Governance Bites #58: angel investment, with Richard Coon

In this video, Mark Banicevich asks Richard Coon about angel investing. This conversation will help directors of startup or early-stage businesses. Mark asks about pitch decks, business valuations, monitoring performance, and how involved angel investors may get in the business. Mark also asks the best advice Richard received as a director. 
Richard Coon, ONZM, was co-founder of two of New Zealand’s largest life insurers, Sovereign (now part of AIA), and Partners Life (which sold to Dai-Ichi Life in November 2022 for NZ$1 billion). He has an MBA from Harvard University, and he is a Fellow of the Institute of Chartered Accountants of England and Wales. He currently sits on or chairs several startup or early-stage company boards.
#governance, #director, #boardroom, #boardcraft, #angelinvesting, #angelinvestors

Transcript

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In this episode of Governance Bites, a slightly different angle targeted at Boards of Directors of startup companies and new businesses looking to raise capital, and I have the pleasure of spending time with Richard Coon. Hi, I'm Mark Banicevich. Welcome to Governance Bites, and today it's my absolute privilege to spend time with Richard Coon. Richard, thank you very much for your time. Welcome. Richard is recently appointed an Officer of the New Zealand Order of Merit. He's a Fellow of the Institute of Chartered Accountants of England and Wales. He has a Harvard [University] MBA [Master of Business Administration]. Has founded two of the largest, or co-founded two of the largest, life insurance companies in New Zealand: Sovereign, which is now owned by AIA, and Partners Life, which sold at the end of 2022 for a billion dollars. So, as a director in those companies, very, very experienced. Now retired from full-time work, as he should be, and spending time with Angel Investors Marlborough [AIM], which is a bit of a passion project for you, isn't it, Richard? Absolutely, yes. Don't ask my wife if I've retired; I don't think she would agree with you. Well, you're the sort of person that would never really retire, though, right? Yeah. But, yeah, Angel Investors Marlborough is something, I moved down there about eight years ago and was sort of getting involved in a number of activities. But one of the things that I've always enjoyed doing is investing in small companies, and sort of going on the journey with others who have started small businesses. I took the opportunity; I noticed there was no angel group set up in Marlborough, so I decided to found one. It's called Angel Investors Marlborough, or AIM for short. And you're now the patron of the organisation? Yes, I was the chairman, but I decided after seven years they probably needed some fresh blood, and they very kindly asked me if I would continue as Patron. They agreed to waive any further membership fees, so I thought I'd agree. Fantastic. But it's been good fun. During those seven years, we've invested some $27 million into 68 companies, and we've probably looked at over 700 companies to invest in. This runs at roughly 10% of what we look at that makes sense for us to invest in. So, yeah, a lot of experience. So if I'm a director of a company that is in startup phase or in a fairly early stage and I'm seeking investment, clearly I want to get in touch with an angel investing entity like AIM. And I want to pitch. What do you want to see in a pitch deck? Well, we want to see really what's the sort of business you're in. That's the sort of key part. And the key is, is there something, are you doing something different? Right. So, what sort of problem are you solving and how big a problem is it? So, that gives us, in terms of the size of the market, is it big enough? Is it going to be viable in New Zealand? Is this a business that's going to have to migrate overseas? And there are problems in doing that? Challenges, yes. So, you look at that product-market fit. You look at the skills of the individual. At the end of the day, most people have a business plan, and what they end up doing is often very different. Right. Just because you never get it right. And the key we're looking for is: is this an individual who's going to succeed? And if they need to pivot or change the nature of the business, are they going to do that? Do they have the skills to do that? So, you look at whether it's just one individual, or is it a team. How well do the team work together? Do they have any competition? And then what do the projections look like? Yes. Most of them are a bloody great hockey stick. Right. You get used to that, and you've got to see through that and come up with something that's realistic. But you can take a view and say, "Yeah, this is a company that's in the right space;"it's likely to succeed." And then it comes down to, how much money do they need? Inevitably, they're going to need more over time, so you have to sort of think about how that money is going to go in, how they're going to use it, and then it's a question of, if it makes sense to invest, agreeing to some terms that are sensible for everybody. Okay. That's really the process. And they've got about 15 minutes to pitch that to you, right? Yeah. Well, if they come to AIM, they send us some material beforehand. And we have a look at it and sort of try to take a view as to whether the membership is — we've got 183 members — the key is, are the members going to be interested in this? Is it going to appeal? We don't want to waste their time. Yes. But if we think it makes sense, we invite them to come down to our next pitch evening. We have one every month. There they'll present for ten minutes and have five minutes for questions. Usually, in that period of time, you learn a lot about whether or not this is something you want to invest in. But the key we do is we get them to stay for dinner. Right. And we make sure that anybody who is interested in investing in them goes and sits next to them. Has the opportunity to talk to them. And you find out a lot more over dinner than you often do from a formal pitch. Right. You can really judge whether or not this is a business you'd like to invest in. Great approach. So that's a key part of our — you know, make it more of a social event like that. Okay. And really understand the company. Now, how do you go about valuing a business that's in one of these early stages where there's so little certainty and things around it? I'd have to say it's perhaps more an art than a science. There is something called the Berkus Method, which really looks at some key factors in a business and sort of allocates a dollar figure to five different areas and comes up with a number. Okay. And typically, that's sort of one and a half to two million [dollars]. So, it's an early-stage business; it might not have customers, but you're going to be judging some key factors, some inputs to see whether or not it makes sense. There's the standard discounted cash flow, - Yes. - which is really sort of look forward, discount it back, at an appropriate interest rate. Some sort of revenue multiple or earnings multiple, looking at comp cos [comparable companies]. In deciding the value, you're not saying — if you say,"Right, I'm going to value this business at $3 million", you're not saying that if I went out and tried to sell it tomorrow, you'd get $3 million. No. You just kind of come up with a figure that is fair, and it accounts for how much more money they might need to raise. And you really want to come up with a number that, once you've had all the dilution, they've still got a meaningful stake that incentivises the management. Right. There's no point putting something together that takes all the shares away from them, because then you won't have a team that's motivated. So, it's just a question of trying to get that balance right. That balance right. And you normally want a valuation that you know is going to increase over time, because they are going to come back for more money, and it is quite important that when they do come back that it's an up-round. Yes. It's quite tough if they have a down-round, because then everybody sort of thinks there's something wrong. Of course. So, but yeah, as I say, it's an art rather than a science. Yeah. And the earnings multiple method would be a particularly challenging one for companies that aren't yet earning! Well, you're looking at a forward figure, - Right. - so you're saying, you know, in four years' time they should be making half a million dollars profit, so that would be worth X, and then I discount it back at 25-30% per annum, which is a sort of an investor rate of return for that sort of risk level. Right. And then you come up to a value today. So, do you generally use a range of different valuation methods - Oh, yeah. - and compare them? Yeah, yeah, yeah. Right. And there is quite a lot of negotiation. And there are quite a lot of ways of structuring it. If they want a higher valuation, you might sort of say, "Well, I'm prepared to do that,"but I'm going to have to have pref [preference] shares, not ordinary shares". Yes. Or something, or I want to — you know, you can come up with ways to offset. Or if you're going to have liquidity preference. I mean, they do that in the[United] States; they give you a higher value, but then they want three times liquidity preference. Right. So that if there's a payback, they get three times their money back before anybody gets anything else. Aha. So it's a way of giving a high valuation. Yes. To sort of change the terms to justify it. We don't tend to do that here. We tend to be much more plain vanilla - Yes. - on the structuring of our deals. Right. Okay. And then, how do you decide whether you want to invest? Well, we sort of — what we have at AIM is we have a checklist. And we look at the founders. We look at the problem they're solving and how big a problem. We look at whether this is going to be a New Zealand-only business or if it's likely to be international, and needs scale, how capital efficient it is, what sort of competitive advantages they've got, how realistic their projections are, and also an exit. We have a strategy within AIM which we call 5x5. Ideally, we would like to invest for a 5-year period and get back five times our money. Right. That simple. We don't want to be an investor in 15 years' time, because the key to being angels is you want to recycle your capital. Right. We can't go and raise a fund; we're taking money out of our pockets, - Yes. - which aren't necessarily that deep. No, no. So, you need to be able to get an exit so that you can then look at another startup. We look for venture capitalists if they still need money after the 5 years. There should be bigger groups, like venture capitalists, that provide that. Right, okay. And are those criteria fairly standard across angel investing? Are there difference? Yes, pretty well. Yes. We have a scorecard. I've just got it in front of me. There areas I've just said, it covers, and we have four or five points for perhaps each area. Yes. And we have a team that looks at an investment opportunity when it first comes in to us, and we score it. It needs to score pretty well, 80 or above, - Right. - for us to be able to be interested. To be one of the one in ten. Because, you know, you've got to have some standard method - Yes. - to be fair to everybody. Absolutely. We want to take a consistent approach- Yes. - to evaluating an opportunity. And you'll also want to maximise your chances of success in the investment as well. Absolutely, yeah. How involved do you then get in the investing companies, and what difference do you think it makes? It makes a huge difference. We have very much an active approach. As angel investors, it's not just about putting some money in; it's what expertise you can provide. You've got to remember, a lot of these are teams who are starting and running a company for the first time. Yes. There will be gaps in their skills and knowledge, and a lot of our members, like myself, are people who have started businesses in the past. They have been through a lot of startups or even run mature businesses, but have some skills they can contribute. Yes. There's some research out of the States. One of the angel groups there had a mix of investments between those that they just passively invested in, and those that they were actively involved in. Yes. They measured it by how many times they were meeting with the teams in a year. Yes. One of them might meet the team once or twice a year, and others might have a weekly call with them. That was how they measured it. It was fairly transparent the way they did it. They found that the returns they were getting from the ones they were actively involved in were three times the return of the passive ones. Which makes sense. Yeah. As you say, with these angel firms often being - with the investee firms often being - fairly new to running businesses. Yeah. Having an idea, having a passion to deliver it, having some skills, but definitely having some gaps. Yeah. And as you say, having experts that can fill those gaps. It makes sense that you get better returns. Yeah. So we have someone we call an investor rep[representative] who works with each of them. They don't necessarily become board members; they don't need to. Some of the companies we go onto a board, but the key is that they're actively involved in working with the companies and helping them. Right, okay. And once you've invested, how do you monitor the performance of these companies? We get a quarterly report from each of the companies. That's part of our terms, that they have to give us a quarterly report. There’s quite a mix of quality in the reports, as you'd expect. We don't have a standard format. Ah, okay. We just ask them to tell us everything that's relevant every quarter. Then we know how well they're doing, how they compare to plan. We ask them to identify what's going well and what's not going well. We get a view as to when they're likely to want more capital so that we can prepare for that. Quite often, we talk about what the exit plans are. Yes. Because as angels, with our 5x5 aims, we like to know what our exit is going to be. Yes, yes. When we've been in for about three or four years, we're definitely having those sorts of conversations. But yeah, we've invested in 68 companies. I would say we've probably had one failure. We've probably got four on what I might call the critical list. But generally, the majority of our companies are doing okay. Right, right. And you showed me some of the overall returns. They're very high, right. Which brings me to the next question. What sort of returns do you expect to receive? You're saying 5x5, you want five times your money in five years. We would like to see five times our money in five years. We measure, we keep a record on each cohort,- Yes. - so we know the investments we made six years, five years ago, and we monitor. We're probably running on our earliest investments at about four and a half times money. Yeah. And obviously the most recent is still at one times. Right. But yeah, I think we sort of think that five times is quite reasonable. Certainly within the VC[venture capital] industry, people talk about a 10 times money return as being the minimum they'd like to see, but they're usually talking 10 years for that to happen. Right. And actually, if you think about the economics, getting five times your money twice is better than getting ten times your money once. Yes. Well, and you're in an earlier stage of investment too,- Yeah. - so that makes more sense. That's right. You're essentially taking more risk. And the key for us is being able to recycle our capital. Yes. That's the main thing. You also mentioned before a cumulative average growth rate of around 25%, which gets you around that 5x5. Yeah, yeah. That's right, yeah. Actually, coming back: a question I meant to ask you about monitoring performance. You said it was very open in terms of the structure and style of reports. I take it you expect a mix of financial measures, non-financial measures, qualitative information. Do you agree on any metrics that you want them to report to you, or do you leave that all fairly open to the business owners? No, we don't say, we ask them, and quite often what they do is give us a verbal report. Which is probably more... What they do, is they say,"Well, I'll just organise a Zoom call. All the investors can just dial in." Right. And they ask questions. And they do a 15-minute presentation and ask any questions. I think it's probably a lot easier than trying to commit it all to paper, and we're very happy doing it that way. Right. If it's a paper one, it's usually a two or three-pager. Yes. And it's quite a lot of words. As long as we know what's going well and what's not going well, that's usually enough. We want them to tell us of any problems as soon as they can. Don't hide it, because we can help. That's what we're about. Are you able to share a couple of success stories? Yeah, we invested a little while back in a company called PartPay. PartPay was in the buy-now-pay-later sector. Okay. We knew the founder, and we got involved in their first raise when they just started before they even launched the product. And we invested a reasonable sum, and they then, within 18 months, got approached by a listed company out of Australia and made them an offer which was pretty good. I think it was about $65 million for this company that was a startup 18 months earlier. Wow! So, we all took shares in this listed company. And then those shares proceeded to increase to five times the value. Wow! But they didn't stay up there for very long; they came down and eventually settled at about three times the value that we'd been given the shares at. So, we ended up making something like 20 times money - Wow! - on this investment which had only been in 18 months. Jeepers! That was a very good story. You were in the right place at the right time. Yeah, but not all of them are like that. But you do try - I always try to think that in any young company, you would hope to perhaps double your money each year. That sort of thing. An like anything, as an investor, it comes down to diversifying your portfolio, right. Don't put everything in one company. That's right, yeah. We reckon you probably should have at least 15 companies in a portfolio to get a reasonable spread. They say that 70% of young companies fail. We would not expect 70% of our companies to fail - Certainly not. - because they've gone through - A strong process.- a pretty rigorous process. But we would expect perhaps 10% or 20% of them to fail over time. Those companies, when they come to see you, what kind of level of governance do they have at the time? Is it a founder and maybe one or two others? Do any of them have advisory board type scenarios or mentors that they work with? No, these are very early stage. It's often just a founder or maybe, you know, two co-founders. Yes. They're not, you know, a lot of them will be first-time founders. Yes. I mean, sometimes you get a second- or third-time founder, and it's a lot easier; they've been through it before. Yes. You know, with a first-time founder, yes, they've had a job, and they've come up with this idea, and this is something they're doing for the first time. Part of what we see to be our role is to put some governance in place. So, in terms of our investment agreements, we agree with them what decisions have to come back to the investors. Right. So, you know, above a certain level being spent or a major change in strategic direction, all that sort of stuff has to come to us. There's usually some negotiation about pay levels to make sure they're reasonable. But, yeah, I mean, it's — usually - sometimes we put a bit of an advisory board together, but the key is to get the board in place, and we look for any gaps. So, as I said before, we may not necessarily go on a board if we think there's a bit of independence there already. We don't think we can add anything; we're sort of happy. So, we're not trying to get board positions. Right. But if they want it and it makes sense for both of us, we'll take a board position. I personally am on six of our boards and chairman of five of them. Right. A bit of a workload. I don't mind because I enjoy it. You know, if I didn't enjoy it, I wouldn't do it. Absolutely. And you do have that sort of extra incentive, in that you're an investor. So it's not like perhaps being on the board of a big company where you're not going to see any financial result from doing it. Yes. You don't normally get any director's fees from these sorts of companies. Right. So, you are going to get your gain from your shareholding. From your investment. That's what you're looking for. Yeah. And that might introduce some interesting issues because you may not be perhaps as conservative as you would be if you were a truly independent director with no shareholding. Yes. I think we've got to recognise that we are perhaps not quite so risk-averse. It's the distinction between an independent director and a non-executive director. Yeah. Actually, just a little question to finish up, so I don't keep you all afternoon. With your extensive experience as a director, because you know you were a director of Partner's Life and a number of other companies, as well. As well as all the startups that you're talking about now. What's the best advice you've received as a director? I think it's really to work out what value you are adding. Because there's really no point you being a director, if you're not adding value. Yes. So, that's the key thing: what is it that you can provide that perhaps others can't? You get far more satisfaction from being a director if you're truly contributing something rather than just sitting around the table. Yeah.

So I think that's the biggest piece of advice: 24:08

is work out exactly why you're there. Right, awesome. Richard, thank you very much for your time. Okay. I appreciate it. It's been a great conversation. And I look forward to seeing you next episode. Okay, thank you.