Conor Mac's avatar
$340.9m follower assets
Advice on Playing in Private Equity
Last week, I sent out a tweet stating that I was potentially making my first private equity investment.

I stated that "Expectations are a) permanent loss of capital and b) a low-cost (~5% of total assets) way to learn about something I want to do more frequently as I grow older."

For context, I stated that this business is small (<10 employees), they are domestically focussed (UK), I know someone on this inside, and they are disrupting a boring market (the alcoholic beverage category). I have the potential to have pre-emption rights to avoid dilution.

I asked Twitter for advice and figured compiling the responses would be a great memo here on Commonstock.

After all the responses came in, someone responded "This thread is a crash course on VC/angel/private investment. Thank you."

The Responses

• "Team (and pmf) are extremely important. Will the exec team hustle till mission is accomplished, if ever? Do they hire the right people? Is the focus in a market with a lot of space to grow? Do they have a solid support structure (vcs, advisors, etc)?"

• "Product-market fit"

• "All of that is secondary in my opinion. Do you trust the management team to deliver long term? Talking 10+ years here."

• "Have an exit plan and growth plan and put systems in place to grow"

• Preferred shares, avoid future dilution. Independent audit. Get an advisory board seat."

• "Look for 'swing the fence' bets that you would laugh at saying no way this works. 5x1% bets > 1x5% bets"

• "Make sure they’re registered to take EIS investments. Most businesses covered, 30% tax back and no CGT on sale after 3 years."

• "Keep in mind SEIS or EIS tax relief. It will help to lower your risk and Improve any possible profits."

• "Make sure you understand the cap table math and the instruments you are investing (e.g. SAFE vs convert vs equity) along with an understanding of how rounds down the road can fuck you (e.g. liquidation pref)"

• "General advice I have is, if you do make the investment, do everything in your power to provide value to the company. Meaning, aside from money, if you can provide them with candidates, or have an industry experience, or are good at gathering data. Everything you can do to help them win.

Only other thing that I personally live by when investing in startups is, "If it's not a fast YES, it's a quick NO. If it excites you, the founder is intelligent and passionate, and you believe the market fit, and TAM are there, go for it and I hope you make a sh*t ton of $$"

• "Make sure that the upside really beats anything that you can find in the publicly listed companies. Lack of liquidity is a big discount."

• "Start-ups = bet on mgmt, anything that you don't like = pass.
Pre-emptive = nice to have
Sounds like this has passed beyond the idea stage, be sure to expect them to raise future rounds.
The board of directors can be helpful or a big distraction - worth it to DD them."

• "What’s the exit strategy. Why are you expecting a permanent loss of capital? Of course it’s fine to be prepared for the worst case, but expecting? F&F rounds are normally for equity not prefs. But see what you can do. Dilution will come later, so try and get in as low as poss now"

• "Also at that size, if I we’re to invest I’d be wanting to speak to some existing customers to understand what they like about the business and why they buy from them. Will help your instinctive gauge of whether or not to invest and goes outside the pure numbers."

• "Expect to lose 100% of capital. Understand there is no liduidity. Have a longggg time horizon. Understand the founders exit plan. Don’t waste time trying to value the business. Expect astronomical dilution (hence don’t value the business). Enjoy the ride."

• "Whenever I throw out business ideas to a friend he always asks "Is it scalable?"

• "Have an exit plan, before you invest."

• "I know you’re looking at the downside but look at the upside too. I second the advice on how the next few rounds will dilute you. If you can potentially make good money from this, it’s worth securing your place."

• "Try to get regular updates (monthly, quarterly accounts) and see if they will share strategic growth plans

Get a decent advisor who can check over the legals of the deal

Maybe, reach out to PE houses or Venture Cap to see if they can give pointers"

• " don’t have any PE experience but I’ll say meet every employee and trust your gut, the people running the show are most important."

• "Scuttlebutt..."

• "2 outcomes are ‘easy’. It goes to plan and you win, it goes to the wall and your £ is sunk. The really tough one is once you’re involved & it is, say, 12-18 months along & it is kinda ok but there is a drag on cash & the biz needs a cash injection, will u want to double down??"

• "Put your own 'man' in there..even as teaboy or cleaner they can keep an eye on culture (not old yogurt in fridge ) and attitude ... everyone lies when asking for money !"

• "At that stage it's basically an investment in the founders

are they worth it?

Probably need a decent portfolio of bets for it to be a good strategy...

Cap your risk at a level where

you are comfortable if it goes to zero

and a 3-10x or greater is a useful sum

Asymmetry ftw"

• "Just know, zero liquidity and can only get out if it takes off and is recognized as huge potential in public mkts."

• "The identified investment time will be far longer than you anticipate. The current principals with whom you are actually investing in may change. Competition will enter the space.
Never underestimate the value of luck! It’s a Hail Mary pass but could lead to great prosperity."

• " The best advice I can give you is: it's all about the team. Have they done this before? Are they capable or is it just a few friends?
I don't really focus on the product etc. I only focus on the team. Hope to helps."

• "Make sure you have the funds for at least two other ‘top up’ funding rounds. They always come baby for more when numbers fall short of the Excel spreadsheet"

• "Ask for audited financials"

• "It will take longer and cost more."

This was all the appropriate response I got back, hope it helps at least one person here :)

If you have any other advice, feel free to chime in on the comments section :)
Gaurav Kotak @ Fincredible's avatar
Private equity is quite broad. I have investments in KKR and BAM which I think are best ways to play late stage private equity.

But I suppose you are writing about early stage private equity (or angel investments). Caution I'm going to likely set the record for longest comment, since this is a topic near and dear to my heart.

I've done dozens of angel investments in the past 3 years, of which 25% direct (I know/get to know the founder) and 75% by backing a syndicate on Angellist (and most of that is backing the smartest seed investor I am fortunate to know, Vaibhav from FYI, a syndicate is where everything is done by the lead (finding, vetting the deal) and he/she writes a memo/sends founder deck but I still decide on a deal-by-deal basis to participate. While I pay no mgmt fee, I do pay 20% of carry (gains when/if it happens)

Almost 100% of my deals are pre-seed/seed, which means there typically isn't pmf fit yet. Either there is early signs of it or I just back the people.

Regardless of direct vs syndicate, here are some thoughts.

1) I believe majority deals will lose money.
2) I also believe, for this to be a successful investment class, 1 deal will return my entire investment across all companies. This is called the power law returns, I believe.
3) 1 + 2 = I decided I'll do at least 30 investments if I'm going to do even one. I allocated money beforehand, so I don't change my mind and I take a small enough position so I can afford to do 30.
4) While 1 & 2 is at the deal-level, this applies at aggregative level too. Which means there is good chance my private investments will underperform or perhaps even lose money. But there is at least a small chance they will very significantly outperform.
5) Even if is turns out to be great investment, you won't see any money for 10 years. So you need to be patient. In fact greatest investments take the longest to get liquidity.
6) It's not just about the money. It's about helping awesome founders
7) It's not just about the money. It's about connecting with awesome founders and coinvestors.
8) It's not just about the money. It's about learning from awesome founders. Sharpening my skills, getting my competitive juices flowing by seeing the most passionate smartest people in world do their thing.
9) It's not just about the return, it's about being a better investor in public markets. Sometimes I get to see trends that impact my view on public companies.
10) It's not just about the money ... you get my point🙂 (P.S. In contrast, with public investments it's also about learning, but let's be clear, I wouldn't do it, if it wasn't for the money)

So what do I look for in an angel investment?
1) TAM. Needs to be a huge market. Basically 'A problem not worth solving, is a problem not worth solving well either'.
2) I need to think the team is awesome!
3) I have no strict rules about sectors/geo but do have more interest in certain areas that changes over time. 3 years ago it was all about India (no sector). Now it's about India, SEA region, Africa, precision medicine, product-led SaaS, edtech, fintech. At least a couple of these are not totally crowded. btw you need to invest in sourcing. E.g. @ekmokaya has been kind enough to introduce me startups / investors across Africa.
4) At my early stage I'm price/valuation insensitive. I view the outcome as a 0x or 100X in both case whether it is 2M or 3M valuation doesn't matter. The only time it becomes an issue is it makes me believe the founder might be unreasonable.
5) I will ALWAYS be founder friendly. Where can I help. If ever I need to vote for something, I'll vote what founders want me to. Almost always there will smarter money than me, but I always want to be the easiest/friendliest money.
6) For UK investors, SEIS is a nice benefit (Gov't gives 50% tax rebate) but I'm indifferent towards EIS (30% tax benefit) since the tradeoff is getting common stock vs preferred stock. More important, tax benefits shouldn't be a reason to invest.

Finally, on average I make a decision in an angel investment within hours with little research. This is very unlike my approach for public companies. The reality is there's very very little data. and a lot of 'gut/instinct'. A qualitative assessment of TAM and Team. If it takes me too long to decide and I feel the need to do more research, it's probably is in itself a red flag. I'm also getting more confident in my 'instincts' here over time.
Conor Mac's avatar
Gaurav! What an incredible comment. Really appreciate this insight, learned a lot from it. Will be making notes :)
Michael Panebianco's avatar
This is class. Aside from not knowing where to find such opportunities, if one did present itself I wouldn't have the first idea how to go about it; this is great stuff. Thanks Conor.
Conor Mac's avatar
@tecantra thanks Michael. I agree thats a tough spot, I only got the opportunity because someone I know works there.
Michael Panebianco's avatar
Well, they say "You make your own luck" so congrats on getting in that position to have the opportunity!

If one ever comes my way now then I've got some good starting points. I've actually copied and saved the list for future reference.
Conor Mac's avatar
Hopefully someday we have a "bookmarks" feature here on Commonstock :)
Nathan Worden's avatar
Great way to compile a memo with aggregate viewpoints.

Interesting that some said “expect total loss” while another said “why expect permanent loss?”
Conor Mac's avatar
For me, I expect it, because this is a new world for me. I am mentally prepped to lose the £X I invest. Just so, if it does happen, I am not disappointed.
  1. The actual experience I had was totally different than what's listed. The founders are generally tech know how folks so they ain't real experts in forecasting or even be able to determine the value of the company. There little or almost no data to research on. I have to based on what I could find, experts pull from else where to determine if it's worthwhile.
  1. Getting regular communication from them is the toughest once they have gotten the funds the communication becomes lesser and lesser. It takes many reminder to get shareholder's update. Well they ain't regulated by anybody so it's not easy to get feedback on the state of the company and investments. Initial talks of going IPO blah blah blah, becomes a different path. Thus exit strategy can't work there at times.
  1. If you toy with such investment be ready to get a lawyer to pull the trigger to help get funds back especially if money at stake is larger. I would even go to the extend of pooling investors together to hire a lawyer, but not all investors thinks alike so beware.
  1. The company which you invested with may or may not be concern with shareholders interest in terms of dilution. Some will try to protect against it most will not since they need varies rounds of funds.
  1. Determine if an opportunity is worth a try depends a fair bit on gut feel and if they could answer your queries well. I had to get help from fellow investors to read their body language to see if they had lied somewhere in their presentations, answers or if they had some hidden fears. We met and exchange notes after the meeting amongst the closer investors.
That's what happened to the opportunities that came by so far. It's a great learning experience but not really something which can be learn through books etc.
Conor Mac's avatar
Just saw this KC, thank you! Thanfully, my investment is not tech heavy, founders have family who were in the industry before, and a rich understanding of the industry themselves. Feeling good.