Sramana Mitra: Hi, Scott. Tell us briefly about your background.
Scott Kosch: I studied economics and psychology at Claremont McKenna College, prior to trying out management consulting, and then business school at Wharton, but all along I was interested in entrepreneurial pursuits. I’ve worn many hats: company founder, advisor, and investor. My passion has remained with the early stages of new businesses and the process of invention.
SM: Do you or the members of your group have any particular industry expertise?
SK: I have worked or invested in many industry verticals, including software, hardware, telecom, media, energy, clean tech, and financial services. I consider myself industry agnostic from an investment approach, although obviously the more expertise I have in a particular space, the easier it is to form investing conviction as well as add more value to a venture than just cash.
SM: Which industries do you have special expertise in?
SK: I have experience in a fairly broad range of industries. From the IT side, my first web-based venture was 16 years ago in streaming video on demand, so I’ve witnessed the evolution of web-based business models. I’ve been involved with SaaS for enterprises, mobile services, e-commerce, ad tech, wireless technology, and so on. I’ve also been involved with clean tech for even longer than IT. Yes, that means I was doing it before we called it “clean tech.”
SM: Do you invest regionally, nationally, or internationally? If regional, what is your primary region(s)?
SK: I do not have a geographic focus. Although I reside in Miami, Florida, I have made investments in Los Angeles, Chicago, San Diego, New York, Dallas, San Francisco, and even Argentina. I see so many companies these days with co-founders and staff geographically dispersed that I wouldn’t even know how to screen companies by location.
SM: What are your current sources of deal flow?
SK: My best deal flow tends to come from referrals within my network. This can include venture firms, other angels, corporate attorneys, entrepreneurs, former classmates, bankers, and so on.
SM: On average, from all sources, how many pitches do you receive a month?
SK: Probably an average of 50 a month.
SM: Out of all pitches you receive, how many deserve a closer look?
SK: I believe every pitch deserves a reply. I have a lot of empathy for entrepreneurs trying to raise capital. It is a very difficult process that I know firsthand. While you are trying to run a business, fundraising is a distraction of time, energy, and emotion. Rejection is an expected part of the process, but it is a lot easier to stomach when you at least get some helpful feedback. I try to treat it as a privilege for me to receive someone’s pitch deck.
So, in that sense, I think every pitch deserves a close enough look that I can at least provide feedback. In terms of how many companies I end up scheduling calls and meetings with each month, probably five out of 50, although I wish I had time for more.
SM: What factors receive the most weight when you’re debating whether to fund a venture?
SK: The most heavily weighted factors are team, potential value (such as margins, net buyer benefit, TAM [total available market], and asset value), and the competitive landscape. Over the years I have learned that team is the most important predictor of success. Unfortunately, these factors and others tend to be very subjective. Plus, luck and timing play enormous roles in the success or failure of a venture. Of course, if it were easy and predictable, then everyone would do it, right?
SM: How many investments have you made in the past 12 months?
SK: Four new investments and four follow-on investments.
SM: How much money do you usually invest?
SK: The range is between $25,000 and $200,000.
SM: How long does it take for a company to receive funding from you or your group?
SK: This can be very situational, where a relationship may develop over a longer period before a fundraising event takes shape, and frequently I may get involved as an advisor before investing capital. In any case, I try to be clear and up front with each entrepreneur about the likelihood of an investment as quickly as possible. I think a lot of investors inadvertently give out false hope by not stating their opinions clearly enough. I have cut a check within two weeks of the first pitch, but that is rare. More typical is 30 to 90 days.
SM: What is the typical valuation of a company that you invest in?
SK: It’s $500,000 to $6 million for seed to early stage, although some seed deals are structured as convertible debt.
SM: In terms of percentage, how much of a company’s equity do you usually seek?
SK: As an angel investor participating in a round with other investors, I don’t think about the percentage. I’m just looking for a reasonable and fair valuation for the stage of development and expected return.
SM: What is the typical return you seek, and over what period?
SK: The standard answer is to target a ten-bagger over five years, but in practice no one experiences the mean on any real-world investment. Most investments of this type are binary: They return big or you lose your capital. If you can’t even imagine a return greater than tenfold, your venture better be a lot less risky than most. And less risky ventures can be quite attractive too, but then an investor can’t afford a loss of capital with a portfolio of companies that don’t even have a potential for a home run in the lineup.
SM: In what stage of business development do you usually invest?
SK: I have invested from an idea on a napkin, but more often, you want some signal from customers that the company is on the right track. Many like to call this “product-market fit.” This might be validation from beta clients or a critical mass of loyal consumers. Of course, actual sales figures never hurt, either.
SM: What should be the TAM for the company’s product/service?
SK: I’m mostly interested in opportunities where single-digit percentages of TAM result in millions of annual revenue; however, I have gotten involved with opportunities where the goal isn’t hyper growth with a high multiple exit. One problem I observe frequently is that the entrepreneur with the $20 million idea doesn’t understand that he or she can’t raise a lot of investor capital to execute on an idea with a $20 million exit. Some angel capital may be reasonable, but these ventures must rely more on sweat equity.
SM: What do you do with your rejects, that is, businesses you don’t invest in, if anything?
SK: Whenever possible, I try to point entrepreneurs in a helpful direction. This might include constructive feedback on their plan or other funding sources or a referral to an incubator program.
SM: Do you have any sector preference? 1M/1M focuses on technology, technology-enabled services, and online businesses. We do not do biotech, clean tech, manufacturing, or similar. We focus on e-commerce, Web 2.0, Web 3.0, SaaS , cloud computing, enterprise 2.0, enterprise 3.0, healthcare IT, online education, mobile and social media apps, healthcare services, outsourcing, BPO, and so on.
SK: Yes, I do look at all of these areas.
SM: Do you have to have an exit strategy, or would you invest in deals that can go on generating dividends over a long time?
SK: Most deals involving angels or VCs navigate to find a liquidity event through M&A or IPO; however, I’m not opposed to cash cows, if ownership and governance is structured to allow for this outcome.
SM: What is your preferred investment type – common shares, preferred shares, royalties?
SK: Preferred shares are typically best, but I’m also comfortable with common stock, convertible debt, and other forms of financing when appropriate.
SM: Do you do debt financing? Convertible? Non-convertible? Terms?
SK: Yes, I have done various forms of debt financing.
SM: Thank you, Scott, for your time.
SK: Happy to do it.
This segment is a part in the series : Seed Capital