ExtraVallis Expert Interview: Ecosystem Building with Peter Adams of Rockies Venture Fund
We had the honor to borrow a generous amount of time from the award-winning author and speaker on Venture Capital, Angel Investing, Entrepreneurship, and Impact Investing who is currently Managing Partner, Pandemic Impact Fund, Mr. Peter Adams. Peter built up the Rockies Venture Club and has been an essential contributor to the Colorado startup investment ecosystem in the United States.
Key Takeaways:
Building a healthy startup ecosystem is not just about supporting the founders, that’s the “1.0 version”
There’s three elements to a healthy ecosystem: founders, investors and acquirers; and then you need: “de-siloing” and a “give-first attitude”
Venture-nomics effectiveness starts with the exit strategy: thinking about the exit from the beginning
Angel groups need to be neutral: helping founders, promoting fairness and education and getting everybody involved on the same level
You have to set up a non-confrontational partnership between investors and founders
You need to know the full lifecycle: if you have no acquisitions, you have no angels; if you have no angels, you have no startups
Founders, on average, need to pitch 400 times before getting USD 1 million.
Why is the system of Wealth Advisors in the US hindering the growth of the startup ecosystem?
Learn how US tax credits make US angels’ average long-term capital gain 32%.
“Angels lose money on nine out of ten deals” is definitely a myth
Edited Transcription (edited for readability):
Interviewee: Mr. Peter Adams, Managing Partner, Rockies Venture Fund, a Co-investment Venture Capital Fund supporting high growth early stage companies with disruptive innovation and clear pathways to executing an exit strategy. RVF makes equity in companies in technology, healthcare and consumer goods companies
Interviewer: Mr. Aaron Everhart, Head of Asia Territory and CMO of ExtraVallis. Aaron is also the founder of HATCH! Ventures, a startup ecosystem builder in Southeast Asia and local implementer of GIST activities in Ho Chi Minh City, Danang, and Hanoi, Vietnam.
Aaron, host: I would presume that you have a sense of the pulse of startup ecosystems in general, not just in Colorado. So what would you say is the current state of startup ecosystems, in general.
Peter: Highly variable, there is a huge standard deviation from the top to the bottom, and there's a lot of misunderstanding about what drives strong startup ecosystems. I've got a lot of different perspectives on startup communities as I was a startup founder in the mid 1980s in Boulder Colorado with a tech company. Boulder is considered one of the top startup communities in the country.
Back in 1985, my resources as a startup CEO were virtually non existent. But today you know it's got some of the top stats in terms of highest skilled labor, best place to start companies, most funding per capita. So what are the things that took it from being a desert 35 years ago to being a lush startup garden today? And there are tons and tons of companies gotten millions of funding, there are all of these organizations that are supporting startups, everything from the universities to TechStars, Startup Week, StartUp Health, Foundry Group, Jason Mendelson.
So all of this support infrastructure and the state has caught up as well in supporting startup CEOs, but this is not enough. The 1.0 way of thinking about startup communities, about the entrepreneur and support systems and pitch events are some of the biggest fallacies when thinking about how to start a community, because it is not just a matter of supporting the startups, you also need to support the angel investors, the exits that the angel investors need. Therefore, you need to engage the corporate entities as well.
So, in Colorado. We've created a community where we are de-siloing, everybody's in it together. We have this give-first philosophy, and this is true for everybody, you don't ask for anything in return. When I serve on boards I don't ask for fees or anything. Everybody is giving first, and it's truly amazing. What an impact this has made people give, and it's super supportive at all levels. So there are three elements to a healthy startup community, and founders is not enough, that's the 1.0 version, you need to have founders, investors and acquirers. From the beginning, we need to think about the full investment cycle and the full corporate cycle for startups. If we only focus on getting startups coached and mentored in Co-working space, that's just the beginning. We need to be thinking about how to get them funded. And it's pretty naive to think that you're just going to get angel investors coming out of nowhere, at a pitch event, and suddenly they're going to write checks.
Angel investors, people think of them as these super beings because they have so much money, but actually I will tell you that the first thing I learned when I became an ecosystem leader was that angel investors know very little about how venture capital works. I have this theory about venture capital angel investments called venture-nomics. Venture-nomics is totally different from what you learn if you go to get an MBA at university, venture-nomics has a totally different set of rules and the rules are driven by the exit. Having the exit strategy, thinking about the exit from the beginning, how that is a value creation, focus point is super important, and missed by most people. I see a lot of angel investors coach their companies to go for positive cash flow, which in some cases is great, but it actually leaves a lot of money on the table and causes them to lose out. So here's the thing about angel investors, people think that they can get together and they will self coordinate, they will not, it is too much work, it is really really hard to coordinate.
A lot of people here watch Shark Tank, and they think this is so easy, we just get this pitch to happen and we'll be sharks, ask a bunch of questions and we'll write checks and it just doesn't happen that way. Angels by their very nature are kind of afraid, they don't know how to value companies. In general, more and more of them do but on their own, they have difficulty with it. And they often ask the exact wrong questions when they're evaluating companies. And so, if they just sort of look at the standards of how their own businesses have worked, they're not understanding how value is created in venture. So we need these Angel groups to be more like a Switzerland, where they're not just representing the angel group, but also they're helping the founders, this idea of fairness and education in getting everybody involved on the same level is super important. And you have to set up the sort of non confrontational partnership between investors and entrepreneurs and so this Switzerland concept is important. But the other thing is, the concept of Wisdom of Crowds, and I'll just say, when I first saw this book by Mr Surowiecki come out, I thought this is the stupidest book ever. But the more that I look at how people, angels, when they approach a deal together, ask questions and evaluate a deal, they actually do much much better. And so, coordinating people within your city there in Vietnam, and another city in Vietnam and another city and getting lots and lots of people in these subsets to work together, leads to better decisions.
Aaron: Well, I'm interested to know whatever you would like to share about what makes a healthy startup ecosystem. It sounds like the startup ecosystem that you have in Colorado is pretty robust and mature. Do you have a sense of what the state of ecosystems are around the world in general outside of Colorado?
Peter: I had the opportunity last year to go to Bahrain and attend the global Business Angel Network, representing the Angel Capital Association, there were thousands of people from all over the world. And I had the opportunity to talk to economic development agencies from all over the world. And it was fascinating, I had a half day session with the economic development people from Bermuda, you think about if you're going to the island in the middle of the Atlantic, what do you do? You have this huge sort of insurance industry and some tourism, how do you develop a diversified investing community with them only, I think there were maybe 65,000 people who live there. Despite having billions of capital there, they had virtually no investment community. And if you look even in Bahrain, the same thing, tons of tons of oil money and they were developing angel investing networks, but they were still relatively small, probably smaller than what we do here just in Colorado. And then I talked to the people from Ecuador or Chile and I asked how many exits they had in the entire country in the last five years. And they were able to point to maybe one or two.
They clearly were thinking about bringing in outside international capital and have pitch events, so that they can see our startups, but they weren't thinking comprehensively about mobilizing their own capital within their countries, and then investing in those startups, and then partnering with those corporate entities to bring those companies that got invested into being acquired. And that is the full lifecycle. You have no acquisitions, you have no angels. You have no angels, you have no startups. So you can back it all the way up. And I will say that in most countries, that's not the case, even the very developed countries. Last February I went to Australia, and I had a chance to meet with the Chief of Entrepreneur of South Australia and with the government there, and they were really thinking about things backwardly. They were flying in jet loads of venture capitalists from the US to look at their startups. A couple of problems there is VCs usually invest in later stage companies, and they're showing the early stage startups. VCs had a great time on these junkets, but they weren't developing their own ecosystem in Australia, and they needed to think about each state having sort of a strong angel investing network, and then they needed to look at how to syndicate from Brisbane to Sydney to Adelaide to the Gold Coast Sunshine Coast. All of those places, they all needed to be working together nationwide to be a syndicate. Just give you a reason why syndication is so misunderstood and why it's probably one of the most important parts, is that if you think about the average Angel deal, at least in the US we're raising about a million dollars. And if you think about the average investor. The average investor writes a check for maybe $25,000. So you can do the math, it takes maybe 10 pitches before you get an investor to say yes. So 10 pitches to get $25,000 but you need 40 times $25,000 to get a million dollars.
It means you have to pitch 400 times. So it's like Groundhog Day with Bill Murray and the movie. There's pitch and pitch and pitch, Question and Answer, due diligence, negotiate 400 times before you can raise a million dollars. Your average Angel group has maybe 30 or 40 people. And, on any one deal, maybe a quarter of those people will invest at best. So, let's do the math: 40 people, a quarter of them invest, that's 10 people writing $25,000 checks, that’s $250,000. One Angel group on average is only going to fund a quarter to a third of the deal. Those Angel groups can't just operate and say ok, go ahead and raise your 750 somewhere else. They can't have the opportunity to create these syndicate networks and create relationships with Angel groups around the country and share deals, so that they can fill up and provide access to capital at the level they need for startups. For a startup who needs a million dollars to only raise 250 is an extraordinary risk. They need to achieve the milestones that the next round venture capitalists or angels are going to need to make that investment. If we only give them part of the money that's like building a bridge halfway across the river. Underfunding companies basically means everybody gets wet up in the river. So, we need to help startups by building syndicate networks. In Australia, we need to have Adelaide, Sydney, Brisbane, all of these different zones talking to each other, having monthly calls like we do here in the US.
When people think about ecosystem development on the national or even global level, we have to think in terms of systems, not just in terms of startups and individual angels or even Angel groups. One of the biggest mistakes that communities have when they begin is thinking about just the 1.0, and that just by doing the math, you can see that that won't work.
Aaron: I’m gonna do a little summary to see if I understood you correctly: there's a perception that the ecosystem requires a certain sequence, let's just call that the value chain. And many startup ecosystems are only focusing on a narrow part of the value chain while they should be looking at a longer one.
Peter: Right. And guess what, you're an angel investor and you invest in a deal and there is no exit opportunity. You're going to stop being an angel investor.
Aaron: So, what would you say is the greatest challenge that you're facing right now? I'm imagining that you're probably gonna say something related to the global pandemic but even before that and in spite of that, what is your greatest challenge?
Peter: Engaging angel investors is still our biggest challenge. I'll just give you some numbers again in Colorado. We have about 5 million residents, 68,000 of those are accredited investors and fewer than 1000 of the 68,000 actually do Angel deals. So out of 5 million people we have, just a few hundred people investing in ANGEL deals, your average investor might do one or two a year. So you can sort of see a state like Colorado that's generating tons and tons of deals, there's a problem for me to go out and recruit new angels, you think it would be easy, but there is a feeling among high net worth individuals that venture capital is for other people, or that it is super risky. And they lose all their money. There is an entire infrastructure of Wealth Advisors, who are all working toward preservation of capital, you see that on all of their websites so they don't want to put people in risky investments, and they don't get paid fees on angel investments that their clients make. So they are disincentivized to have people move into angel investing as a part of their portfolio. So there are all sorts of headwinds. But the main one that can be controlled is thinking about education to teach people how to be smart angels, and the fascinating thing is in the US, Angel groups average about 23 to 26% IRR (internal rate of return) every year. That is an amazing return. Compare that to 6 to 8% on the S&P. And the other thing, in the US anyway, that's all tax free. So you don't pay the 22.7% long term capital gains tax meaning your 25% is actually in like 32%. If you had invested in a hedge bond or some other thing that returned. But you had to pay 22.7% of that in taxes.
Aaron: How is it tax-free? Is there an exemption?
Peter: At the federal level there's section 1202 of the IRS code that says if you invest in this startup and it's C Corp and you hold it for five years, you pay on it as an equity deal, not convertible debt, you pay zero tax. So that's a federal thing. Now, you know you're asking about state, they are sort of regional startup ecosystems. Well, here in Colorado, we have a 25% angel investing tax credit. So if I write a check for $100,000, I get 25,000 back from the state. So I really only have 75,000 at risk in my investment. There are various states. I think the majority of states in the US have similar tax credits, they're all structured a little bit differently. Australia has tax credits like that. And an important part of supporting the investment is sharing risk because this is creating job growth to an extraordinary extent. Angels, basically in the US anyway, it costs about $125,000 to $150,000 for an economic development agency to create a job. And bringing in Amazon or tax credits, they give these big benefits to these huge corporations, which ultimately, they may create some regional jobs but over the last two decades, big corporations have shed more jobs than they've created, and it's been the startups who've been responsible for most jobs, in the US anyways. Giving a 25% tax credit, a few million dollars a year, and you're bringing in hundreds of jobs so now the cost to the state for creating jobs is just a few thousand dollars as opposed to hundreds of thousands.
Aaron: If you could change one thing about the people's current practice and building a startup ecosystem, what would it be?
Peter: Two most important things: First is demystifying angel investing and venture capital. And then the second is, I would implement a detailed education program for new angel investors to teach them how to value deals, how to look at exit strategies, how to negotiate term sheets, how to maximize returns after tax, how to do due diligence, intelligence, how to work with groups and syndicate. Once you've invested, how to do the post-investment management and be on board and support the companies with the help in contacts that they need.
And I will say they're just one of the myths that is most frustrating to me, and you may have heard this, is that angels will lose money on 9 out of 10 deals.That is absolutely false and not born out of data. So if you look at actual data, you will see that about a third of deals, go belly up. So, it is a risk category and angels need to think in portfolio strategies, not individual investment. This is super important, but now we have, a middle third that is doing okay, 1 to 5x, and then one third is going to be doing 5, 10, 30x or more. And so this is how we get this net IRR, net of wins and losses at 6.26%. If people understood that and thought in terms of portfolio theory, they would be doing a lot more angel investing and creating a lot more jobs in their communities.
Aaron: You mentioned that you have a population of accredited investors in Colorado but many of them are not doing this probably because they're getting information from those financial advisors that are set up in the shopping mall. So, what would you do to reach that population more effectively?
Peter: We have banged our head against the brick wall of working with Wealth Advisors. And that will never work. What that results in is a de-homogenized investment environment where we send all of our money to the coasts. If you look at money drives economic development, but where do we send our money? We give it to our Wealth Advisors and all goes to Wall Street companies. That it's going to be our balanced portfolio of small cap, large cap, bond, stocks, international, whatever, but nothing in local. We're not investing in our own communities. And the big public markets are sucking money away from our local communities, so this is really a super important fact that you need to be involved in this to be thinking about that.So, on a state level, The Colorado Economic Development Agency is helping us with programs to educate new angels, to reach out and to be verticalized. So we now have a Life Science, CleanTech, EdTech Angel group,so now people can come and work with like minded people in spaces in which they have interest and expertise. So the state has helped us to do that. The other thing, and this is not obvious but I learned it very quickly, is that angels are lazy, and they are not willing to drive more than 15-20 minutes to go to any Angel meeting or pitch event. So what we found is we have to take ourselves to where the angels are, and we take the companies to where the investors are. So we literally do a road trip every month, we are bringing companies to angels around the state, we are doing education around the state, and the local governments are helping us to do that. For example if we go down to Colorado Springs or up to Fort Collins, which is an hour away from here, we don't have boots on the ground to create relationships and engage people, but the economic development agencies, there have been helping us to reach out to those communities, bring people in, we have webinars, we have education, and you know certain number of those will join.
But partnering with both the state, local economic development agencies, and the vertically oriented associations, like for life science we partner with the Colorado BioScience Association, for Cleantech, we partner with NRL on the national stage and with the Colorado CleanTech industry association locally, that allows us to tap into the people who have those interests but being an angel group involves this networking and tapping into other organizations and what's awesome is that this helps every one of those entities to achieve its objectives. So, Colorado BioScience Association, part of their mission as an association is to fund early stage bio science companies, they don't have the skills or expertise or people or infrastructure or time to do that, we can. And so it's a perfect partnership, we achieve our nonprofit objective, and they achieve their nonprofit objective. And the same thing with state. Same thing with contact.
Aaron: It sounds like the beauty of three-way negotiation, which generally works much better than just two-way. Now you've mentioned silos a few times so what are the silos and how can we avoid that pitfall?
Peter: The silos are various types of entities, you may have, first of all, universities, they are now becoming more and more engaged in the startup community. The economic development agencies are sometimes solid in themselves. There's this city which is very siloed and which we have given up on, the Economic Development Agency refused to come to meetings that we held to bring everybody together to see who everybody was and what the roles and responsibilities were and how we could work as a community. Okay, so that's a silo: people start their own little angel groups and they don't think about syndication so they create their own little silos around that. There are some accelerators that silo and just work with themselves as opposed to partnering with others. So there's lots of siloing in certain organizations, but certainly for us statewide, people give first, they engage and I think that has a lot to do with the startup success in this case.
Aaron: What do you think leads to the fear of those organizations?
Peter: I think most of it is more related to just not understanding how startup ecosystems work and they're working on that 1.0 concept and not thinking about helping startups, and to do that you have to help angels, and to do that you have to engage the corporate acquirers, all three of those parts must be engaged or the entire house of cards would crumble. Thinking holistically is the only way to create a successful startup community, and we haven't talked much about the corporate side. But let's look at the data. Over the last two decades, R&D spending in the United States has been severely on the decline. And at the same time, Corporate Venture Capitalists (CVC) has gone from 10% to over 50% last year of all venture capital. So we have record amounts of venture capital investment in the US, and over half of that now is coming from CVC, and they are working with the corporate development arms of those organizations to then acquire new technology and innovation. So the way that the large corporate entities are innovating, in the US anyway, is to stop doing R&D and start doing early stage investing to get their hooks in and see where the new technologies are and then to acquire those companies down the road once they get to the point where they are satisfied with the technology and the market need for various technologies.
It was fascinating, because if you look at Japan for example, Japan has the exact opposite sort of thinking about their ecosystem. Whereas here in the US, maybe 2% of startups that we invest in will have an IPO, in Japan it's almost flipped with maybe 98% of an IPO as their exit. And the reason for that is those corporate entities are doing internal R&D, they're siloing, and they're not acquiring. So startups have to grow to the point where they have an IPO. And of course that has the net result of creating a dysfunctional ecosystem with very little startups, at that time when I went, this was just two or three years ago, there was zero Angel group in the entire country.
Aaron: I have two final questions: (1) What leader in the space of startup ecosystem building do you admire the most, and why? And (2) Could you direct us to any books or web resources or, or other places where people might look to so that they can increase their ability to build a stronger startup ecosystem?
Peter: My overall hero in this space is Brad Feld from the Foundry Group, which is one of the top VCs in the country. Rather than just starting a venture capital fund and investing in companies which he could have done, he's done that, and he has billions under management. But he has created this give-first philosophy, he's also thought way out of the normal general partner, limited partner concept of being a venture capitalist. He and his partners engage with university, they work with the University of Colorado law school and business school, they teach entrepreneurship and venture capital workshops. Along with David Cohen, they founded TechStars. This was like the earliest days of the accelerator and they were thinking not about just having companies come to them and they invest in them but creating a pathway for companies to get to sufficient traction where they would be investable. And that was really innovative, I mean now in Colorado alone we have 30 accelerators and thousands you know worldwide. We take that for granted but that was really innovative and that was Brad Feld driving that. He has invested in other things like the Startup Weekend program. He gives freely of his time to help people in the community. Pretty much anybody can talk to him, you may have to wait two or three months, but he'll have a meeting with you for 20 minutes. And he's really been been very generous, but also very strategic, he's created a pipeline to Foundry Group, but also he has thought about how to create a startup community, and he has traveled around the country to various startup communities to teach them how to do this and he wrote a book called Startup Communities, which is a great resource. I think he, as an individual, has done more to elevate how startup communities think about themselves and how to operate effectively.
ExtraVallis would like to thank Mr. Peter Adams for his time.