"Be Patient" | A Conversation About Angel Investing w/ Pascal Levy-Garboua (Part 2)

Today: A seasoned angel investor shares insights on deal flow, how many deals an angel investor should do every year, what exits to expect, and more.

Credit: Nik Shuliahin

The Agenda👇

• What it takes to succeed in angel investing

• What’s a ‘unicorn’ and why it matters

• Is there still such a thing as a local deal flow?

• Are European founders pursuing the wrong opportunities?

Yesterday I sent out Part 1 of my most recent conversation with Pascal Levy-Garboua, a former executive at Checkr and a seasoned angel investor. You can read it here: “Be Patient” | A Conversation About Angel Investing w/ Pascal Levy-Garboua (Part 1). Below is Part 2 of our conversation. Please enjoy and send feedback!

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Now let’s embrace the point of view of the aspiring angel investor. For someone who wants to do it well, with a deal flow that remains dependent on geographic proximity, what would you say is the best approach? How should one anticipate the long cycles that it takes to see an actual return on your investments? How many investments a year? How much is invested in each company?

It all depends on the strategic positioning you want to have on the market. I know very skilled investors who are very busy these days deploying capital at an incredible rate. I recently talked to someone who signs 2 or 3 checks each week!

So what’s the right number of deals over a year? Let’s say you’re in a tier-2 city and your deal flow is mostly local. If you want to make 10 deals a year and these deals are local, the probability is high that most of them will be mediocre deals. It’s possible to do 10 good investments a year in Paris, London, Berlin, maybe Amsterdam. But doing the same in Marseille, Lyon, Nantes—I don’t know. Maybe, but most likely not! In Nantes, for instance, there are one or two good startups every year, so if you’re doing 10 investments a year there, you really need to be in the right cap tables!

For me, the idea is that you should have enough opportunities so as to maximize the probability of having one or two unicorns a year. If that’s not the case, if your model is to invest when the company is worth €5M and to divest when it’s worth €25M—then, really, I don’t think it’s worth it, at least if the goal is to make money. (Investing to give back to the local startup community is another matter.)

So if you have a good deal flow and if you invest in a systematic way, then yes, you need to do 1-2 investments a month—that is, 15 to 20 a year. This has been my personal strategy for years, and this approach has always been considered quite quantitative by my fellow investors. And by the way, when I have slowed down on the number of deals in a given year, I’ve seen lower returns. That’s because, once again, returns depend mostly on 2-3 startups. And if you do fewer deals and miss these outliers as a result, you’ll end up with a 2x return after 10 years, which is definitely not worth the effort!

The last time we spoke you mentioned the fact that you were surprised by the ticket size in some European deals you had considered—as in, individual investors investing €200k, even €500k in just one company. On the other hand, market practice in the US seems to be investing $10-20k in 15 to 20 companies a year. 

Indeed. It might be true that if you have sufficient insight on the local market, then you can risk more by signing bigger checks in a few companies which you know are above average. But then you need to beware being too insightful in a given market or a given industry.

Recently I was listening to a podcast with Andreessen Horowitz’s Chris Dixon, who was saying that his first startup (as a founder) was in cybersecurity, and then when he started angel investing, his deals in that particular field ended up being the worst in his personal portfolio. The reason is that when you know a given market well, you tend to fall in love with ideas and not pay as much attention to the founding team. It turns out that the best investments are usually made when you concentrate your attention on founders rather than on the idea or the market.

The situation is different for a VC firm. If you have an entire firm that is in charge of deploying capital, then you can concentrate your efforts on a lower number of deals. But that’s only because you can dig deeper into analyzing the market, you can do proper due diligence, and you also invest at a later stage. 

For instance, Keith Rabois, back when he was at Khosla Ventures, had implemented a strategy focused on new batches at Y Combinator, which was essentially quantitative—as in, 10 companies in each batch. He generated excellent results because he excelled at picking (he invested in companies such as DoorDash and Checkr), but also because he had this quantitative approach that secured one or two huge successes in each batch. On the other hand, if you only sign one check and it ends up being in Uber or Google, yes, you look like a genius, but the truth is it’s pure luck. It’s like winning the lottery.

So I’m a firm believer in a systematic approach: signing a lot of smaller checks in quite a lot of startups, with the goal of generating substantial returns over a 10-year period. 15 deals a year over 10 years translates into 150 holdings in one’s personal portfolio. So it has to be small checks. Investing €50k in 150 companies in 10 years is just too much of a commitment—it’s €7.5M!

This is why there aren’t many angel investors that can keep up, and eventually they turn their investment activity into a proper business. It’s what happened to me: after 4-5 years, I realized I couldn’t commit more personal capital and I had to raise outside capital. I turned to AngelList to raise that money, to manage the related back office and to ensure compliance while still doing my day job—because being an angel investor has always been a side gig for me.

As for Europe, it’s too early to tell if you can make the same kind of money by doing 15-20 deals a year in countries such as France or Germany. I honestly don’t know. It’s much too early to tell if the market is deep enough. I can see that the 4-5 unicorns that France now churns out every year often have a pool of investors in common in their cap table. That means the market is small enough for the best angel investors to see every deal. But that definitely isn’t the case in the US

Even people like Keith Rabois, Scott and Cyan Banister, and Naval Ravikant (whom I think are the four best angel investors in the US) can’t see every deal—there are simply too many of them. Whereas in France, for instance, the best angel investors see all the best deals.

What about this word, “unicorn”? What does it mean exactly?

It means a company that’s worth €1B after having raised €100M-150M. It’s rare to see a company that reaches such a valuation without raising that much money. Notion reached unicorn status after having raised only $70M; Clubhouse is now worth $1B and they’ve raised $110M in total. But such cases are extremely rare. Every $1B company has usually raised at least 15-20% of that amount from investors across several rounds.

And why do unicorns matter? Why do such companies trigger a virtuous circle when it comes to liquidity?

One thing is that there are many more secondary transactions with unicorns than with companies which haven’t reached that level, so it definitely makes a difference from a liquidity perspective. Secondary transactions happen for companies whose valuation is between €500M and €1B, but it’s usually as part of funding rounds. It’s only when the company passes the $1B that secondary transactions start happening in between funding rounds. You need to reach unicorn status so that your brand can exist for brokers and investors start expressing interest.

What about you? As an angel investor, have you made a lot of money by selling shares on the secondary market? How do you decide if you should hold or sell when there’s an opportunity to do so?

Actually, I only did it once, and it was with Checkr where I was an employee. My shares in Checkr represented a significant amount of my wealth and when the opportunity presented itself for employees to sell up to 10% of our stock options, I decided to diversify and sell—but it was before Checkr became a unicorn. On the other hand, as an angel investor I’ve always refused offers to sell shares on the secondary market. My view is usually that there’s still upside and so I’d better hold my shares and wait for more wealth to be created. 

That being said, it’s my approach, and people consider me a long-term investor, someone who’s not afraid to take a risk over very long time horizons. There are other approaches: a friend of mine, for instance, had raised a small $1M fund and he did what it took to be able to return the capital after a short period of time, if only because he wanted to prove to himself that he could return money to investors. But it was a tough decision because there were three unicorns in that portfolio (DoorDash, Instacart, and Hashicorp), and my friend ultimately left a lot of upside on the table because each of these companies eventually passed the $20B threshold.

You discussed the idea of a local deal flow, but what about this new, post-pandemic world in which people make deals over Zoom and AngelList, providing you with a potentially infinite deal flow across several geographies? Should we expect investors to detach themselves from their local ecosystem, or will people keep on investing locally?

It all depends on one’s perspective. For an angel investor who’s only used to looking at European deals (or French deals, or UK-based deals), I can’t really imagine them having a good deal flow and seizing the best opportunities in the US. I think that certain people have the ability to do so, but that’s a tiny minority. They simply don’t know the local market well enough.

When you think about it, it’s very hard to invest in consumer startups on another continent, especially at the early stage, because the culture is so different, consumer habits are so different, and you can’t really spot the signals that a given deal is worth considering.

Even for enterprise startups, it’s very hard! I’m sure the best VC firms in Europe can do good enterprise deals in the US, but I don’t think most angel investors have the ability to do so. There are exceptions, of course—I can think of a few. But these remain exceptions, and I think of them because there were unique circumstances that made such deals possible.

Take the case of Notion, in which I invested in 2013. For me, that deal happened because I personally knew the founder at the time, and being in Silicon Valley, we all had a sense that something was coming, a trend that eventually became known as the ‘no-code’ phenomenon. I liked the founder and his mindset, so I invested, and now my shares are worth a lot. But I had to be there and to be part of the same social network to have a shot at the opportunity. Other Europeans invested in Notion from Europe, but that only happened later, when Notion was more visible and the case was more obvious.

Ultimately, it’s all about the deal flow you have access to and the ability to compare one deal to another. If your deal flow is local, you’ll always end up comparing a given deal to the average deal at the local level. But most likely that’s not the right benchmark and the bar should be much higher! An above-average deal is not necessarily an excellent deal.

As for AngelList, sure, there are many, many deals that are now made accessible from anywhere in the world. But you can only have a look at the deck and in most cases, you won’t have an opportunity to interact with the founding team. Yet as I mentioned, assessing the founding team is the key to succeeding in angel investing at an early stage. If you can’t interact with the founders, then you need to trust the lead investor and the fact that they’ve formed a good opinion of the founders. Or you simply follow a VC firm with an excellent track record at that stage, such as First Round Capital. This is something I’ve been spotting while managing my syndicate on AngelList: when a prominent firm invests in the round, people are relentless and sign checks in an instant; in the absence of such a firm, even with similar metrics and my personal engagement, people are more reluctant to invest.

That means AngelList is not about angel investment per se. It facilitates Europeans’ ability to access deals in the US, yes. But it’s not what angel investment is about: you don’t have to assess the founding team, you’re simply following someone who’s leading the round and whom you trust has conducted a proper due diligence. 

In the end, the most difficult part of becoming a good angel investor is to have a good deal flow. I can see that with the firm where I’m a venture partner, which is Scott and Cyan Banister’s. Scott and Cyan are arguably the Lionel Messi and Cristiano Ronaldo of angel investing. And if you have a closer look at how exactly they do it, a few things stand out: first, they have a very good deal flow; second, they don’t hesitate to do deals that don’t fit in current trends.

Specifically, they currently have 20 unicorns in their portfolio, but you won’t find many enterprise SaaS startups like every other VC is crazy about. What they have are companies such as Uber, Affirm, Wish, even SpaceX. Sure there are exceptional founders in that group, but when the Banisters invested none of those deals was obvious—they simply didn’t fit in the trend of the moment. And none of those deals could have been seen without the right connections, being in the right flow, having a reputation.

If I take myself as an example, at one time I had a reputation as an investor keen to invest in startups in the on-demand economy. The consequence is that at some point I started to see every single deal in that space; but on the other hand, when I finally reached that point, on-demand was already starting to lose steam. Scott and Cyan have invested in on-demand startups, too (companies like Uber and Postmates), but they haven’t ceased to express interest in new things that few other investors were willing to consider. They are moved by their own curiosity as opposed to investors who simply follow trends.

And that is exactly what makes them exceptional angel investors: you realize how good they are when they ask you for an opinion on a company that you’ve never heard of, that isn’t part of any preexisting trend, but is clearly a jewel and a no-brainer.

I have one last question. When we last talked about all this, you told me about the difference between VC-backed founders in Europe and the US in terms of their background. Can you elaborate on that?

Sure! This is what I’ve observed: what we see in Europe is people with exceptional backgrounds, the European equivalent of an Ivy League education, who pursue opportunities on markets that are not that big—typically various verticals in the SaaS industry, such as designing a SaaS tool for chiropractors, hair salons, or contractors in the construction industry. In the US, people with a similar background will go after much bigger opportunities. They won’t let themselves be confined to a narrow vertical. Instead, they will focus on a deeper technological layer, which represents a much bigger opportunity.

That is exactly what is happening in Israel, by the way. Israeli founders know that building a consumer startup is not their best shot at reaching a large scale, and so they tend to focus on building technological assets that then become an acquisition target for large US companies—who will then pay a high price because they have the ability to deploy those assets and distribute the resulting products at a very large scale. 

The same opportunity doesn’t exist if you’re building a SaaS product in a given vertical. There are very few large tech companies that are interested in acquiring SaaS startups, except for a firm such as Constellation Software. And by the way, even in the US these companies developing management software are typically bought out by private equity firms, not by larger tech companies.

And so the number of exits and the amount of liquidity all depends on the kind of companies you’re building. If Europe focuses on growing companies such as Doctolib, I don’t really see what the end game is except for Doctolib going public: who would buy Doctolib at the valuation it’s aiming at? Not Google, not Apple—and so getting to the IPO is the only way out for Doctolib.

Where should European companies do their IPO by the way?

I certainly hope that at some point there’ll be stock exchanges in Europe where local tech companies can go public at the same multiple as their US counterparts. 

Remind me of your typology of exits, based on your experience as an angel investor.

If I consider my own experience, I have seen very few exits at a price between $100M and $1B. This category of exits has almost disappeared from the current tech landscape in the US. There were a few recent exceptions, but such deals are less and less frequent—yet such exits are typically the ones you find in the models used by VC firms to predict their returns! So these firms will have to change their models at some point.

The reasons why such exits have disappeared are numerous: companies don’t go public anymore at such a low price; when you reach a valuation of several hundred millions, capital is so abundant these days that it’s easy to raise more capital so as to stay private and delay acquisition talks; in addition, founders can still make some money on the secondary market if they want to put some cash aside. Sure, there are still buyout deals thanks to private equity firms, but as an angel investor I have seen very few exits in that price range.

Thank you so much Pascal for sharing such incredible insights!

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Make sure to read Part 1 of my conversation with Pascal: “Be Patient” | A Conversation About Angel Investing w/ Pascal Levy-Garboua (Part 1)

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From Munich, Germany 🇩🇪

Nicolas