"Be Patient" | A Conversation About Angel Investing w/ Pascal Levy-Garboua (Part 1)

Today: A seasoned angel investor shares insights on liquidity, returns, IPOs, and secondary transactions.

The Agenda👇

  • Why it takes so long for liquidity to happen

  • How to make real money as an angel investor

  • Why the IPO market is so hot these days

  • Why there isn’t such a thing as a secondary market

I was first introduced to Pascal Levy-Garboua by a common friend, Misha David Chellam. When we first interacted, he had to postpone further interactions because he had just left Checkr, where he was the VP in charge of Business Development (actually the first non-founding executive), to embark on a long journey around the world with his family. That wonderful trip was sadly cut short by the pandemic, and Pascal ended up in Paris, which was his initial destination, earlier than anticipated. 

Here’s what’s so singular about Pascal: although he’s French and now lives in France, his entire career as a senior operator happened in Silicon Valley, and his portfolio as an angel investor (and a venture partner with Long Journey Ventures) is based in the US—with some rare exceptions. Hence for us Europeans he’s kind of a gem: someone with whom it’s easy to interact, but whose background and experience with entrepreneurial ecosystems is in Silicon Valley. I hope you’ll enjoy Pascal’s insights as much as I did.


Is there a difference of mindset between Europe and Silicon Valley when it comes to liquidity?

I’ve read about European investors being worried about liquidity, and the fact that the lack of it could make it complicated for local startups to raise funds. But in my opinion, an entrepreneurial ecosystem such as France’s, for instance, is only five years old! Before that, there was almost nothing. And now, after five years, it’s already quite an achievement to have a few unicorns. People need to realize how long these cycles are, and how long investors need to wait for liquidity.

Let’s have a look at what happened in the US in 2020. In Q4 2020, there have been many IPOs there. Two VCs (Keith Rabois and David Sacks—both PayPal alumni, by the way) have seen six of their portfolio companies go public. But this incredible outcome needs to be put into perspective: we’re talking about investors with a very long experience, the best network there is, and an incredible track record; and we’re talking about investments that were made a long time ago—between 2010 and 2012!

Therefore, the issue is not that we need more exits—rather it’s that the exits need to be big enough, to generate enough liquidity so that the ecosystem can grow further. Look at French startup Mirakl, for example, which has just raised $300M at a very high valuation ($1.5B). The most important thing for the company is not to justify that indeed it’s worth what investors have said it’s worth; what really matters is being able to grow to a point where it’s worth 2 or 3 times the current valuation! The same is true for other French unicorns such as ManoMano or Doctolib.

If these companies which just raised a lot of money keep on growing, then collectively the entrepreneurial ecosystem will create enough wealth and liquidity to flourish. If ManoMano, for instance, ends up being worth €20B, then it will be easier for them to purchase other, smaller startups whose businesses complement theirs—it’s easy to buy someone for €200M when you’re worth €20B! We really need to pursue the right objectives: the goal is not for legacy bank BNP Paribas to buy a fintech startup such as Qonto for €1B; the goal is for Qonto to reach a valuation high enough so as to be able to buy many other startups for several hundred million euros each.

This is something I’ve experienced as an angel investor. One of my portfolio companies was purchased by DoorDash back when DoorDash was worth $1B. Today, DoorDash’s valuation as a public company is $50B. For me, as an angel investor, it has made a huge difference. Back when my portfolio company was acquired, I traded $1 worth of shares in the original company for $1 worth of shares in DoorDash. And now $1 has turned into much more—and the multiple on my investment is effectively 30x. 

Here’s another example: another portfolio company of mine was acquired for $100M by a listed company, and since then the valuation has doubled! Sadly the main investors in the cap table decided to cash out rather than to hold equity in the acquiring company, and most angel investors had to follow. But I was lucky enough to hold common stock from an earlier round, which means that I wasn’t forced to cash out; and now my investment is worth much more because I have been patient enough.

And so here’s the thing about exits: exiting is not only about cashing out. The most consequential exits are obviously when your startup goes public, like Spotify or Adyen did in Europe. But the second best is rarely when your startup is acquired by a legacy blue chip company—rather it’s all about the cases whereby a startup you invested in is acquired by a larger tech company which then goes on to become even larger (and you are paid in stock).

And that is how high multiples are achieved on early angel investments: most startups don’t have the potential to grow that much, but they can still be acquired by a larger company that will then proceed to grow further—and at a much faster rate, thanks to increasing returns to scale.

So this is the key: seeing the capital you deployed early on hop from one company to the other so as to benefit from these increasing returns to scale?

Absolutely! I had the experience early in my career as an angel investor: I had invested a small ticket in a startup that was then acquired by Square for $100m in stock, and after that shares in Square saw their value grow from $9 when Square went public to $260 today. From my perspective, Square’s journey as a public company has created much more value than the startup I originally invested in. For all of us who were lucky enough to be paid in Square shares (angel investors like me, but also the founders of this startup), this early acquisition has translated into a huge return on our initial investment. It’s the difference between making some money and making a huge amount of money.

And so the idea is that if you own shares in a company that goes public, you should keep on holding the shares even after the lock-up period? 

It’s up to each individual investor to decide. As for me, I’m not a good trader of public equities: I prefer to buy and hold. I don’t want to have to decide every day if I should hold or sell. And then there’s an advantage from a tax perspective: if I had cashed out when my portfolio company was acquired by Square, I could then have proceeded to buy some stock in Square. But in between those two operations, I would have had to pay 30% of my proceeds in taxes. In the end, I might end up paying much more in taxes, but my capital has compounded in the meantime, and holding was definitely the right decision for me.

It would have been different if this startup had been acquired by an established company—an incumbent such as Procter & Gamble, for instance. In this case, there’s no point getting shares of the acquirer, because it’s likely that those shares won’t be worth much more in the future. But if the acquirer is a tech company with a lot of room for further growth, it’s an entirely different story! Seeing a portfolio company being acquired by the likes of DoorDash, Square, or Stripe is a great opportunity because those acquirers still have a long runway for further growth, and they excel at making your capital compound. This is how exits that initially look average eventually become enormous.

By the way, founders can be strategic about this: they can seek to be acquired by a larger company which they think is undervalued, and then work on the inside so that the value is eventually realized, making a lot of money for themselves in the process. It’s exactly like a SPAC: the acquiring entity is not an end in itself, it’s just a vehicle to continue the journey and unlock unrealized value in the process.

All in all, solving the exit problem requires already having a significant number of tech companies that are listed. Having this two-part journey is the key for delivering very high multiples. Again, founders need to be strategic about this: they have the ability to work so as to make themselves fit for an acquisition by the company with the highest growth potential. In some cases, the intermediate acquisition price won’t be that high, but if it’s a deal in stock with a company that has more potential, it’s really a no-brainer compared to a deal in cash whereby founders simply work 1 or 2 more years and then leave. The latter is like surfing a big wave, taking a nice picture when you reach the top, and then getting out of the water. The former is about surfing even larger waves and winning bigger competitions.

And so I think this is what is at stake when it comes to startups in Europe. We need that first generation of European companies going public in various geographies and industries. Then it will become possible for these listed companies to acquire many more startups that have reached an intermediate stage. And everyone will eventually make a lot of money in the process, which will propel the ecosystem further up.

It could be happening today! If you’re a founder in Europe and a company that’s already quite large, such as Mirakl, offers to acquire your startup, here’s what you should do: take the deal and demand to be paid in equity rather than in cash. This is really your best chance at getting very rich—because it’s likely the acquirer has a greater potential for liquidity than your own company. And that, in the end, is what drives wealth creation.

What’s the reasoning from an acquirer’s perspective when it comes to deciding if the deal should be in cash or in equity? Is there some reluctance when it comes to issuing shares?

It all depends on the amount, how much it dilutes existing investors. But to be fair, in general cash deals happen when the acquisition is too small compared to the size of the acquirer. Also, from a corporate finance perspective, if there’s cash available, it makes sense to deploy it in an asset that effectively strengthens the acquirer’s balance sheet by way of diversification.

But really it all depends on the relative size of both parties. Amazon, for example, won’t do a deal in equity if the price is below $500M—except if the target’s founders negotiate well, like was the case for Zappos back in 2009 (the late Zappos CEO Tony Hsieh negotiated $1B in cash and $2B in Amazon stock, which means a 4x return eventually became 80x). 

Let’s come back to the question of IPOs. I remember back in 2014-2016, everybody in Silicon Valley was lamenting the lack of IPOs. There was this interview of Marc Andreessen in which he explained why it had become impossible for tech companies to go public. And six years later, we see all these companies finally going public and generating huge amounts of cash for their shareholders. What happened? Should we expect a similar inflection point in Europe?

I think so. What it took in the US was several companies deciding that enough was enough. They put their toe in the water and proved that it was indeed still possible to go public, and that public market investors were in fact welcoming to tech companies. Then the levees broke because things went much better than what everyone had expected. 

Not being listed is convenient. Founders don’t have to report constantly; if they miss a quarter, it’s not that problematic; and they can still organize some liquidity for themselves. Then a few years ago, SoftBank came along to fill the gap and made it possible for companies to stay private even longer. But then we had an inflection: early investors were growing impatient and SoftBank was having problems of its own, depriving large private companies from accessing that large pool of cash. Then the WeWork debacle was really the tipping point: everyone decided that they had to go public after all, if only to make sure that what had happened to WeWork wouldn’t happen to them.

And then there were some specific cases. Airbnb, for instance, had an issue with its employees: most stock options had been issued in 2010-2012 and had to be exercised over a 10-year period, which was a source of worry for many early employees. Sure, Airbnb could have decided to issue a new pool of options, but that would have been complicated and expensive for all parties involved. Instead, they decided to go public even in the context of the pandemic—which has arguably been a big hit to their business—because, from an early employee’s perspective, it wasn’t possible to wait any longer. There was this “forcing function”, as Americans say: the constraints exerted on the company were such that they had no choice but to go public.

Now, because the stock market is booming, many companies think that it’s the right moment to go public. That being said, it only works if the company is already quite large and its business is predictable enough for public equity investors. For those who don’t pass the predictability threshold, they can still go public via a SPAC, but my impression is that there’s some adverse selection when it comes to SPACs: good companies prefer to go public the traditional way, and those that are on shakier ground use the alternative (and more expensive) version of going public via a SPAC.

I’d like to hear your views about secondary transactions. On this side of the Atlantic we’ve heard a lot about the fact that in the US, angel investors, employees, and even founders can make money early on by selling some of their shares on the secondary market. There was the rumor that when Uber went public, most of its early shareholders had already sold most of their shares. Is that the actual situation?

No, it isn’t. For a very long time, it was impossible to purchase Uber shares on the secondary market—just as it is almost impossible these days to purchase Stripe shares. There are some very hot private companies for which demand significantly exceeds supply: these days it’s the case for Stripe, SpaceX, the military contractor Anduril (founded by Oculus’s founder Palmer Luckey), and Plaid. Then there’s another tier of companies for which there is some demand, usually at the last round’s price. And then there’s the rest, for which demand is essentially nonexistent (say, a few million dollars worth of demand).

So, yes, there is such a thing as a secondary market, but it’s not that deep, it’s not working that well, and there are a lot of constraints that make it essentially impossible to sell shares in many private companies. On the other hand, there are venture capital firms that find that the stock market has been going a bit too far in terms of pricing stocks and prefer to sell their stake early on the secondary market rather than waiting for the IPO. But it’s easier for a VC firm which can influence the company’s board and force a secondary transaction than it is for an individual investor who doesn’t have access to the big guys in the boardroom.

And so, as for Uber, it’s more or less a legend. Some people sold their shares shortly before the IPO, but most of those transactions happened internally—as in, the founders buying out some employees with capital brought about by pre-vetted investors such as SoftBank. Those were late secondary transactions, at a price that wasn’t far below that of the IPO. So from an investor’s perspective, the economic equation is similar to waiting for the IPO, and the returns are rather similar whether you sell one year before the IPO or during the IPO itself.

All in all, some investors have the opportunity to de-risk their investment by selling slightly ahead of the IPO (it happened with Uber, it happened with Facebook), but I wouldn’t talk of a liquid secondary market per se. For such a market to exist, you need many companies that are very hot on the market, and whose board makes it possible for early investors to sell their shares to third parties. It’s a very narrow category—for the time being. 


Continue to Part 2 of my conversation with Pascal 🤗


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From Munich, Germany 🇩🇪

Nicolas