Peter Adams is the Executive Director of the Rockies Venture Club and a Managing Partner at the Pandemic Impact Fund. The Rockies Venture Club is one of the longest running angel groups in the country, having been founded in 1984 and boasting over 300 active members to date. In July of 2020, Peter and his team closed the $100M Pandemic Impact Fund — a venture fund dedicated to financing companies that solve problems directly and indirectly related to the COVID-19 pandemic. Before being appointed as the Executive Director at RVC, Peter held roles as the CIO at Design Workshop, the President and CEO at Omniportraits, an Adjunct Professor at Colorado State University. Peter holds a bachelors degree in Philosophy from Colorado College and an MBA from Regis University.
You can find Peter on Twitter and on LinkedIn.
KEY THEMES:
Fund structure
The Pandemic Impact Fund team is ratio-driven when developing a fund structure.
The optimal allocation of venture dollars requires an investment in ~25 companies to achieve proper diversification without spreading the fund too thin. A minimum of 50-60% of capital should be reserved for follow-on investing in order to properly re-invest in the winners.
A fund’s size and fund structure dictate the stage focus. For example: Out of a $100M fund, $60M is reserved for follow-on investments, $40M is used for initial investments, (divided by 25 deals) which results in an average initial investment of $1.6M. This average investment size limits the fund to Seed and small Series A investments.
Deal analysis
The gaps in a market (especially over a 5-10 year timeframe) that can be filled by a new business or technology are far more important than the size of the market at the time of investment.
Begin with the end: Instead of posing the question, “How many people can this company sell their product to immediately?” an investor should be asking, “Who will eventually buy the company that sells this product?”
The exit is the most important consideration when analyzing a deal. Any question about the team, the market, the product, capital requirements, etc., is ultimately a subset of one question: “What is the likelihood, size, and timing of a potential exit?”
The term “exit” has become a dirty word because it often falsely implies the loss of the founder and the dissolution of a startup’s sovereignty. It’s more accurate and more constructive to think of an exit as a “commencement” where the startup has newfound access to the resources and capital it needs to further advance its own goals.
Gentrification of capital
Entry into the public markets is not as desirable as it once was. An increasingly-restrictive regulatory environment and a high degree of scrutiny from investors creates an environment that is unfriendly to a large number of late-stage private companies.
Private capital has become much cheaper and more accessible to a larger number of companies. As a result, it is preferable for companies to remain private longer.
At the same time, corporate venture investment now makes up over half of all VC, while corporate R&D spending is declining. It appears as if corporations are purchasing startups with complementary technology rather than developing it in-house. According to Peter, “M&A is the new R&D.”
However, the attention of VC firms is being directed upstream. The number of total venture capital deals has declined while the average deal size has increased. This creates a funding gap for early-stage startups as growth- and late-stage companies receive the majority of VC dollars.
How did you get involved in angel investing?
I first got involved in angel investing quite a while ago. I joined Rockies Venture Club in 1992 after I had exited my technology company. I dabbled around with angel investing for a while, but then stopped for about 15 years to raise a family.
When my kids were just about to leave high school, I started attending RVC meetings and mentoring founders through the Angel Capital Summit. Eventually, the original founders of Rockies Venture Club all retired after running the group for 27 years. Admittedly, it had been run into the ground by that point. So, the Board of Directors allowed for different parties throughout Colorado to make their case to replace the previous leadership. And, for better or worse, my pitch “won” in the eyes of the board.
So, I bailed out the existing board, asked them all to retire, and I started fresh. At the time, I really got to know Jim Arkebauer and Maita Lester. They had previously been running RVC and were gracious enough to provide me with the support and the encouragement I needed to take the group in a new direction. And we did. RVC changed dramatically.
Things really took off for RVC when the JOBS Act was passed in 2012 and we were permitted to put together syndicates. Almost immediately, we became more sophisticated with how we conducted diligence, worked together, and invested together. That changed a lot of things for us as an organization. Prior to that, angel investing often involved a group of angels watching a pitch and then writing checks individually. You never knew how many people were going to invest in any given deal and you couldn’t track anything. So, the JOBS Act was really a game changer for us. Since then, I’ve made 150 investments in 60 companies using that model.
Can you tell me about the Pandemic Impact Fund?
In 2017, we raised our first institutional fund (separate from RVC) called the Rockies Venture Fund. We wanted to be able to give outside LPs access to many of the same deals that Rockies Venture Club has been participating in for years. Soon after raising that first fund, we began talking about what we wanted to do for Fund II. I and the rest of the management team quickly concluded that we felt very passionate about impact investing. And, instead of raising a traditional venture fund, we wanted to invest in a way that aligned with several of the United Nations’s 17 Sustainable Development Goals. After all, many of our previous investments with the first fund had fallen into one of those categories. It would allow us to utilize our expertise, leverage our great relationships and make a positive impact. That was the plan.
Then the pandemic came along. Almost immediately, no one wanted to talk about impact anymore. It forced us to take a long, hard look at our investment thesis to look for opportunities to pivot the fund. We quickly concluded that we wanted to convert the second fund into a pandemic impact fund. We would still be abiding by the UN’s SGDs, but we would have the opportunity to fund companies tackling pandemic-related problems that affect every single person on the planet.
The more we thought about it, the more excited we became. This pandemic has torn a hole in the fabric of society. When you have these fissures, there’s always opportunity. For example, Amazon’s growth exploded after 2001. Companies like Square, Venmo, and Pinterest all emerged following the tumult of the 2008 financial crisis. I suspect this is even bigger. The effects of the Coronavirus pandemic will cut deeper and last longer than the global financial crisis in 2008. PandemicTech is the newest technology category which will create the unicorns of tomorrow.
For us, I believe we define PandemicTech in a very unique way. It’s not just about vaccines. If you think about all the ways that the pandemic has impacted us, there are countless opportunities for development. Our goal is to invest in a way that allows our portfolio companies to have an impact on this pandemic and future pandemics. This includes themes such as the future of work, the future of education, shifts in global supply chain operations, and rethinking international travel; in addition to developments in testing, contract tracing, and telehealth.
When establishing the Pandemic Impact Fund, how did you approach the fund structure?
As fund managers, the team and I are very ratio-driven in how we approach fund structure. For example, the Pandemic Impact Fund is a $100M fund. We believe the optimal allocation of dollars in any given fund should be in about 25 companies. We also believe that there should be a minimum of 50-60% of capital reserved for follow-on investment. You don’t want to be one and done as an investment strategy. Investors have high degrees of transparency into how a company is doing and therefore we have an advantage in doubling down on the winners.
So, if you have $40M in initial investment capital divided by 25 deals, we have an average of $1.6M for first-round investments. If we’re investing alone, that clearly puts us in the early stage; even if by virtue of the fund size itself. But, of course, we’re also retaining another $2-3M per company for follow-on investment. The great thing about this strategy is that it also provides enough capital for the Pandemic Impact Fund to make opportunistic, half million dollar investments in some RVC deals as well.
How do you think about market opportunities?
When analyzing market opportunities, I begin at the end. A while ago, I wrote about RVC’s Exit Strategy Canvas, which details six major considerations when developing an exit strategy for any company. One of those sections asks founders to study the incumbents within their industry and consider the technical, social, economic, environmental, political, and legal changes that could occur in the industry. Where are the gaps going to be in the market over the next 5-10 years? When I’m looking at any given market, the size of the market is not nearly as important as the types of gaps within those markets.
In traditional venture capital, the size of the market has always been one of the most important considerations when assessing a deal. Venture investors almost always want to get involved in giant markets. However, those markets are often a red ocean — High competition in an existing market. Oftentimes investors will evaluate a market by asking the question, “How many people can this company sell their product to immediately.” I believe this is a 1.0 way of thinking about an investment. When assessing a deal, I first ask myself, “Who will eventually buy the company that sells this product?”
The next thing I consider is whether the company has a product that the market really wants and needs. I look for some evidence of product-market fit. Unfortunately, I’ve heard a lot of investors give advice like, “Just build something people want, deliver it with excellence, and then acquirers will come.” Quite frankly, that is some of the worst advice I’ve ever heard.
I believe it’s far more important for a founder to carefully consider who their potential acquirers may be one day , as well as the possible gaps that those companies may have in their own industry. Founders shouldn’t be just looking for the big exit, but they should also look for a values alignment with their acquirer. Any exit strategy requires the managing team to ensure that the values of the company align with the values of the acquirer so that their company’s work will be carried on by the new combined entity. So, thinking about those things and building relationships from day one (rather than waiting until month 60) is very important.
Do you think this “exit first” focus comes from investing at the angel stage?
It comes from a few different things. Not surprisingly, many founders look at me like I’m insane when I talk about this exit-first approach. After all, when you’re first starting a company, it’s difficult to spend a lot of time thinking about something so distant. During these discussions, I often find myself quoting from the 7 Habits of Highly Effective People. Habit number two is, “Begin with the end in mind.” So, in many ways, the early stage is the best time for a founder to be planning out an exit strategy.
If a founder is thinking about the end, they can go so far as to construct things like their corporate culture to match that of a potential acquirer. Or, they could build their product on a technology stack that would integrate with those acquirers. For example, I even had one company who designed their logo’s colors to align with the branding of a target acquirer. Of course, that’s going a little far. But, seriously thinking about the liquidity event from the beginning is crucial. Otherwise, the company’s journey can be much more haphazard - failed product features, multiple pivots, and an uncertain long-term vision.
When you know who you’re creating value for, it gives you a framework to answer so many questions that you have to tackle as a CEO. For example, I coached a company that built a legal practice management software. They were asking me whether they should pursue smaller practices (2-20 lawyers) or larger law firms (100+ lawyers). One has a shorter sales cycle with a smaller contract value and the other has a much longer sales cycle with a higher payout. To me, neither of those things matter. Average contract value isn’t what’s important. The important thing is who your acquirer is going to be, and what they’re going to value from your product and your business. If a target acquirer wants a lot of smaller law firms, then go with that. If they want to work with much larger firms, then pursue that market.
This is really just one example of the hundreds of questions you have to ask yourself as a CEO. And having that framework helps you drive the straightest line between start and exit. This mindset also helps a startup become more effective, more capital efficient, and achieve an earlier exit.
What initial question do you ask yourself when first looking at a deal?
It’s interesting. Some investors believe that the most important components of a startup are team, team, and team. Other individuals focus on the market or the technology. All of those questions are subsets of the one question: What’s the exit opportunity for this company? Anything you ask is all about the exit. Whether you’re talking about the team, the market, barriers to entry, or capital requirements, they all lead back to that one big question regarding the exit. As a Venture Capital fund manager, my job is to maximize the returns for my Limited Partners. And the only way I return money to my LPs is by way of an exit. That’s my job.
After all, if my mission is to invest in good teams, that still circles back to the question of the exit. Bad teams don’t often achieve successful exits. So all those questions that investors ask lead back to this: What is the likelihood, size, and timing of a potential exit?
Other investors don’t seem to talk about the exit very often. Is the concept of an exit a dirty word?
I think part of the issue is the unfortunate nature of the word “exit.” People assume it’s the exit of the founder. However, the exit event has nothing to do with the founder’s place in the company. So, I think “exit” is a bit of a dirty word. I think a better word is “commencement.” Think about it. When you graduate from college, you don’t have an exit. You have a commencement. If you think about liquidation events, it’s a commencement — It’s when everything the founding team has been working towards is given support in the form of additional capital and resources. Everything that is important to that team is commencing to grow tenfold. So, instead of asking about a company’s exit strategy, we should be asking, “What’s your commencement strategy?”
How do you see the private markets evolving over the next 10 years? What about Angel Investing?
I have a grand theory about how I believe the capital markets will evolve.
If you observe all of the major sources of capital including IPOs, private equity, venture capital, angel capital, banks, bonds, etc. they have all been shifting in big ways. I think these changes are indicative of something that I call the “gentrification” of capital.
Think about how a neighborhood gentrifies when wealth moves into a new area: Everything moves upscale. During this process, property values tend to rise, people started investing more money into the area, and many low-income individuals eventually got pushed out. I believe we’re seeing the same trends in the capital markets. Because of the low prices of bonds, T-bills, and other debt instruments, the capital is flowing out of those instruments and flooding into the private markets.
At the same time, changes in the regulatory environment have made the public markets less attractive to many investors. Some of the extreme regulatory measures instituted after the 2008 financial crisis have made it much more expensive and undesirable for companies to exist in the public markets. And, we have seen a steady decrease in the number of public companies listed on the New York Stock Exchange over the past several decades.
In addition to the public markets, there have been several other big shifts in both institutional and corporate venture capital. In 2010, corporate venture capital made up 10% of all venture capital. And, last year, it was over 50% for the first time. So we’re seeing a substantial shift in the way that U.S. companies are innovating. They’re buying rather than investing in-house. So, you’re seeing an extreme rise in corporate venture investment activity to the tune of $67B per. At the same time, we’re seeing a drop in R&D spending within U.S. corporations. The way I see it, M&A is the new R&D.
So overall, everything is getting bigger and moving upstream. The number of venture capital deals is on the decline while the average deal size has continued to increase. Many startups are not going public for this very reason. Capital is becoming more cheap and more accessible to private companies. Because of this “gentrification”, we now have the ability to throw tens of billions of dollars at companies to keep them private longer.
This has huge implications. The most consequential implication, in my opinion, is the fact that all of the attention from venture investors will point upstream into the later stages of fundraising. We’re already seeing this. In fact, the total number of series A deals has been on the decline over the past several years, while the number of growth- and late-stage deals has increased. So, this gentrification of capital has actually hurt the startup investment space. Many investors are chasing unicorns by ensuring that late-stage companies stay private longer while early-stage startups remain neglected.
What do you think of the recent change in the “accredited investor” designation?
I’m all for it. In fact, I’m on the board of the Angel Capital Association and we have been actively lobbying the SEC for years to get this approved. One of our biggest challenges has been the fact that Congress is resistant to loosening regulations surrounding the accredited investor designation. They don’t seem to understand the difference between multi-billion dollar hedge funds and these small angel groups.
I can understand why the million-dollar threshold [a minimum net worth of $1M in order for any individual to qualify as an accredited investor] for accredited investors was established years ago. One million dollars then was worth something closer to five million dollars today. So, in reality, the minimum net worth has actually been creeping down in real dollars over the course of several decades.
But, I like the fact that private market investing is becoming more democratized. It’s ridiculous that people like me can make angel investments while younger people with a smaller net worth cannot — even if they have the same exposure and level of expertise within the private markets. As someone who meets the old requirements for the accredited investor designation, I have been able to take advantage of tax-free returns while growing my wealth for years. This has basically allowed the one percent to accumulate wealth while keeping others from opportunities to achieve the same level of wealth. After all, it’s well known that long-term wealth comes from investment returns, not income. So, democratizing angel investing and allowing a larger number of people to take advantage of 10x tax-free returns just makes a lot of sense to me.
While this newest development is a step in the right direction, the hurdles to becoming an accredited investor are still very big. The lowest one, to me, seems to be the Series 82 exam. You can enroll in a class for 40-50 hours and then take a 50 question test for $40 and become accredited. And that’s good... Even though exams like the Series 7, Series 65, and Series 82 don’t really teach you about angel investing. The rules in venture capital investing—Portfolio theory, balancing risk, analyzing deals—are totally different from the rules in public market investing. And, if you took all that public-market knowledge from the Series exams and applied them to angel investing, you’d probably be one of the worst angel investors in the country.
So, there is a downside to these new requirements. But, by taking a few tests to gain the accredited investor designation, you learn the legal, regulatory, and risk elements associated with investing. Because, at the end of the day, the accreditation is meant to protect you from yourself. Which… is great. But, it doesn’t teach you how to make intelligent angel investment decisions.
Is it possible that this “democratization” can go too far, considering the amount of inherent risk in private market investing?
Market risk has always existed for individual and retail investors; whether it’s zero-commission trades on Robinhood or $4.99 per trade on E-Trade 20 years ago. Day trading has also been around for a long time. And, many people have been able to develop discipline around it. To be honest, you can lose your money doing anything. I believe that if you protect people too much, you don’t give them access to the upside. You’ll certainly have some people in the future that end up on the wrong side of an angel investment. But, that’s why we have safeguards. Institutions like bankruptcy court help people get back on their feet after a failure without suppressing the potential upside from investing.
What’s the most important lesson you’ve learned as an investor in the last six months?
One of the biggest mistakes I made in the last six months occurred because I ignored my own advice. When I’m managing other people’s money with the Rocky Venture Fund, I remain extraordinarily disciplined about how we allocate our investment dollars. Personally, however, I’ve allowed myself to get excited about some later-stage angel deals that hadn’t been de-risked. For one of the deals, I invested about 2-3X my normal amount. The company eventually went belly-up, taking tens of millions of other investors’ dollars with it. So, while it teaches a tough lesson on discipline, it was one I needed to be reminded of. My takeaway was that I need to remember to heed the advice that I give to other people.