Recently, I was in a shareholder’s meeting of a portfolio company. It has been a gut-wrenching last 3 years for the leadership. Unfortunately, the company’s market pretty much shut down during Covid. Significant liabilities built up & the team saw significant churn. To survive, the company had to raise a bridge at a major haircut.

During the meeting, the management team walked us through their journey of turning the business around from this dire situation. After the lockdown was over, customer demand got re-ignited. The company drastically cut costs, improved operating metrics to get revenue back on track, re-negotiated long-term vendor contracts, and cleared-off short-term liabilities, all while retaining the core manpower, many of whom had to take salary cuts.

As a result, the company is now PBT-profitable & growing through internal accruals. Btw this turnaround was achieved on a ~$13Mn revenue base. As an operator & ex-founder, I was blown away by this execution story & the team’s grit.

But then, I put my investor’s hat on – despite all this progress, early investors are deeply out-of-money & are likely to remain so for a while. During 2017-19, the company raised equity at aggressive valuations that were misaligned with both the maturity of the business as well as the underlying multiples the sector trades at. In boom times, startups get valued at hyper-growth tech multiples. However, as soon as the cycle resets, follow-on investors revert to valuing them on realistic sectoral comps.

The good news is, courtesy of the awesome restructuring efforts, the business is on a profitable growth path. But given the extent of divergence between our entry valuations & current market comps, it’s going to be a long road toward generating healthy returns for early investors. And even if we get there, the sheer time taken will negatively impact IRRs.

As an angel, this is the part I really struggle to get my head around – how important is the entry price? Bill Gurley says in this 20VC podcast with Harry Stebbings – “the market sets the price on a deal-by-deal basis but as an investor, you have to keep an eye out for the price you are paying at a portfolio level”. This becomes especially hard for angels, who typically have to adhere to the price set either by the founder (SAFEs) or an institutional lead. In this era of fragmented checks via syndicates, SPVs & RUVs, I frequently see valuations that aren’t correlated to the underlying risk in the business & smaller check investors unable to push back. Ultimately, everyone ends up toeing the line.

As an investor, I always have the option of not participating in a highly-priced round. But then enters the other side of the coin – power law ensures very few companies drive a majority of venture returns. Therefore, angel investing is the game of accessing the “best” companies, which often requires paying up to get in. An argument frequently made is “if the company ends up as an outlier, it doesn’t matter what price you got in at”. I get this line of thinking but an “outlier return” is very contextual. Eg. a 10x return potential over a 5-7 year period is very solid for an angel, though might not meet the deal hurdle for a large fund. There are cases in my own portfolio wherein early angels are sitting on a 5-10x unrealized return because we entered at sub-$10Mn valuations and frankly, the likelihood of a startup hitting a $50-100Mn valuation is significantly higher than becoming a unicorn.

Over a 20+ angel portfolio built over 8+ years, I still struggle with thinking about entry valuations the right way. Presently, am taking it deal-by-deal with the guiding North Star of discovering & backing the best founders I can find, while also accepting the reality that angels will usually be price-takers that are prone to macro sentiments & the whims of lead investors. As Bill Gurley advises, maintaining perspective & discipline around portfolio-wide avg. entry price seems to be a smart way to play a balanced game.