"Becoming successful in startup investments involves a lot more luck than most would like to believe. It is something that most first-time investors find hard to swallow."

These were words from a prominent angel investor who actively invested in India for the last 15 years, both as a fund and an angel investor. He made this observation after his experience of seeing where the $100m+ fund failed to give a 3X return (baseline expectation) in a 10-year window. Yet one of his angel investments of INR 10 lakh netted him a $70mn return in that time period.

Naval, founder of AngelList, has summarised angel investments into one of the best aphorisms ever:

"Angel investing is like buying a lottery ticket where you know one digit."

First step in winning any game is knowing the rules of the game

In angel investments, it is knowing that it involves a lot of luck. It is closer to Roulette than Poker. However, people with a Poker mindset can turn a game of Roulette into Poker by playing an iterated game of small bets and exploiting the in-efficiencies. Looking for that one digit of the lottery.

In angel investment it is important to have access to deal flow and capital but the most scarce part is developing the judgement to bet on the right investment. Building skill and muscle for that judgement on the digit is what investors spend decades honing.

Those investing in other investment categories such as real estate or public market stocks usually ask the question: what is the rate of return in angel investments. In angel investment, data is actually an anathema. Moreover, there aren't many good studies on what are good angel investment returns. One of the most cited studies done in  2016 and supported by Kauffman found that the average IRR (i.e rate of return) in angel investments was around 22%. However, this kind of average can be quite misleading. The reason for this is called ergodicity.

Startup investment outcomes follow power law distribution. This means just one outlier can skew the outcomes for the entire lot. Ergodicity is a key property of any power law distribution. In simple language, it can be translated as the fact that knowing the average of how lucky others got can't inform how lucky I will get.


Position first, judgement luck later


Before 'Judgement Luck' comes 'Position Luck'. Michael Mauboussin in his research and book titled Success Equation says that most professions - if thought of as a game - can be laid out in a line spectrum of luck and skill. To the extreme left is pure luck and towards the extreme right is pure skill. In between, Position and Judgement Luck can be sub-plotted. And in that, Position Luck comes before Judgement Luck.

The fact that you choose a specific area (ex SaaS) and focus on that, can be a source of significant advantage.

Consider this: since 2004 - when Salesforce went public - about 115 SaaS companies went public. By 2021 they all have cumulatively added more than $1 trillion in market cap. While post-IPO these companies have added 5X over their IPO price, a venture fund expected to return 3X of their capital often struggles. That is concrete, quantitative proof of how software is eating the world and SaaS is eating Software.

From a global lens, SaaS data is abundant. From an India perspective the data does not exist. Yet if someone did a study of how angel investors in SaaS startups fared compared to angel investors across 'all' startups in India, it is highly likely that angel investors in SaaS lost much less on each individual bet. Why? Because not only did a big SaaS IPO happen this year but good exits have happened consistently over the last 5 years (Minjar, ShieldSquare, Cloudcherry, Automate.io, etc.)

It is the same difference of winning cricket matches by scoring 2-3 runs as opposed to winning by hitting sixes. Of course to win big and in style you need to hit a lot of boundaries but one can win through hitting consistent 2-3 runs.

The base rate of success for every investor is much higher when investing in SaaS. Just picking to focus on the SaaS sector has helped many improve their odds. Within SaaS there are a few more things that can be judged to improve the odds further.

Become a magnet that attracts good luck deals

Angel investment is a risky affair. It is the easiest way to lose a lot of money. Usually you do it only with play money. In fact it is better to even call it 'burn money'.

An experienced Indian angel investor explained the 'burn money' metaphor like this: "an angel investment is like pouring money as if it is butter into a fireplace specially designed for rituals (the Indian name for this is 'Havan Kund') and enjoying that money burn. If that ritual becomes successful then a celestial god may appear and grant you untold financial returns.

That kind of magic is therefore very hard to come by. It does happen once in a while but the critical part of this experience is that one should have the affordability and ability to stomach such a ritual of seeing your burning money in the fireplace.

In this field, winning early leads to winning more and more. Look for early wins. So to improve the odds of this successful ritual, do this with people who have had success in doing this ritual before. Follow good deals before you can lead them.

A trivial but often ignored step is clearly articulating in writing, via website, blog or even Google docs, on what you are looking for and what you avoid. This would help with a lot of self-selection and conversation. Angel investors are one of the best influencers and personal brand builders; they do this by publishing their thoughts via books, conferences or podcasts.

Build a reputation of being helpful by first thinking of not doing any harm and second helping founders in which way possible as agreeable by them. Play long-term games with founders. Be good to them.

Today where capital is abundant - anyone and everyone is able to provide capital - founders choose based on who are the people they would like to work with. The supply-demand situation around fundraising has changed so much that there is more capital than good founders and ideas. What this means is that you will have to have reasons on why founders should be attracted to you as opposed to any other source of capital.

If as holders of capital, you flex your muscles with founders and do a founder-unfriendly deal, they will not come to you again. And a founder does not do one startup alone, they are wired to repeat. If you respect them, their time and be a supporter in addition to that capital, that great founder investor experience would want them to come back to you.

Founder is the least changing core, evaluate her

The most unchanging variable in a startup is the founder. Ideas may change, customer segments may change, positioning may change, market may change and even teams may change. What does not change is the founder. She has to adapt for sure.

Among all the variables in a startup, the founder is least changing one. Therefore the most important thing to evaluate is the founder, not the idea or the market or anything else. At least founder, before evaluating anything else in early stage bets. More than half of that one digit is judgement about the founder.

A related counter-intuitive question to ask is how much is the founder willing to change. Does s/he have a growth mindset? Are they willing to challenge themselves, question their limiting beliefs? Move outside their comfort zones?

Practically at every stage the growth of a startup is bounded by the growth of the individual founder. Look for signals where founders are eating their frogs. Is an engineer founder willing to step away from his comfort zone and get into marketing and sales. In case of a sales or marketing founder, is she willing to know enough about tech to get things shipped.

Check for problem mindset in founder

My partner Shekar has outlined over a dozen inflection points that we observe in SaaS startup journeys as they grow to their first million in annual revenue. The first and biggest is startups finding their problem value. This requires founders to think in the problem domain as opposed to the solution brain.

Our education system is partly to be blamed here. Most of our lives we are only encouraged to answer questions and never 'ask' questions. We get into a discussion and we jump to ideas and solutions, talk about platforms and features.

The best founders are those that define the problem way better than anyone. There is anther part of the brain that needs to be accessed to think in problem as compared to thinking in solution.

Sniff for any bad co-founder chemistry, it quickly becomes explosive

Watch out for founder chemistry and team dynamics. Most people cite lack of finding unit economics as the major killer of early-stage startups. There is another big reason that is not talked about as often as it should be - co-founder conflicts.

More startups have died because of co-founder conflicts than documented. Meet all the co-founders, even if the tech co-founder does not want to meet. Ask how they make decisions, especially when it comes to deciding tricky topics. How do they decide when they disagree specifically?

The YC definition of co-founder is really good here. If a co-founder does not own 10% equity, he really does not have enough stake to be called a co-founder.

If not having domain expertise means two years of investment in building that muscle, having co-founder conflict means dialling back the startup's progress by another 2 years.

Domain expertise and founder chemistry are the most important things to evaluate.

Everyone falls at stories, check if you are doing too?

We all have a fault in us - we are wired to respond to stories. No doubt storytelling is important for acquiring customers, building teams and getting investment. And founders should be able to tell good stories. However history is replete with examples of how storytelling starts have not ended as the story that succeeded. The best example in the recent past is Theranos. Theranos founder was so good at storytelling and hacking social proof that no one was willing to ask the question whether the story could become real for more than a decade.

Many success stories have had bad story starts. Once successful it can always get packaged into a good story. Remember vision is always best viewed through a rear view mirror.

While all humans are suckers for stories, investors are the most susceptible to narrative bias. Remind yourself of that. Look for action and traction. Does the SaaS startup have a handful of customers who have voted with their wallet to demonstrate value?

Market size is irrelevant, don't waste time on that

Even for a later stage venture investor the question around market size is totally irrelevant. When it comes to angel investors this is an utterly useless question. Why? Because the first idea for which the pitch gets built is not the idea that finds traction in the market. Remember it is an idea maze.

Experienced angel investors therefore totally ignore the forecast and market size in an early stage angel assessment. More useful question would be whether there is a path to ten million in annual recurring revenue (ARR) or even one million in ARR. In almost 100% of the cases, once SaaS startups reach the stage of a million dollar in ARR, they change in a big way. They add an adjacency market, or additional product lines or they even play at a higher-level category .

Many investors have missed out on promising category defining SaaS companies by asking the TAM question way too early.

Don't follow thumb rule. They are usually dumb rules

Learn to evaluate every startup idea for its own merits. Don't follow the ‘This is X of Y formula’.

Five years after Freshworks became popular, an investor at a panel discussion told Freshworks CEO Girish Mathrubootham that he missed out on investing in Freshworks. Girish calmly said that he in fact had pitched to another colleague of his years ago who had declined saying the firm's thesis was to invest in 'eCommerice of X' and Freshworks did not fit that thesis. Fast forward five years, another investor was nursing his wound because he could not invest in Whatfix. When he had looked at Whatfix, he was looking for the thesis that in the Indian context and in SaaS high-velocity sales Freshworks is the only thing that works, and Whatfix did not fit that thesis. Today’s thumb rule is tomorrow’s dumb rule.

Keep up with changing mechanics to gain edge

In SaaS, debt in the form of a convertible note can work because there are predictable revenues. If all the angels are Indian citizens then this is straightforward. If FDI funds are involved, then it needs a different structure.

Many have seen SAFE & KISS work - it is temporary debt that converts to equity. indie.vc is another new model like SAFE - it is a convertible note but does not by default convert to equity unless explicitly triggered. The jury is still out but we have a deep belief that not only is it founder-friendly, it is also investor-friendly.

Public market valuations are frothy and we can't take cues from there on valuation multiples. The average SaaS valuation has jumped from 8x to 25x this year. A lot of deals still happen around 7-10X multiples of ARR in the earliest stage. For any company that is doing $100K-$200K in ARR in case of a priced round (not convertible), a $1.5 - $2mn valuation is common for Indian SaaS startups. Structuring this in a founder-friendly way would help build long-term relationships with them.

Contrarian and right is the way for success

Most investments run like a game of beauty contest. What gets funded is not what is most likely to win in the market but what other immediate peers or downstream investors will think is going to be a winner. However many studies prove that any investor - angel, venture or public market investor - succeeds when they are contrarian yet right. The most defining version of this study was done by Nobel Laureate William Sharpe who provided the mathematical proof in his research entitled 'The Arithmetic of Active Management':

You simply can’t be part of the crowd and at the same time beat the crowd, especially after fees and costs are imposed. The technical term for this is mis-priced optionality. It is like discovering Sachin Tendulkar while he is in nursery school while all others can only see a flailing kid.

You improve luck by removing things that come in the way and by increasing things that enhance the odds. You remove biases of your mind such as not getting caught in narrative bias, groupthink and certainty bias. OTOH, you use an optimistic attitude, being founder-friendly and developing a sharp judgement on people. Specifically, assess if founders can learn a domain deeply and can lead a working team together.

Thanks to Malvika Tegta and Tanuka Dutta for helping with editing early drafts of this post.


About Upekkha Up Funds: Up Funds is a SaaS-focussed fund that offers a founder-friendly structure to early-stage SaaS founders who choose to build capital-efficiently rather than diluting too much equity early on. This helps them retain control over their growth journey. Up Funds continues to invest in promising global SaaS startups with the aim to invest $10 million in 100 startups each year. Learn more about Upekkha Up Funds

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