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Seed Capital From Angel Investors: Ho Nam, General Partner, Altos Ventures (Part 7)

Posted on Thursday, Aug 12th 2010

By guest authors Irina Patterson and Candice Arnold

Ho: Whenever we turn down companies, they always ask whether we can refer them to other investors. Sometimes the company would be better suited for certain investors who we might know and if there is a fit, we’ll refer them.

But in general, we don’t like getting referrals of companies that other people have rejected, unless they know that this particular company might fit our strategy and they know us well and they think it’s a good match. Certainly, we’ll take those referrals. But if it’s just a random referral . . .  if somebody kept referring us deals like that that were not highly qualified for us, that relationship would not be a very good relationship and we would not pay attention to their next referral.
Irina: What do you think funded companies should do to improve their chances of success?

Ho: Whether it’s angel backed or venture backed, I think what we try to get companies to do is really focus on getting to profitability. One of the main reasons that people want to be entrepreneurs is they want to work for themselves. They want to control their own destinies and until you get to a point where you’re at cash flow positive, you don’t control your own destiny.

You’re at the mercy of bankers or investors – VCs or angels. You want to get to the point where you control your own destiny and you have a viable business. Some of those viable businesses could become just good lifestyle businesses and some of them could end up becoming home runs but until you get to that sustainable level, you are severely at risk.

A couple other things really is we have our entrepreneurs think a lot about building their teams and what kind of people they want to have around them. Certainly for us, as I mentioned, it’s very important who we’re working with, what kind of people we’re working with.

Whether a business succeeds or fails sometimes depends on factors beyond our control.

But one of the things that we can control is what kind of people we work with. If you work with really good people, it makes the job fun. If you work with not so great people, maybe you’ll end up making money, but maybe you’ll end up having not so much fun and it is not a good life. So, think about the team that you pull together – these are people who you will be working together for a long time.

Ho: The third thing is really think about is how do you build lasting competitive advantages? What Warren Buffett likes to talk about is moats – building deeper and wider moats.

How do you widen and deepen your moats? If every single day you’re figuring out how to build a bigger moat, a bigger competitive advantage, that will buy you more time to keep building a bigger and bigger business.

Ho: As we say, “If you’re profitable, that allows you to be more patient, buys you more time.” Right? Because you’re not running out and you’re not desperate.

If you have great competitive advantages, that allows you to be even more patient. It gives you more time. If you don’t have competitive advantages, guess what, somebody who goes out and raises $50 million in funding or somebody else who comes after you discovered a great market, maybe it’s a hot market, you’re going to get crushed over time.

So, if you’re not every day building something that’s special, that’s different, that’s differentiated and that somehow builds increasingly competitive advantages over time, your business is severely at risk. It doesn’t matter if you’re a $100 million profitable business. You could be crushed overnight, especially in the tech business.

I think those are the three key things that we have people think about.

Irina: What about venture capital funds? What do they need to do to survive and thrive?

Ho: I think our primary job is to help entrepreneurs build really great companies. At the end of the day, the venture capital business is a hits-driven business. You know about the 80/20 rule: 80% of the returns coming from 20% of the deals. The 80/20 is not just some venture rule. You see that everywhere, in the financial world, in nature.

The 80/20 rule came from an Italian monk, Vilfredo Pareto, who was studying counting peas in pods and realized that 80% of the peas were produced by 20% of the pods.

But think about the extremes of 80/20 rule. Let’s say you apply the 80/20 rule to the top 20% of companies. That means 20% of the 20% is 4% of the companies. It’s a pretty skewed result when you have 4% of the companies producing 64% of the profits, or almost two-thirds.

You can apply the 80/20 rule again, that means you have 0.8%, less than 1% of deals producing more than half of all your profits. It’s really the outliers that produce the mega returns.

It’s hard to predict what’s going to be the homerun.

There’s no way I would have predicted something like Twitter or Facebook would have been really big. It’s hard to predict upfront. Back the entrepreneurs, try to build a lot of value with very little capital, and then once in a while you can get a really big return and build a pretty big business.

Irina: Thank you, Ho. Really great insights.

This segment is part 7 in the series : Seed Capital From Angel Investors: Ho Nam, General Partner, Altos Ventures
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