Jason Calacanis on how to attract angel investors

Jason’s also an entrepreneur, host of the wildly popular This Week in Startups podcast and founder of the LAUNCH incubator (a place I’ve spoken at several times). In anticipation of his new book, Angel: How to invest in technology startups, I hosted Jason on our podcast to find out what he looks for in promising founders, when they should begin pitching angel investors, how to approach valuation, and much more.

Additionally, we’re giving away 100 free copies of Angel to our readers and listeners. Simply contact us through the Intercom messenger on this page, share why Jason’s advice resonates with you, and you’ll be entered to win.

If you enjoy our chat check out more episodes of our podcast. You can subscribe on iTunes or grab the RSS feed in your player of choice. Below is a lightly edited transcript of the conversation. Short on time? Here are five quick takeaways:

1. When a startup fails, it’s typically not because the founder ran out of money. It’s because the founder quit. This is why Jason invests in founders who show resilience and a willingness to contribute sweat equity.
2. There’s still plenty of value to be found in conversations with angels who aren’t ready to invest in your product – provided you’re willing to engage in candid conversation.
3. If a founder goes for a higher valuation, they must be ready to show why using hard data, or risk losing many of the more desirable investors.
4. Your customers love talking to investors. After all, they want you to succeed and grow your product. So for an angel investor, it’s the ultimate tell if you won’t let them talk with customers.
5. Innovation can happen anywhere, but Jason believes the high art for founders will be having a headquarters in the Valley, while also having offices in places where costs are less and employee turnover is slower.

Des Traynor: Jason, welcome to the show. To get us started, what attracted you to the world of angel investing? You obviously made some money off Weblogs. Was it just people asking you for money as their rich friend or had you always an eye to get into investing?

Jason Calacanis: My original position on investing was only to invest in myself, and by doing that, I missed investing in Twitter and Zynga, which are like a $50 million and a $25 million mistake. After a while of this position, I realized I have so many smart friends who are doing so many big, ambitious projects. I even passed on investing in Tesla, and I’m good friends with Elon. All my friends were starting these great companies and I made mistake, after mistake, after mistake. I realized that when my friends tell me they have an idea, I need to invest in it.

When Travis came to me and said, “Can I get your advice on my new startup?”, the first thing I said to him was, “Can I invest?” He said, “Do you want to know the idea?” I said, “No. I just want to invest in you,” and he showed me Uber with one or two cars on the map.

Des: You’ve obviously had a lot of hits along the way, but angel investments don’t all work out. That’s kind of the point. But you’ve had Uber, Thumbtack, Wealthfront – why do you keep your chips on the table?

Jason: I love angel investing because you have this proposition, if you’re doing it in Silicon Valley, where you’re investing in people who have a high likelihood of having success at some point in their life. If you miss on an investment, let’s say with Travis on Scour, his first company, and then Red Swoosh is a single or double, you go invest in his third company and it’s a mega hit. The odds are so in your favor if you’re networked in Silicon Valley that it’s crazy not to angel invest in 30-50 companies. I wrote the book because I’ve learned so much about this after 125 investments, and six of them have become unicorns. Literally since I wrote the book I found out I have three more unicorns in my portfolio. Every 21 investments, I’ve hit a unicorn. If I only hit one unicorn in 125 investments, it would’ve been in all likelihood a very profitable endeavor for me.

As an angel investor, you get to talk to somebody who wants to change the world and you get to be part of that. It’s super thrilling, exciting, educational and fun. It’s literally the greatest job on the planet. Running a company, you lay in bed and you stare at the ceiling worrying about customers leaving, customer engagement, losing your CTO, losing your head of sales, when are we going to run out of money, etc. But when you’re angel investing, you have a portfolio strategy and when six, seven or eight out of 10 companies fail, most people get super depressed, but once you understand that’s a sign that the remaining two or three that have not died yet are going on to great success, you become very peaceful about the failures. It takes a year or two to get through that.

In the book, I talk about year two and how terrible it is as an angel investor, because you start having all your first year companies fail while you’re investing in the next year’s company. If you can get through your sophomore year, when you become a junior and a senior, you can see the light at the tunnel. When you go on to your fifth and sixth year, that’s when it gets exhilarating.

How angels approach deal flow

Des: How do you think about deal flow in that regard? Your network is growing all the time, so in theory your odds are probably getting better as you get more and more connected as well. Is it fair to say then that your early years might be barren for a lot of reasons, or is it possible that you could start and be a winner on day one?

Jason: There’s a lot of randomness here, but what I advise people is in year one, make $1,000-2,000 investments via syndicates – AngelList, SeedInvest, Republic, FundersClub, etc. – so that you’re investing very low dollar amounts while you’re learning. I use the analogy of learning to play poker. If you wanted to go play poker, you should play at the table where the bet sizes are $1 and $2 and where you have to buy in for $40. This way you can buy in five times, lose $200 and not care. Whereas at the bigger tables, you may have to buy in for $500 or $1,000 every time and then if you lose $2,500 or $5,000 learning to play poker, you’ll be a fish and the sharks will be eating you up. If you know you’re a fish, if you know you’re new, bet the smallest bet size possible while learning.

The best way to do this is start slow. Put that $1,000 or $2,000 into deals that have been pre-vetted by other angels, but act as if you put in $100,000. In other words, be as helpful to the startups as if you put in $50,000-100,000 so you can learn and build your reputation. Then in year two your signaling gets better, your network gets better, your reputation gets better, and all of those things then draw better startups to you.

I wrote the book because I really want people to learn how to do this better than I did. I put every secret I know in the there because it’s not a zero sum game. As you know, every startup that’s raising from angel investors, they usually have 20, 30 or 40 investors before they get to the VC round. I’m not sure how it went down with Intercom, but I’m guessing there were 20 investors before the first VC.

Des: Certainly more than 10.

Jason: It’s not zero sum game in the early days. Later on, something like Intercom, it’s going to be competitive for the series B, the series C and one VC might try to block every other VC. It gets sharp elbowed and it is zero sum. One person gets the deal and the other people don’t. For me, I’m just trying to increase the number of people angel investing to increase my own deal flow. The more people I inspire and help do this, the more they’re going to send me the next Uber, Thumbtack, Robinhood, Desktop Metal, DataStax, etc.

Robinhood, a free stock-trading app, is one of six unicorns in Jason’s portfolio.

Des: Do you have any sort of thesis around return profile or when you’ll see your money back? Or is the whole beauty of it that it’s just not that complex and you can just do things to feel good?

Jason: As an angel investor, the likely scenario is you either lose half your money or you double your money. You might invest in 30 companies and they lose half their money. If you were investing $5,000 per company or $10,000 per company and you invest in 30, your $300,000 could become $150,000 or their $150,000 could be $75,000, and, in which case, you will have learned a lot and built their network for less than the cost of a master’s degree.

There is also a chance that you’ll double your money, and you’ll feel great. Then there’s this outside chance of outside returns. If you hit a unicorn and your average investment size is $5 million, that’s a 200X return if it hits $1 billion. If you were diluted by half, it would still be 100X return. That means you invested in 30 and you got 100 units back so you’re going to be way in the money.

It is possible theoretically to invest in 30 or 40 Silicon Valley companies and miss everything, but even the people who’ve gone super crazy investing in tons of companies like 500 Startups, Dave McClure’s incubator, which has invested in 1,500-2,000 companies now, hit only one or two unicorns. Dave’s hit rate is one every 750 and he still says he has a profitable portfolio. He hit Twilio, which I’m assuming is a 500X or a 250X (return). You don’t have to have a 1:21 ratio like I’ve lucked into, but the return profile in the first three or four years is miserable and you only get bad news.

The companies that don’t work, you’ll find out quickly between months 12 and 36 that they’ve run out of money. It didn’t work. They’re shutting down. When they shut down, you usually get no money back, half your money back, or 1X your money back if it’s an acqui-hire. The companies that survive, if you’re in year four, five, six, and seven, either you found enough money to break even or you’re off to the races and your revenue is scaling to seven, eight, even nine figures. You’ll find out about your winners in years 7-10. I’m in year seven now, and I’m starting to have all these winners pile up from the first four years.

The makings of a billion-dollar founder

Des: In your new book, you talk about the importance of not going for billion-dollar ideas, but instead looking for billion-dollar founders. What do you mean by that and how can you identify them?

Jason: If you try to understand if people will be willing to rent out their extra bedroom in their apartment or their extra couch in their living room to a stranger, it’s a crazy idea. It was also one of the top five bets you could’ve made in the last 10 years, Airbnb. I would never stay in an Airbnb. I found the concept insane, but I’m 46 years old and I’ve stayed at hotels my whole life and I’m risk averse. I don’t want to meet new people. I don’t want somebody having my phone number. I don’t want somebody making me breakfast. I’m not that adventurous now. I want to get in and out of a hotel. I’m busy. I’m not the market for Airbnb.

If you try to understand these ideas and you look away from (asking) what happens if it does work, you’re going to miss all the big opportunities. I thought Twitter, if it succeeded, would just be a cacophony of idiots talking to each other about inane stuff. You know what? I might’ve been right in some ways. But the fact is I didn’t realize that as a blogger, somebody who liked to write a thousand words, Twitter was not for me. Twitter was for everybody else who didn’t have the ability or didn’t want to write a thousand words. It was for people who wanted to write a sentence. When you try to understand these big groundbreaking ideas, if they are in fact groundbreaking, nobody would ever rationally think they would work.

The reason most startups fail is the founder quits.

To bet on somebody like Elon Musk to make an electric car or SpaceX or his new company, The Boring Company, those are illogical bets to make. The chances of success are 1-3%, but the payoff is 1,000 to one. You don’t have to know if the idea is going to work; you just need to know if the person is passionate, the person is capable and the person is not going to quit.

If you look Travis from Uber, Elon from SpaceX, Mark from Facebook or yourself at Intercom, I can meet a person and know they are not going to quit. This person is going to work through the hard times. Now that doesn’t mean they’re going to succeed, but it does mean if they have that resiliency and the idea matters to them and they’re passionate about it and they have some craftsmanship in their works and pride, some attention to detail, that’s the prototype of somebody who will do great work through the hard times and not give up.

Most startups fail not because they run out of money. The reason most startups fail is the founder quits. I’ve seen founders who run out of money tell their team, “Hey, I’m not going to pay you for the next two to four weeks, but I’m going to get a bridge loan and if you stick with us, I’ll make sure you get paid back over the next six months. If any of you need to pay a mortgage payment, I’ll put it on my credit card or I’ll give you a loan, but I really I want to try to keep this startup alive,” and they’re honest with their team. I’ve seen this happen and they survive. In fact, Tesla was one of those companies. Elon went into debt to save that company personally.

You’re looking for those kind of indefatigable, rabid, hardworking founders, and you can figure that out by having open-ended conversations with them where you ask questions like, what are you working on? Why are you doing this idea? Why will this idea work now? Then just listen to their answers and look for ideas that the person is passionate about.

When is your startup ready for an angel investment?

Des: As an angel, when should you be willing to look at a company? On a spectrum of, “Hey, I’ve got a half-baked idea in a Google doc,” all the way through to, “Hey, I’ve got this product built and it’s generating revenue,” when should a founder reach out to you?

Jason: Depending on where you’re at in your angel investing career, you can choose to focus pre-product/market fit or post-product/market fit. If something has product/market fit and a bunch of traction, they’re going to trigger a series A investment. A series A investment these days is in the $12-30 million range, what used to be a series B. If something has $50,000-150,000 in monthly revenue or 5 million monthly users, there’s a good possibility they’re going to trigger a series A. In other words, they don’t need angel money anymore.

People can build a prototype in a couple of months off sweat equity.

If you look for things just to the left of that – maybe somebody has $10,000 a month in recurring revenue, if somebody has a million users a month, 10,000 a day, 20,000 a day – they probably are not going to trigger a series A and they’ll be what I call a goldilocks startup, which is not too cold and not too hot. If you go into the not too cold area as an angel investor, especially a new one, you’re going to be betting on people’s charisma and their enthusiasm. Founders are highly charismatic, but you’re going to be investing probably too early.

In today’s market, it only takes 10 weeks for someone to build a hardware prototype, an app prototype may take six weeks, and a website might take four weeks. People can build a prototype in a couple of months off sweat equity, and there are so many of these people building minimum viable products, that you don’t need to go to the idea stage as a new angel. You can wait for people to have a product that you can play with, that they can walk you through and that maybe has five customers or 10 customers. That’s where I advise people to focus their attention.

If they need somebody with an idea, it’s fine to go to a meeting. You could say, “Great. I invest when the product’s been in the market for 60 days and you have some modest traction.” That will eliminate the 90 percent death rate of companies that are prelaunch. Post launching the product and having a modest amount of traction, maybe half of them fail from that point forward.

Des: A common criticism you hear from founders is, “VCs or angel investors, they never say no. What they say is ‘not yet’ or ‘a little early for me.’” Do you ever say no? Do you default to, “Hey, look, I’ll chat with you again in six months.”

Jason: I used to say no, and I wound up hurting some people’s feelings, especially some people from certain incubators that they’ve been built up to think that they’re just these titans of industry. People are very sensitive these days, especially young people. They’re used to people giving them participation trophies. I used to tell people, “I give your design a 6 out of 10. I think you could do two revisions with a designer you find on Dribble or Behance and make this a 7.5. If you spent $5,000, if you spent another $20,000 after that, you might be able to make it an 8.5-9. If you did that, it would probably trigger more investment, but right now it doesn’t look good enough to get really serious investors. You’ve got to fix that.”

That would be the best advice you could give somebody. I’ve actually dialed that back because I realized I was getting a reputation for breaking people’s spirits by being too candid. What I do now is I just tell them, “It doesn’t fit my investment thesis,” and they say, “Why?” and I say, “I’m looking for companies that are a little further along, and you have a little bit of work to do, but if you get a little more traction, the product improves a little bit, I’d love to take a look at it. Put me on your monthly mailings.”

To be accepted in my incubator, which is a 12-week program where I invest in them, you must be willing to have candid discussions about what you need to do. I tell them that on the way in. “Listen, if you come here, it’s going to be candid and if there’s a problem with the startup, I want you to tell me what the problem is, and I’m going to tell you if I see a problem, and we’ll have candid discussions. Are you up for that? Are you up for just putting a massive spotlight on your startup, having 50 investors tell you what they love, what they don’t love and being ranked at the end of the week against your peers?”

A look inside a demo at the LAUNCH incubator

This is like hardcore stuff, but the truth is VCs don’t do this is because, what if the person figures it out? Now you’ve made them feel bad. Now they’re not going to let you in the next round. It’s like Hollywood where everybody’s says, “Oh, my God. You’re so brilliant,” and then they don’t cast you. They’re just keeping their options open.

As a founder, what you should basically do is have a forcing function. Send VCs or investors you’ve met an email, “Are interested in investing? Yes, no or not yet? Please pick one of these three choices so that I can efficiently move on and know which category you’re in. If it’s a hard no, that’s great. I’d love to know what you’re investing in. If I meet anybody, I’ll introduce you. If it’s a maybe, I’ll put you on my monthly update. If it’s a yes, I’ll send you the documentation and let’s talk about any concerns you have or details that you want to discuss.” Be cutthroat about that. You can even add, “If I don’t hear from you by Friday, I’m going to assume it’s a hard no.”

Just assume if they don’t get back to you, it’s a hard no, and that will free you from this problem of everybody trying to keep their options open.

The risk of overvaluation

Des: Do you care about the terms or the valuation when you see something you like?

Jason: Valuations are an opportunity for an investor and a founder to have a meaningful discussion about something important. It doesn’t really matter at an early stage if it’s $3, 4, 5, 6 million. It’s early stages and you want the founder to feel good about your investment and you don’t want to feel like you’ve been taken advantage of as an investor. However, if it’s a competitive market, it’s a great founder and they’ve taken a lot of risk out, if they say, “Hey, listen, I’ve gotten a bunch of offers. I understand our initial valuation discussions were at $6 million, but we now have a $10 million offer and we’re pursuing that. We’d love you to be involved,” then I as the investor can say, “Wow, the marketplace thinks this is worth $10 million. I’m going to go for it.”

The problem is when somebody has very little traction. I had a lot of Y Combinator companies telling me they picked their valuation based on the highest valuation from the last class. They say, “We heard this company got $15 million so we’re doing $16 million, or “We think we’re right behind them so we’re doing $12 million.” It was just like a competition to see who could make the highest valuation. Then some people were going for uncapped notes. I think Y Combinator took a big reputation hit based on the kind of crazy valuations.

If you go
for a higher valuation, you’re going to lose potential investors.

To Y Combinator’s credit, they talked to everybody and said, “If you go out there with a crazy valuation, it’s going to put people off to our program. It’s going to put people off to you as a founder.” Go out with a realistic expectation. All these high pressure tactics I got from Y Combinator companies, they work with dentists and they work with naïve angels, but they drive away the high quality people who don’t want to deal with that kind of manipulation in the marketplace. All of those people I turned down and said, “Hey, I’ll meet with you in two weeks. I have an opening in my schedule in three weeks,” and they said, “Oh, the deal will be closed by then.” Every single time, the deal was not closed.

The market has now leveled out and even though there’s a lot of investors, we’re seeing valuations for early stage startups with little to modest traction be in the $3-6 million range. When somebody’s in that $7-10 million range, you have to start looking deeper at the traction there. Either they have traction or an attraction, and the attraction might be it’s Mark Pincus. It’s Adam Williams. It’s some great entrepreneur doing their second or third company. Or they’ve got a great customer or they’ve got some great engagement metric.

If you go for a higher valuation, you’re going to lose potential investors and you’re going to have to prove to them why. I just tell people to stay in the normal ranges so you don’t trigger massive debate. If you start triggering that massive debate and you can back it up, fine. Go for a $10 million valuation, but you better have something good there because you might start losing the Cyan Banisters or the Kevin Roses or the Chris Saccas or the Ron Conways who will look at it and say, “Nah, I don’t need to hit every investment.” You lose the good investors and you get the bad investors. That’s really the risk for founders.

Doing due diligence on data

Des: I remember reading about Y Combinator, and Paul Graham said that one of the jobs they have in the run-up to demo day is to help the not-so-strong investments look more like the strong investments. It got to a point where every startup has the exact same charts and the exact same advantages. More indirectly, you’re giving a lot of guidance to founders on how to look like a great or promising startup. Do you ever wonder you’re teaching people how to play you?

Jason: That’s a valid point. You can put a lot of lipstick on the pig and dress it up, but you can only do that to a certain extent and those hacks only work for a short period of time. What I try to do is get people focused on having a metric that they can focus on that is truly meaningful for their company and try to get to the truth and reality.

The great entrepreneurs, they can tell the truth and say “Listen, there’s a chance regulation could kill this business, but here’s how we’re going to handle it. We think there’s 20 markets that are very progressive and they’re going to let us do Airbnb, but these other 200 markets are not so our plan is to focus on the markets where we will be allowed and then have those inspire other markets to follow us. But listen, there’s a lot of regulation risk.” Being upfront with it and explaining it in that fashion will get people who are risk takers to understand the risk-reward ratio.

I do think that there was a lot of what Paul Graham was saying, but people have seen through it. In the book, I talk about a bunch of startups that I busted in due diligence who were just flat out lying or misrepresenting the truth. A lot of times, I’ll ask people, Hey, what’s your revenue? They say it’s $10,000. A month? You have 120 MRR? They’re say, “No, it’s $10,000 to date. Okay, how long has the product been in market? They tell me it’s been 14 months. So you actually have $1,500 a month? “No, we did a consulting project where we built something for somebody one-off. It was customware and they gave us $8,000 so we have $3,000 in revenue.” Can you break that down for us? “We had somebody buy 10 seats for $300 a year.” Can we talk to them? “Oh, they just canceled.”

It’s the ultimate tell if somebody doesn’t want you to talk
to their customers.

These are the conversations I wind up having with people. You start pulling the string and it’s very simple to get the actual data. I just say, “Give me a weekly chart of revenue. Give me a weekly chart of page views. Give me a weekly chart of unique visitors.” The great startups will give it to you, and it’s not going to be up into the right perfectly. It’s going to be spikey. It’s going to be weird. There’s going to be events, and that’s when you can start to see the pulse of the business. At Y Combinator, what a lot of people have done is, “Okay, we’re going to graduate in eight weeks. Let’s spend this amount of money on Facebook ads for eight weeks and it will make our page views and engagement look like this.” It’s so easy to spot. If anybody’s got that up and to the right chart, all you have to do is ask them for the backup data and say, “Did you pay for any of this? How much of this is paid traffic? Give me the 10 top customers. I want to talk to them on the phone.”

Literally, in due diligence, I’ve asked people to give us the contract that they told us they had, contracts with Google and Facebook, and they didn’t have contracts. When I caught them, they said, “Oh, it’s a verbal commitment.” Okay, who did you talk to about the verbal commitment? They say, “We met somebody at a party.” What? It all comes out in due diligence. You can play these games with your charts, but I think the gig is up now. A lot of angel investors are becoming professional. They’ve gotten burned and they’re asking people very specifically, “Can you give me the data?” When people ask to get the raw data, you can’t manipulate it.

Des: I’ve had friends who’ve been asked, “Show us some proof that you actually have this revenue. Can we see your bank balance?” When you have it, you take a screenshot, done. Next problem. Anyone who gives you an, “Ah, mmm, mmm, let me check, hmm, we’ll see,” it’s an immediate alarm bell.

Jason: I had somebody who once said, “We don’t want to have you talk to the customer.” You don’t want us to talk to a customer? Customers love to talk to investors. If you have a customer who’s loving your product and you tell them you have a high profile investor who’s going to invest, and ask them to talk to the investor on the phone, they’re like, “Absolutely, I want to see you succeed. I want to see you have more resources to make this product better.” It’s the ultimate tell if somebody doesn’t want you to talk to their customers.

Success beyond the Valley

Des: In the book you said that to be a great angel investor, you probably need to be in Silicon Valley. The reasons for that are obvious, but do you think the same is true for building great companies? When you look at a company as an angel investor, are you only attracted to Valley companies or do you ask companies you invest in to move? How do you think about all that?

Jason: Innovation can happen anywhere. If you look at Stockholm there’s been nine unicorns there in the last 10 years, including Spotify, SoundCloud and King, the makers of Candy Crush. We have Snapchat worth $15-20 billion. We’ll see if it’s actually worth that in the coming years, but even if it’s just worth $5-10 billion, that’s a very significant exit for an angel in Los Angeles. If you look historically at the largest companies, they’ve been based in the Valley. The $100-billion companies, there’s a small handful of in Seattle – Amazon, Microsoft – but all the rest, Cisco, Apple, Facebook, Google, eventually Airbnb and Uber perhaps, Netflix perhaps and Tesla, are based in Silicon Valley.

The outsized returns will inevitably come from Silicon Valley, but that has been changing over the years. What I would say is either you have to be here or you have to have access to the deal flow here by coming here on a regular basis. Chris Sacca did a great job of living in Tahoe and driving into town for 48 hours every other week. He’d meet with a bunch of interesting companies and then go back and do his work and live his life in Tahoe. That’s completely possible.

Until three years ago I did all of my investments by getting on a plane from Los Angeles and coming up (to Silicon Valley). I invested in all of those companies while living in Los Angeles, but I did come here every week for two days a week. I would get on my Southwest flight at 6 a.m., stay over and come back the next night. Finally I said, “Gosh, I’m trying to invest in 30-40 companies, so I’m going to have to be up here for three or four days a week. Screw it. I’ll just move here for the next five years and see how it goes.”

The high art for founders is going to be having their headquarters here, but having a location in Ireland or Austin or Seattle or South America, in Uruguay or Paraguay where there’s great developers, or Canada in Waterloo, Toronto or Vancouver, Seattle. It’s having an office where the cost of living is a third or half of what it is here, where people turn over every three or four years as opposed to every 12-18 months. The turnover in Silicon Valley is devastating. The cost of living’s devastating. It’s very smart to do what WordPress did, or what Intercom is doing. You can have a development shop. You can have sales and marketing (in one place). You can have customer support in Arizona or Colorado, in one of these different, awesome states here in the union, or in Canada and Europe. It’s a great way to arbitrage the costs.

Des: It’s certainly obviously a strategy we’re somewhat fond of here at Intercom. We should probably wrap up. Congrats again on the book launch. Angel is out July 18. Where else could our listeners go to find out more about the book and more about what you’re up to generally?

Jason: On Twitter I’m @jason. I tweet pretty frequently. If you sign up for the email list at angelthebook.com, you’ll get invited to some hamburger meetups I’m doing around the country. I’m just going to buy everybody who buys the book a burger and sit and talk with them about startups, technology and business. You can search for the book at Barnes & Noble, Audible, Amazon and it’ll be in your local bookstores. It’s everywhere.