “Sheeple?” More so than angels?

14. “Returns to Angel Investors in Groups” • November 2007 study by Rob Wiltbank and Warren Boeker for Angel Capital Education Foundation (now the Angel Resource Institute) • 539 angels provided data about 1,137 of their exits over prior two decades • 61% of angels had portfolio returns exceeding their capital invested • Top 10% of angels earned 50% of total returns

15. “Returns to Angel Investors in Groups” • Angels made follow-on investments in 29% of the ventures from which they exited • 68% of exits with follow-ons resulted in losses • Average returns: 2.6X in 3.5 years = 27% IRR • Ventures without follow-ons yielded 3.6X, but those with follow-ons yielded 1.4X

16. “Siding with the Angels” • May 2009 study by Rob Wiltbank for the BBAA (British Business Angels Association) and NESTA (National Endowment for Science, Technology and the Arts) • 158 UK-based angels from 31 angel groups who invested in 1,080 ventures of which 406 had exits • 9% generated >10X which provided >80% of returns

17. “Siding with the Angels” • 35% of exits made solid returns of 1 – 5X • 60% of angels were in “the black” • 29% of the exits involved follow-ons • Average returns = 2.2X in 3.6 years = 22% IRR • These exits with follow-ons yielded only a 1.2X

18. Rob Wiltbank’s Summary “In ventures where the same angel investor wrote more than one check to the same venture their multiple was significantly lower. This was true even in ventures where VC’s also join into the venture in subsequent rounds.” “In my opinion probably the most central issue is the extent to which the follow on investment was planned at the point of the initial investment, rather than made as a separate follow on investment.” Source: January 14, 2013 e-mail

19. SO: Demand a CAP! • CAP = Capital Access Plan • How much dilutive capital needed to achieve Cash Flow Break Even (CFBE)? • How much capital needed…”From Here to Liquidity?” • Will angels or VCs be driving the exit? Question:Have you ever seen a Bridge Note Round in a Capital Access Plan? Answer:No!

20. Huston’s Musings • If VCs didn’t allow following-on the data is skewed……angels may not have had a choice • If following-on yields >1X should you do so to protect your initial investment? • The US returns = 3.6X without follow-ons versus 1.4X with follow-ons, but would the 1.4X have been ZERO? • Death dampens a portfolio’s returns more than dilution! If >50% of ventures expire, why make a follow-on investment to protect against dilution? • VCs or angels better at sequential decision making?

21. Let’s look at one angel’s portfolio • First check in 2000; 64 checks; max. = $100K/venture • 47 ventures (only those > 20 hours of DD) • Willie for 27; Freddie for 20 of 47 ventures • Ceases to invest when VCs arrive • Directors checks = 9 ventures got 21 checks • Most rounds: 4 (Director) • 7 Lucrative exits of 47: Only 9 checks…….why?

22. One Angel’s Kennel (47 dogs) Best in Dog At the Cuddly ShowDiedVetPuppies >2X cash <1X cash Would take Refuse a return return 1X 2X offer Willie 5 6 7 9 Freddie 2369 7 9 13 18

23. One Angel’s Kennel (47 dogs) Cos.F-On%VCs Best in show 7 2 29% 3 Dog died 9 3 33% 1 At the vet 13 6 46% 3 Cuddly pups 18950% 11 Totals 47 20 43% 18

24. 7 “Best in Show” Dogs • Why only 2 follow-on checks of the 7? • 2 would not accept more dilutive capital • 3 led by VCs (lowest returns of the 7)

25. Directorships & Checks • 9 Board Seats; 21 checks written • Only time written 3rd or 4th checks • 9 Outcomes: • 1 Best in show • 2 dogs died • 2 at the Vet • 4 Cuddly puppies

26. Remember……… “Culling out those portfolio companies you decide not to further feels like drowning puppies!” Allan May (Nov. 2008)

27. Huston’s Follow-on Filter: • When do I automatically invest? • Why do I usually decline? • What 10 factors do I assess?

28. I Automatically Invest When: • I’m a Director (or an Observer) • I really, really like & respect the founders/CEO/team (They deserve to win) • The round is grossly oversubscribed so I take my preemptive share (to avoid “Dope Slap”)

29. Usually Decline if: • Lost confidence in CEO (communications!) • Gross underperformance (50%) • Excessive uptick in price (>50% in 12 mos.) • Selling band-aid notes (I do not buy notes) • More of my $ won’t fix lack of sales • Need a pivot • VCs driving the round • Would prefer to help another venture

30. My Follow-on Filter • Do I like & respect the Founder/CEO/team more than when I wrote my first check? Communications? • Was this follow-on round planned in the Capital Access Plan? • Did OTAF lead this deal? • Will the Lead Director keep the BOD focused on the exit? (Kelly “Edge”) • How skilled are the other Directors at orchestrating an exit? (“Edge”) • Can I help the company achieve a lucrative exit? (“Edge”) • Are VCs needed for an exit? If so, can we attract them? • Deal terms & paper being sold? • What’s the uptick in share price? (>50% in 12 months?) • Is this a case of just buying more runway……….or building a completely new runway (pivot)?

31. Remember……… “Angels who never write a follow-on check deserve the same fate as Stuart Sutcliffe and Peter Best who left the Beatles early!” John Huston

32. One Angel’s Pathway “You have no relevant experience!” Started via “Spray & Pray” • Be the smallest investor • Willie One Check • Spread across lots of deals & deal terms • Learn from the seasoned angels (ACA) Result: Today would duck first 5 deals

33. One Angel’s Pathway (continued) Tried to learn from each loss & success Started to feel confident about adding value: IRC 1202, 1045……and especially 1244! Pursued BOD seats to get the Kelly “Edge” • Start-ups are NOT just tiny public corporations • Reserve most dry powder for them • Boost returns via Directors Options (1%) • Run VC & Banker vetting Today:Largest investments when improve odds by being a Director/impact the exit

34. Rob Wiltbank’s Personal Approach • “In my investing, I make a hard and fast rule: any follow on investment must meet the same standard as any first time investment I might make, no exceptions.” • Then I have 2 possible exceptions: • No brainer; I’m lucky to participate • If circling the drain without more money…….”AND if I really, really like the entrepreneur, I’ll do it.”

35. Rob Wiltbank’s Personal Approach “But in general, I worry much more about getting into another high potential company than I do about avoiding dilution and putting more money into a situation where my decision biases are working against me.”

36. In Closing: • Academic data doesn’t answer the question whether Willie or Freddie makes the most $$ • Each deal is a story, but establish a process for vetting follow-on requests SO: I feel like the mechanic who tells you………. “I couldn’t fix your brakes so I made your horn louder!”

37. “For every problem there is one solutionwhich is simple, neat, and wrong.”H. L. Mencken (1880-1956)

38. QUESTIONS/COMMENTS? John O. Huston; (614) 939-1503; jh@OhioTechAngels.com