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Inside the Mind of a New York Angel Investor: Jeffrey Finkle of ARC Angel Fund

 

Welcome to Inside the Mind of a NYC Angel Investor, a series at AlleyWatch in which we speak with New York City-based Angel Investors. Today we chat with Jeffrey Finkle, Chairman of the Evaluation of ARC Angel Fund and General Partner at 4Scale Ventures. Jeffrey sat down with AlleyWatch to talk about his roots in technology as a serial entrepreneur and operator, his past venture fund during web 1.0, how he started in angel investing, trends in the marketplace including cannabis, and much, much more.

If you are a NYC-based Angel interested in participating in this series, please send us an email. We’d love to chat. If you are interested in sponsoring this series that showcases the leading minds in angel investing in NYC, we’d also love to chat. Send us a note.

Jeffrey Finkle

Jeffrey Finkle of Arc Angel Fund

Bart Clareman, AlleyWatch: Tell us about your journey into the angel business – how did you become an investor?

Jeffrey Finkle: I spent the very early part of my career as an entrepreneur. I started a company in Boston where I lived, which was a storage management software and hardware company; this was 1986. We developed software to integrate optical disc drives, which was the precursor to CD-ROMs, into Sun and Microsoft DOS environments.

I operated it for seven years, and I ended up closing that and going to work for a competitor. As an aggressive but not very experienced 24-year-old, I tried to finance software development with a line of credit on receivables. I don’t advise it – I ran the business for 7 years. Let’s just say there was less of a startup support system back in 1986.

From there, I became a partner in one of my competitors’ companies that was doing something similar. I joined as VP of Marketing, Sales and Acting CFO and in one year we sold that company to Cheyenne Software, which was a hyper growth publicly traded network infrastructure software company. I grew up there as an executive; I ran product management and corporate M&A – we acquired seven companies – and then I became the General Manager of their UNIX Division.

We sold the business to Computer Associates, now called CA Inc., where I was the product manager for their main product, UniCenter, and then VP of Channel Marketing. They bought us for our reseller channel expertise, until I switched back to corporate M&A as we were buying professional services companies.

From there, I was very friendly with a young GP in a venture fund called Wheatley Partners, in which I was an investor and LP. That gentleman and I left to start Odeon at the beginning of 1999.

1999 was a very interesting moment in time – it was a whiz bang time until it wasn’t. Tell us about that period.

I wish it was a longer “whiz bang time until it wasn’t.” The first thing is, we raised a $115M fund, probably the first >$100m first-time fund at the time. That may sound like a lot, but the average seed investment then was really a $3M check, not a $600k investment like you have today, because it took a lot more to get a company off the ground. There were no open stack software platforms.
The infrastructure required to start a company was a lot more expensive, there was no Google Docs and Gmail, there really was no notion of agile startup methodology. So companies burned through a lot more cash to get to the point where they were viable.

So while $115M sounds like a lot, it was really only enough to invest in 20 companies, much like a $30M fund would do today.

What amount of the cost reduction in starting a company is attributable to an advancement in tools – AWS, Elance, etc. – and what amount is attributable to an advancement in methodology (e.g., Agile)?

Let’s talk about it a bit before we come to a number. What did Agile do to reduce costs?

Before Agile, the primary development methodology was Waterfall. The biggest failure relative to that methodology was Webvan, which spent hundreds of millions of dollars to build all these factories to provide an online grocer, before they tested the product with any one user. Think about how crazy that is.

What Agile allowed you to do was to keep infrastructure really, really low and experiment through iteration with your product, until you got to the point where you could determine there was enough efficacy to either raise a follow on round or identify you had product-market fit and were ready to scale.

The fact that if you could experiment without spending a lot – think about that, if you used Waterfall you had to go through all these QA cycles to build a rev, and it’s rev 1.0 and it’s ready and you’re launching. Well guess what, if it’s wrong or doesn’t meet the market need, you’re pretty much fucked.

What Agile allowed you to do was to experiment in a cost-efficient way, and change direction maybe while you still had cash left to spend.

Back to that period of time when you raised the Odeon fund – what was it like in 1999?

We were so busy. We must have seen thousands of business plans – and they were truly business plans, they weren’t thoughtful PowerPoint decks – in our first 14 months. We literally had meetings on the hour; it was truly the Wild, Wild West.

And there was less to go by, because in the Web 1.0 world ecommerce was a new idea. Now, there are very defined metrics that imply an ecommerce company has efficacy – you can look them up on the web, or you will have learned them through experience. We didn’t have that then, there was really less of a playbook.

Does the Odeon story end the way so many stories ended around that time – badly?

Well, it was probably the best time ever to raise money, but it was probably the worst time to put money out given the dot-com bust, which happened a few years later.

We did have some very good hits. DealTime.com, which we took public and was then acquired by eBay, FalconStor, which was an enterprise storage management company started by my prior Cheyenne colleagues, was a big success for the fund.

But overall it was a very, very difficult vintage. If you look at all the private equity reports, 1999 was truly the worst vintage in a 20-year period. That said, we did as well as we could.

What did you learn from the Odeon experience?

I learned a lot. One idea that was a big idea back then was: bring in adult leadership. This was the idea of moving the founder aside early to bring in the experienced businessperson.

At the end of the day, it didn’t work for a number of reasons. Oftentimes when you pull out the founding CEO you’re pulling out the heart and soul and vision behind the product – and that’s something that’s not easily replaced by experienced management.

The second thing to that point is that experienced management, we found, didn’t necessarily have entrepreneurial management skills. They needed too damn much infrastructure to do their job.

What’s happened today among funds is that a lot of fund managers have recognized it’s almost better to surround the founding CEO with strong C-level operating execs, and make training available whether it’s through mentorship coaching or close relationships with Board members, or something even more formal to fill in the knowledge gaps. Notwithstanding that sometimes you’ve got to replace them.

But the default isn’t to replace like it used to be. That’s a big evolution. That’s a big philosophical change from the Web 1.0 world to today.

When is the right time for a founder to bring on that seasoned right hand?

Once companies raised their Series B – which in the Odeon days was the first round of scale capital and today would be more like the A round – that was the time where the decision was made on whether or not the CEO would cap out in terms of his or her ability to lead, or reach the milestones that needed to be achieved in that round. Today, that time comes in the A round – so when you think about it, it’s early.

Is that to say that the right time to take on the Sheryl Sandberg-type COO is at the A round?

I don’t think so. I would say it’s certainly not a rule across the board. Today we have more established ways to help CEOs – we can give them education and support, we can help them recruit and hire. In answer to your question, there’s not that many A round companies that have COOs unless they were part of the founding team and that’s probably how it should be.

How did you come to be Chairman of ARC Angel Fund’s Evaluation Committee?

The first thing I did after I wound down Odeon was I laid in bed for a week, just to rest. The second thing I did post-Odeon was, my lawyer, who was helping me wind down the fund, was trying to put together an angel fund in New York with participation from a lot of his colleagues and clients.

He invited me to become a member and help lead the evaluation and decision-making process, and that’s how I became the Chairman of the Evaluation Committee for the ARC Angel Fund.

So put your Evaluation Committee Chair hat on for a moment – I’m an entrepreneur pitching you my business, what do I do have to do, say, or show to impress you?

I’ll answer that this way: as ARC, we invest in the Seed round. Let me tell you what I think that means.

Let’s say you and I have an idea; you code, I don’t code. We study the market together and recognize there’s a gap somewhere; we study it, we understand the competitive landscape, we know what’s missing, we see we have an elegant solution. You start coding at night; neither of us has left our job, and we have this plan.

Who’s investing in us? We have nothing to show, there’s no demonstration of efficacy at all, there’s no numbers to go on. So what now? We raise a friends and family round, because the only people who will invest in us are people who know us. The bet is on our integrity and our capability of figuring it out and building something that will solve a problem.

Now, we take that friends and family money, we hire a couple of developers we know who can work under your direction on the coding side, while I’m acting as Product Manager, talking to customers and partners on the sales and marketing side and better defining the product.

We get something out there with this friends and family money – let’s say it’s $200K – and most importantly, we define our success metrics.

We get something out there, albeit imperfect, we can start to watch how it’s being used relative to our success metrics, in terms of downloads, average usage, monthly average user data, whatever is appropriate for that product. But in that early data, what we’re looking for is evidence that through further iteration this thing will get to product-market fit. That’s when you are a candidate for a Seed round.

The ACA says the average Seed round is $1.5M. That’s where ARC comes in, that kind of Seed round. It’s not perfect yet, it could be pre-revenue or revenue generating, but for me that’s not the binary measure – it’s about what the data’s saying.

Some investors require $1M in annual revenue. But you could have two customers, both of whom are prior relationships, at $500k a piece. That doesn’t mean the market has spoken and the sales economics will work. For me, it’s about whether the data is suggesting that this thing gets to fit and then can scale.

Do you have a strong preference for serial entrepreneurs rather than first-timers?

Serial entrepreneurs are good, but often that implies somebody who is trying to be an entrepreneur for the sake of being an entrepreneur.

It’s the sort of person who’s always thinking, “what’s my next thing, what’s broken in the world, what should I fix? What’s going on in the this industry or that industry?” But they have no deep domain expertise; they have no aspect of living with problems in an industry that’s been plaguing them for years. That sort of person is saying, “I want to be in business for the sake of being in business”. In my experience, it’s better to have wrestled with a problem in an industry for a long period of time, and understand the nuance of that industry so that you can build the right solution and know how to get it sold and adopted in that industry.

That said, it is also essential that one of the co-founders have been in an entrepreneurial environment before. If you’re an early employee or a C-level person in an entrepreneurial environment then you’ve seen what it takes, you’ve seen the kind of grit and resiliency it takes to succeed as an entrepreneur, you understand what it’s like wondering if you’re going to make payroll, you know what it’s like to work on scant resources over long days, evenings and weekends– that’s essential. If you’ve never seen that environment, you’re really going to have a hard time knowing how you’ll feel in that environment.

The ideal person has been in that environment but has wrestled with a problem in the domain space for a long period of time. I like that person.

Here’s the issue: more companies fail because they built a solution to a problem that either nobody had or wasn’t topical enough to pay for a solution. Here’s the misnomer: people think businesses fail on execution. To fail on execution is a luxury, because most people don’t get that far.

On its website, ARC Angel Fund says it is, “in essence, a hybrid model between an Angel Group and a Venture Fund” – what does that hybrid model look like in practice, and why is it right for ARC’s members and portfolio companies?

Most angel groups are loose networks of people that pay a fee to be part of a group to see deals together. It’s a network. What happens is people pitch and then somebody in the group says “I like this” and then they have to aggregate and herd cats of other members to put together a group to invest with some support of the entity itself.

Conversely, ARC is not like that. We are 60 individuals, but we are a committed capital fund. Our members have committed capital, just like a venture fund limited partner would do. We make capital calls over a number of years, that’s what makes us venture-like.

What makes us different from venture is we’re member-managed. We make decisions based on a vote of our members. Once we vote to fund, we cut a check out of our treasury. But our members make decisions on what we invest in, and our members share in the GP economics.

What’s required for a deal to move forward?

For a deal to go forward, a majority of members need to have voted, and at least one third of the members must have responded with an affirmative yes.

Who are your members? How does someone become a member?

Our members have a range of backgrounds. Some are ex-VCs. Some are ex-entrepreneurs who have had exits in software, digital media, and non-traditional tech businesses. Some are members of the financial services industry or members of the legal community.

ARC is a great option for investors because what we offer is access, participation, and education. Access, because our members have deep tentacles into the startup community, so we see quality deal flow. Participation, because our members participate in the decision-making process. And education, because you get to see how more experienced investors vet a deal and you may get to see how technology will impact your profession.

Let’s talk numbers, how many deals do you review per month, and what percent of those deals, typically, makes it past the Evaluation Committee?

We see 40-50 deals a month. There’s a screening working group of the Evaluation Committee, which narrows it down to six to come in and present to the Evaluation Committee.

Of the six, we usually select two to come back to the full membership to present yet again. Then from there, we decide to go into due diligence, at the end of which we cut a check or pass. That’s our process.

Over the years, on average we’ve made investments in 6-10 deals per year.

Do you take a Board seat?

Not usually. ARC members may sit on the Board but not because of ARC’s investment.

Mark Suster at Upfront Ventures released a report recently showing that VC investment sentiment had swung sharply positive from a more negative sentiment last year. What does Mark’s data on the VC side tell us about Angel sentiment? To what extent are they the same and where do they differ if at all?

I think they do correlate. What Mark was mostly writing about was the “VC Winter” that was supposed to have come in 2016, that he said did come but it was more like a cold spell that didn’t last and there’s still a lot of money going out into new deals.

That’s true. There’s been a lot of new funds raised in the last few years, a handful of $30-60M funds, so there’s more Seed and a number off $100M funds, so the Series A gap has also mitigated.

At the angel/Seed side, it still feels a little crowded. We’re still seeing a lot of deals that look like other deals we’ve seen. There’s still a lot of capital for both angel/Seed and institutional A rounds.

How does the investment sentiment at ARC compare to where it was a year ago?

I think people are still optimistic, but the one thing I would say I’ve noticed is that in my startup advisory practice, I increasingly find myself advising entrepreneurs to rethink raising professional outside capital.

There are many companies that come for angel or seed money that are probably not a long-term candidate for institutional venture capital. Maybe the market’s not big enough; maybe the solution in the industry doesn’t have an institutional venture capital characteristic.

What those companies might want to do, if they can’t fund it themselves, they should consider raising some friends and family or friendly angel money, and quickly manage towards becoming cash flow positive. That means taking the throttle off of growth, and run it more as a slower growth business that can generate cash so they can pay themselves money and not worry so much about the pressure to exit.

Once you take professional venture capital, there’s a whole different expectation that has to drive the trajectory of that business. It’s about scale, it’s about share, and at the end it’s about, staring at your investor’s expectation of an exit or a redemption right, which may be incompatible with where the business is.

Where I used to have that discussion occasionally 2-3 years ago, now I’m having that discussion often. So it’s not that there’s lack of optimism, that’s just not really the path for all startup companies.

That must be a hard message for a first-time entrepreneur to hear.

It is. Because they grew up in an environment where the mark of success was raising a Series A or B with a Tier A VC. So they don’t understand what they’re really trying to do.

Is the culture that emphasizes raising a round as the mark of success changing?

No, that culture isn’t changing unfortunately. I’m trying to speak about it more though.

Experienced business people who weren’t in a startup but had their own business in the traditional, non tech-startup world had to get to cash-flow positive.

They had to start small and grow. And that kind of got lost in this rush to scale. It’s just not right for the nature of a lot of businesses nor the nature of the founder of the business. It’s just oftentimes incompatible. I see that more and more to be honest.

Nevertheless there does remain such a stigma around building a lifestyle business.

Correct. You know what though – what’s wrong with a $10M business that generates $2.5M of EBITDA and grows 4% per year, and where you can make all the decisions?

What trends or sectors are you watching closely as 2017 ramps up?

The three most exciting areas on the tech side are AI, AR/VR, and legal cannabis. To that end, at our annual VCs on Skis event last week, there were two panels: one on AI and I led a panel on the legal cannabis industry.

On the tech side, AI and AR/VR are attracting a lot of capital. I think what people realize is AI is less of a discreet sector, but more of an enabling technology that will weave itself through all kinds of products and services whether they be a SaaS product, ecommerce, or an IT infrastructure product or whatever.

Legal cannabis is interesting and occupying more of my time as now 30 jurisdictions (29 states plus D.C.) have now legalized some sort of cannabis sales.

Nine (8 states plus D.C.) of those 30 jurisdictions have adult recreational programs. So it’s really crossed over into the majority – the cat’s now out of the bag on this.

What’s interesting about it, also, is it’s not just one sector. When you really think about it, it’s many subsectors, seven of which I’m focused on: agtech, cultivation, dispensary (retail), infused products, ancillary services, biotech, and Software, Media and Analytics.

So it’s not one thing. People tend to think of the cultivators, but that’s just one piece of it.

Is there one of these sectors that’s going to be first?

Well, some of them will pull the others. Cultivation is pulling agtech, sales at dispensaries create a need for analytics and seed-to-sale software systems, consumer demand creates the need for different kinds of consumption devices. Continued research on medical efficacy is driving biotech.

Here’s the other point I want to make about cannabis: the market already exists. Present estimates suggest that the illegal black market is $40B that will transition to a legal green market over the next 10-12 years.

In the shift from illegal black market to legal cannabis, what does $40B become?

It’s very interesting. What’s not in that $40B number? Medical and pharma’s not in that number, that’s just money on the street. What else isn’t in that number? Related sector activity. And lastly what’s not in that number is growth due to decreasing social stigma. If you don’t use it, guess what, if it were legal you might use it occasionally, just recreationally.

Is any of the growth or increasing legality challenged by the Trump administration having different attitudes than the Obama administration had?

Cannabis lives in this weird space between state legality and federal illegality. Thirty states have programs but federally it’s illegal.

Now, that creates lots of consternation for both entrepreneurs and investors. For the last number of years, the federal government has outlined to the states procedures that would dissuade any federal action. That could change under the new administration; it’s clear that Attorney General [Jeff] Sessions is not a fan of the industry. Although as recently as last week he validated that much of what is outlined in the Cole Memorandum – a series of guidelines put together by James Cole, the Deputy AG under Obama – was in fact valid.

That said, states’ rights are a big part of the Republican platform, and it’s hard to believe that the federal government is going to clash with those 30 jurisdictions and jeopardize their growing tax revenues from legal sales.

About the author: Bart Clareman

Bart Clareman is Senior Manager of Hardware Outreach at Indiegogo and the Founder of Clareman & Co. LLC,  a management consulting firm offering sales and marketing, business development, product management, and fundraising services to startups and other companies in the media, hardware/IoT, retail, and e-commerce spaces. He previously was Cofounder and COO of Tiggly where he was responsible for consumer retail sales and marketing from 2013-2016. He has an MBA from Harvard Business School and a BA, cum laude, from Williams College. He volunteers for Venture for America.

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