Seed Capital From Angel Investors: Dave McClure, Founder, 500 Startups (Part 6)

By guest authors Irina Patterson and Candice Arnold

Irina: So, what’s your return target?

Dave: I think 10x to 20x is the ideal target. Obviously, if we get more than that, that’s great. But that’s probably not the typical scenario. In most cases things don’t work and usually we get zero. I think we have a very different strategy from most funds.

Because we’re not looking for board seats or control, the amount of the company is not important, it’s just the return.

Hopefully at incubation or seed, we’re thinking in terms of a 10x to 20x return or better. At series A, we’re thinking somewhere around a 10x return and at series B, maybe a 5x return.

Irina: Over what period would like to see these returns?

Dave: For most of the things we’re looking at, either incubation or seed, it might be a three- to five-year time frame. If we’re investing at series A or B, it might be less. But we’re looking at a little bit shorter horizons than the average venture investment, which is aiming for larger exits.

In some cases, we may be investing in companies that do end up becoming ventures profile companies as well. And those could be longer horizons. But I do think we’ll see exits within a few years’ time, maybe five years if they’re ending up in larger companies.

Irina: At what stage of a company’s development do you prefer to invest?

Dave: Usually, most of the companies we’re investing in are seed-stage companies, so for the most part, incubation and seed are the stages of our investments. In a few cases, we might do some series A and B investments, but that’s probably more after we’ve done the original seed investments.

Irina: What if an entrepreneur comes to you with an idea on paper?

Dave: We like to see that they’ve already got a product built or that they’ve had some experience building a product before, so not as much napkin concepts. In a few cases we have but usually it’s people who already have some prototype or at least an alpha. But usually, it’s pretty early stage so they may or may not have many customers. They may not be generating revenue.

We like to see that they have some concept of customer acquisition, and we certainly like to see an idea on revenue models. We’re not very aggressive on revenue models most of the time.

When we’re looking at companies, we want to see either a straightforward transactional business model, a subscription business model, or a lead generation/lead qualification business model.

Typically, we’re not investors in advertising businesses, and usually we’re not investors in businesses that are growth without a business model. We will do that in a few cases, but mostly it’s transactional, subscription, or lead gen for all the things we’re doing. We like to stay close to the transactions.

Irina: So, it’s OK if they come to you without customers?

Dave: It’s OK, but we want to understand that they have customers in mind and that that’s something that’s fairly soon on the horizon. That’s going to be something we’re working on pretty quickly.

Irina: What would be your next step of engagement with someone who sent you a promising pitch?

Dave: What I like to do is have people come through referrals from other portfolio companies. It’s truly challenging to get cold calls or e-mails as a way of introduction. It’s usually through getting to know other people whom I’ve already invested in or people who are mentors who have funds.

If they haven’t come through those channels, then I refer them to those channels and try and find an entrepreneur who I’m already an investor in who’s familiar with that category. And then a lot of times they help to determine whether the company has interesting technology, or they help us with due diligence and understanding what the market opportunity is.

Assuming we progress to the level where we’re interested in making investments, we start looking at financial terms. In the case where they already have a lead investor, we probably look at the documents that the lead investor has prepared. If we’re jumping in as the first investor, we probably use a convertible note structure and either work with them on drafting that or provide them with a fairly simple structure that we use for initial investment.

This segment is part 6 in the series : Seed Capital From Angel Investors: Dave McClure, Founder, 500 Startups
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