David Gardner (Cofounders Capital): We have a joke that if we don’t understand something in the first 2 minutes, we won’t invest.
30 Jul, 2021
Bill Trainor is a co-founder of Mutual Capital Partners who leads b2b practice there. He is also a co-founder of Access Ventures Fund and has been an angel investor for over 20 years. Before starting his two funds, Bill held a position of Senior Vice President-Head of E-Commerce Investment Banking at McDonald Investments, where his area of expertise included retail, healthcare, consumer, and service companies. He also serves on several non-profit boards, including Flashes of Hope and the Pennsylvania Venture Capital Association Board of Directors.
Back in the 1990s, I was an investment banker at a small regional firm called McDonald Investments that later became KeyBanc Capital Markets group, their investment banking group. Before that, though, in 1997 I made my first angel investment, and I didn’t put a lot of money in, but to me, it was a lot, it think it was 15k or 20k dollars. And the minute I did that, the exchange I had with the CEO, changed overnight. We went from me being the advisor to him being more of a partner. He opened up a lot more, he was asking managerial and operational questions and things that I’ve never had exposure to. So I kind of started to catch the bug then, I did a handful of angel investments in the 1990s, and that worked up really well. It was a little bit like fish in the barrel: if you picked good people with good technology, it was very difficult to get a bad return at that time.
And there was another firm in the Cleveland Ohio area where I based that was doing these small pass-the-hat-around type investments into their clients, that was an executive search firm, at the time called Christian & Timbers. And their outside council, who knew me as well, said: “Hey! You should talk to Bill Trainor, he’s making angel investments, but he’s doing it strictly from the financial due diligence perspective, while you guys are doing it strictly from the feedback you get on the executive search process.” And so we got together at the tail end of 1999, and by early 2000 I had contacted an idea for a venture fund that we called Access Ventures. And the idea was: Christian & Timbers were doing about 200 searches per year in the US venture-backed space, they were making 10 investments or so a year, and just passing the hat around, no formalized fund or anything like that. We proposed the idea of creating a fund to capitalize on the unique access to top-10 venture capital fund talent in the US.
And so I went out looking for 20–25 million, and I ended up raising 43.5 million dollars by the end of that year. And so I started to invest, and over the next 2 years, I made 8 investments in companies that worked with Christian & Timbers. Unfortunately, the dot-com burst dramatically hurt Christian & Timbers: they had too many partners and not enough revenue, and they started to go into a little bit of financial tailspin. Next thing you know, a bunch of the partners left, and when they left, the relationships with those partners left, too. So in 2003, I had only called 20% of the money, I forgave the other 80% of the money I haven’t called. I was a really young guy at the time, I was 29 when I started all this, so I knew I had a lot of years left, and I didn’t want to make a bunch of very wealthy people angry because our thesis was completely different at that point. So by the end of 2003, I said: “Okay, I’ll manage the remaining 8 portfolio companies,” and the investment did amazing. We had 2 IPOs, 4 public company trade sales and we only had 1 outright failure out of the entire investment thesis. So the idea worked well, it’s just our timing and our partner weren’t perfect.
So in 2004 I said: “Okay, I miss the close interactions I had with the CEOs when I was making angel investments.” Because with my firm, Access Ventures, I put a half a million or a million dollars into a company, but that would be part of a 20 or 30 million dollars financing round. It lacked a little bit of intimacy. So in 2004, I started to make some angel investments, but specifically around the Midwest. And after I found a couple of companies and sat on their boards and got to know them really well, I said: “I’d like to create my own venture fund here, in the Midwest, focused on Midwest technology businesses.” So I brought in a gentleman that I’ve worked with back in my McDonald Investments days, and he and I created Mutual Capital Partners and we raised a small fund that we closed in January 2005, and we called it Mutual Capital Partners Fund I. It was 13.95 million dollars. We’ve made half a dozen investments over the next several years and we’ve made every mistake in the book, got lucky with some good wins and everything else, but high level, that’s how we got started with Mutual Capital Partners and we just continued to refine that process every day and every year.
With our first fund, we made those 6 investments, we had 4 public company acquisitions and 2 companies we had to shut down. And we’ve learned a lot from that process. We’ve learned that we need to find companies that not only have great technology but have great people. And geography – it’s nice to say you are going to invest just in the Midwest, but sometimes you might have to go a little bit further. So, when we raised our second fund, which ended up being double the size of our first fund, we said: “We are going to continue predominantly focusing on the Midwest, but we are going to focus specifically on b2b software companies and medical device companies, and specifically in a couple of different industries.” On the b2b software side, it was in FinTech, MarTech, and general mobility, and on the MedTech side, it was around cardiovascular and orthopedic implants.
And so in Fund II, we made 6 investments. Interestingly enough, 5 of them were in Ohio, which was a larger concentration of Ohio Midwest companies than in our first fund, but we’ve also invested in a California-based business, OrchAlign California, orthopedic products business. We’ve worked through that portfolio, we’ve sold one company already to another large public company, and the five remaining companies are all doing well, interestingly enough.
Then, a couple of years ago, we raised our third fund, which was the size of our first and second combined, and we said: “We’ll just keep doing the same thing. We just plan on investing more money into companies in those industries in every geography, except Silicon Valley north or New York City north, but all United States-based businesses. We do like direct flights only or drivable businesses, but we’ll go further if needed.” We continue to learn that even with the best technology you have to have an absolute world-class management team and board of directors around them, or these businesses are just not going to generate returns necessary to deal with the risk associated with venture capital.
So we have a bunch of sub-criteria. High level: if a company can’t show us five customers that are jumping up and down because they use that technology, they literally can’t live without it. And if we see customers churning, that’s a very important metric, if they are staying with the business, and the customers are very happy and they are expanding, and they are adding new customers as well. We won’t invest as early as a quarter of a million dollars of revenue, but until we see those five referenceable customers, not pilots, actual customers that are living and dying using the technology, we will not move forward. So that’s the biggest third criteria we have, is that the customers are going to help us on the technical due diligence as well as on the general sales due diligence. If you have a major customer that is giving you 25 000–200 000 dollars a year for your technology, that’s probably something meaningful to you and to them.
We’re looking for people that know what they are really good at and stay in their lane. For a lot of entrepreneurs, it’s their baby, and they want to do everything for their baby. But let’s say, they’re a technical founder. That doesn’t necessarily mean they’re the best salesperson, probably doesn’t mean they’re the best financial mind as well. It probably doesn’t mean they’re the best at customer success. It doesn’t mean they can’t do all of those things, but there are probably people out there that have already figured out how to do it better than what that entrepreneur or founder could do. And it’s finding people that want to have us help them build out and professionalize the management teams of their business.
Now, we’ve invested in businesses that are a little further along, let’s say, 5–10 million dollar revenue level. At that point, you might be looking to make a replacement or two, but for the most part, we probably wouldn’t invest if we didn’t think that the core nucleus of the team that was there was capable of building this business to exit. Whether it’s an earlier stage business or a mid-stage business like that, they all have to have a willingness to bring the best people at the right time or maybe even in advance of that to make sure that the growth doesn’t stall out. Then again it goes back to finding people that are willing to admit that they are not going to be able to be everything and anything to a company and that they’re going to need help, and they’re prepared to hire really smart well-compensated people to come in and turn those responsibilities over to them and support them as well.
It doesn’t do you any good to say: “Okay, I’m prepared to bring out a head of sales,” and then undermine that person because you don’t like their style or you feel like you’ve given up too much. That’s the micro dance most of VCs do with their companies in terms of getting appreciably better talent around the technical aspects of the business and the existing customers in section. That’s where we spend the majority of our time.
We never have. We have supported a startup that had 5 people, but there’s enough angel capital around. That single person is more likely to raise money that way than to get to our stage. It would be very difficult for one person to get five referenceable customers and be able to develop the technology, sell it, implement it and support the technology, all along continuing to build the sales pipeline and everything. It would be nearly impossible for a person to do that.
Five is probably the smallest team we would ever look at. And our average team is ten or fewer when we first get involved.
We have invested at that lower revenue level, let’s say, five hundred thousand dollars of revenue, but we have to have those five referenceable customers. The customers have to be meaningful. If you tell me that IBM is one of your customers, but they only pay you 2 000 dollars a year, that’s likely not a valuable customer. If you tell me that IBM is one of your customers, and they did 20 000 in year one, and then they increased it to 45 000 in the year two, and by the end of year two they were now at 90 000, if there’s a call at land and expense strategy, that’s a really good customer. That tells me that they really loved the technology.
The same thing with the hospital system, if it’s a medical device. If only one doctor is using it, and there are twenty of the same type of that doctor at a hospital system, and no one else does, that would be something we would have to really check out. Maybe they just know the founder and want to use it, and maybe it’s not the best technology.
So I would say stagewise it’s difficult because we see companies that are raising Series B or Series C money, but in total, they want to raise a couple of million dollars. They just call each of the rounds like Series A or Series B, but for all practical purposes, we’re the first real institutional money in most of our companies.
It’s well over a thousand. I’d venture to say, on average at least two a day, and that doesn’t include when we go to a trade show or something, and there are 75–100 companies presenting. And we go to on average almost one of those shows a month. Just from those conferences and trade shows you may see 500–1 000 companies. And then, when you also get the referred or unsolicited, that might add another 1 000 to the equation as well, 500 for sure.
If we see a thousand opportunities, over 500 of them go away immediately just because they have almost no revenue or they don’t have any revenue. Another a couple of hundreds of them go away because they are not in the right geography. Another a couple of hundreds will go away because they’re not in the right industry. We’re not going to invest in CleanTech or hardware or drug discovery or things are at aerospace, stuff like that.
So of a thousand, it narrows down to a hundred. And of those hundred then we start to dive in and then we’ll have not necessarily face to face, but conference calls, Zoom, WebEx presentations. That will eliminate another half almost by the end of the call. Because you find out “Oh, you have 2 500 of revenue, but it’s one customer, and half of the revenue is consulting. It’s not real software revenue.” So it’s peeling back the layers of the onion to understand what the executives’ summaries and the pitch decks we see are representing the best possible face of what a company can be. And we’re not looking to make the face ugly, we’re just looking to make sure that we don’t waste their time when we know there’s a handful of criteria that are extremely important to us. And if they don’t meet those minimum criteria, we just won’t waste their time.
We may keep in touch with them quarterly to see if they progress and expand, and move on, but unless they have those five referenceable customers, roughly 2 500 dollars a year of recurring revenue. If they are not growing 5–10% a month (ideally 10% per month) at the earlier stages, and if they don’t have the people, if they don’t get along with the people also, it makes it very easy to pass.
And so we get down to maybe 25–50 companies a year that will take the next step. We will meet with them and spend time with them. And the more time we spend, the more comfortable we get. And out of those 25 companies, we may submit 6 term sheets a year. And out of those 6 term sheets a year we average 1 investment every 6–9 months.
Our best opportunities don’t necessarily come from going to the trade shows. I would view that more as a networking thing: you see a lot of companies, but they’re generally not companies at the stage we need them to be, they are closer to the idea stage or 1 or 2 people. For us, going to the trade shows is a great opportunity to connect with the other check writers that come in at the earlier stages and to cultivate those relationships for referrals on everyone: the angel funds, economic development funds across the country – they all need follow-on money. If they put 5 000 dollars into a business, that business is going to need more money inside of a year. That’s where we get the best quality deal flow, is from other check writers that we’ve cultivated good relationships with in the last nearly 20 years, even longer, as I knew a bunch of them back in the 90s across the Midwest, so almost 25 years of connections.
We get referrals from those check writers. We also get a lot of referrals from our investors. Our investors are predominantly family offices and wealthy individuals. Some are angel investors, some aren’t, they just share everything that they see with us, and we get some really high-quality opportunities from them as well.
I’d love to tell you that some company came in and they blew us away, and we had hyper accelerate to put money into the business and everything else, but there hasn’t been anything like that. We’ve met with some teams before and loved the technology and we knew it was a great opportunity, but the valuation was such that there was no way we could get enough ownership to justify the risk. So we knew they were highly likely to succeed, but it just wasn’t the right time or stage for us.
But I think what’s more memorable to us are the weird pitches. We’ve had people get very argumentative with us literally to the point where they are projecting numbers that Microsoft didn’t even do when it’s started up. Or Google, or others. And they just absolutely will not back down that there’s any way they won’t do those numbers. Or we’ve had people just walk into our offices (and they are not the easiest offices to get into), just show up, walk in and start pitching us. That’s not the best way to do it either. You can’t necessarily go to the doctor and demand an appointment, you can go to the emergency room if you’re really sick. We’re kind of like doctors: we’re by appointments only. So it’s more of the funny memorable things that way than we’ve missed out on some company that we thought wasn’t any good, and it turned out to be great.
Almost every major success across the Midwest we have seen the opportunity, the company, maybe even had the opportunity to invest, and we didn’t for one reason or another. And the biggest reason usually boils down to we either saw it too early, they didn’t have the revenue at that time, or we saw it too late, and us putting a million, two or three million dollars into a company to buy a tiny percentage of the business – it’s just there’s more downside than there’s an upside. If you own a percent of the business and you sell it for a billion dollars – okay, that’s great, your million dollars you may 10X your money, but there aren’t just out there many billion dollars exits. There aren’t many great exits anyway, but as you scale down from a billion to 500 million, to 100 million, to 50 million, the ownership percentage means a lot more. And if we can’t see a way to generate a third to half of our entire fund in terms of return from every single one of our investments, it just doesn’t make sense for us to invest.
They’re all pretty unusual. I tried explaining to my children what I do, and they kind of get it, but they don’t get that there’s still so much that needs to go right when you’re investing at the Series A stage. There’s so much work that needs to be done. In the Midwest often the Series A, B, and C equate to the size of one round of Series A on the East Coast or the West Coast. In the Midwest, you might have a company that raises 7.5 million dollars through three rounds of financing, and that’s one round right out the gate in the Valley, and then another round follows up the next year that’s double that. In the following year – another round that’s double that. And so the speed of capitalization and the speed of scale is greater on the Coast, and every company we see just don’t have access to that much money not because they are not great, just a lot because of their geographic location. And we try to help push them to spend capital efficiently, but to make sure they can get to that next inflection point where they’re raising money at a positive valuation form the post-money of the prior round. And to do that – that’s when it gets unusual.
You’ve got to get out over your skis a little bit. You’ve got to hire salespeople in advance of knowing whether they’re going to be good. Just because a customer signs a million dollar a year annual recurring revenue deal, if they don’t recur the next year, then that was not ARR, it was a one-time deal. And when earlier stage businesses are just getting started, they don’t have a lot of that time history. They may have only been in business for two years, and they may have only had 2 or 3 customers that renewed that were there in the first year. So year 2 comes around, and now they have 15 customers. They lost 0 customers from year 1, year 2 comes around and they loose 2 – what’s going on there? That would be a very large churn number (again, it depends on the amount of revenue as well). Or was it just a unique situation because any way you got it, it’s 2 companies out of 12, it’s still not statistically viable.
And that’s why all of these things are very unusual. Because you’re looking for patterns and trends, and you’re looking for areas where you deploy more money. But ultimately, you just got to make some hyper-educated gut checks, gut calls, and if they won’t work out, it’s going to be painful for the business and your investment.
Our minimum is one million dollars, our average bite size is 2–3 million. We will go as high as 4 million right out of the gate. That’s our range. We want to be able to deploy somewhere between 6 and 8 million dollars into every one of our portfolio companies. So if we’ve started at a million, it might be very difficult for us to get 8 million dollars or even 6 million to work. We always syndicate our financings, we are looking for other partners, for other check writers, so that’s why if you’ve only put a million dollars into business upfront it gets difficult to get that money to work later on.
90% of the opportunities that we see that ultimately become investments – we’ve known them for years. Again, 90% of the time we see them when they appear as startups or an idea or they’re just raising angel money. And then we follow them over the years and eventually if the circumstances work out very well, we invest.
From the time we make that decision of “Oh wow, we want to have a face to face meeting,” and that face to face meeting turns into a term sheet and term sheet turns into a signed terms and due diligence and ultimately closing – we have done that as fast as one month. I’d say our average is 2–3 months, but it all varies based on how prepared is the company for that capital. If they’ve never raised real institutional money, if they’ve just raised angel money, there might be some process stuff that we need to help them with. We don’t invest in S-corporations or LLCs, so they may need to be a conversion to a C-corporation. If you do that, you might need to get accounting and legal advice to make sure there aren’t tax implications and such.
So a lot just depends upon the structure of the business, the structure of their information, making sure there aren’t many weird what we call contingent liabilities. Like some email out there that says: “You join our business, and we’re going to give you 5% of the business. CEO.” But they don’t assign the number of shares to that, so 5% of the shares then would be very different than 5% of the shares when we’re looking to invest.
So it all depends upon the planeness of due diligence, but for the most part, it’s around 2 months. It can go as long as 3 months, meaning the longer the deal drags on, the less likely it is to close.
When we go into a diligence process, we look at that as a conformational, we are looking to confirm what the entrepreneurs are telling us, not try to discredit them, but if the diligence comes out and something pops up, that discredits direct questions or even the integrity of what the entrepreneur or the team has said. That’s a big red flag for us.
Making venture investments is a lot like getting married. The average marriage in the US lasts less than the average 10 years of Series A to exit. It’s like 40 years longer to get to exit if you invest in Series A. The integrity, the information the team shares with us is paramount to us moving forward. And anything that comes up that materially contradicts what we’re being told or shown or acquainted what we’ve questioned them about, that would be a red flag for us.
Same thing. One of the companies in our first fund that we shut down – they were 10 million of revenue, profitable, they had a couple of million-dollar lines of credit with a large bank in Cleveland Ohio, at that time it was called National City. In the 2008–2009 banking crisis National City imploded. PNC Bank of Pittsburg ended up buying its assets for nearly nothing. I think the government-sponsored the purchase, and then they picked up 20 billion dollars of loss. It was an amazing acquisition for PNC. But National City just didn’t care, so they called the loan, even though we were not in default and broken the covenant, and replacing debt with equity in 2008–2009 was nearly impossible, let alone replacing debt with debt. And so we were able to do that, we have found the asset-based lender to get us through the process, but when we make a new investment into an existing company, we have to forget that we already have money in. You want to make sure that you’re putting new money in, and it’s new money after whatever money, not that ideally bad money.
And so we went back in and we were doing some due diligence, and we just found out that the team was – stealing is too strong of a word, but it’s an essence of what they were doing. They were flying their wives on business trips with them and taking the money out of the company. They were paying for Internet access, their vacation homes and paying for automobiles that weren’t board approved. It did the amount to much more than 20 000–30 000 dollars a year, but it was a huge credibility issue for us and we opted not to fund the business anymore for that one reason. If you can’t trust the team you’re with, it’s extremely difficult to give them additional capital.
I personally find fascinating this race to the autonomous driving, the autonomous industry, where a car is communicating with the other cars and as it approaches a stop area, it’s communicating with the cars that are ahead of it, behind it, going side to side, as well as the traffic signals and things like that. I love that large scales-form communication side of things, but we’re not a big enough fund ever to participate in anything like that, making 2–3 million dollar investments, and these companies are raising 500 million dollars at a time. Again, it’s not the right capital structure for us to get involved with. Even if we had a lot of industry expertise, which we don’t, it would still be difficult just because it’s almost a zero-sum game, there’s only going to be a handful of winners out of the dozens and dozens of startups. It’s the same thing with SpaceX and Blue Origin, and some of the other startups around space satellites and taking the next steps to go and explore the solar system. I love all that personally, but it doesn’t mean it’s the right investment for us.
I’d venture to say almost every venture capitalist in the world right now would love to be an expert at drug discovery or they’d love to have the chops to really understand what’s going on in the pandemic world and try to be able to help to extend, to fund the company that can help fix that. But there’s just so few that are qualified to do that. So it’s very interesting to me, but it’s not something we would ever do as a small fund.
It’s both. Near-term it’s a threat just from the perspective it’s a prevailing wind against every portfolio company, and we invest in b2b software companies. We have 7 portfolio companies across Fund II and Fund III. On one end on the spectrum, we have one company that has actually increased the revenue because they do technology services around mobility management. So they have the software, ultimately people, if needed, that manage mobile assets for workforces while everyone’s mobile right now. So their business is exploding. We have companies that are still selling existing technology into the enterprise space.
But as you move down our portfolio, we have 3 medical device companies, and all 3 of them were hammered on the revenue front because elective surgeries are closed, and they are still doing surgeries because their technology is used in non-elective surgeries also, but it is predominantly used in elective surgeries. And that’s a real threat for those businesses. There are businesses that were doing 4 million dollars a month of revenue that are now doing a million a month. That’s a very big difference in revenue. If you have the infrastructure for that business, you can’t make that up overnight. It’s going to take some number of months, maybe even year or a year and a half to get that business back to where it was in February.
That’s the opportunity if your cost infrastructure wasn’t high. We don’t have that as Midwest has predominantly smaller cap investors, we don’t have huge burn rates at our companies. So with just a little bit of capital and a little bit of belt-tightening, and a little bit of restructuring and such, our businesses will make it. There’ll be the ones that are still going to be alive 6 and 12, and 18 months down the road, and there will be less competition at that point because they did survive, and others will not.
It’s also an opportunity for our third fund, our newest fund, because we only have 2 investments out of the portfolio, and we will make 4 or 5 more investments out of that fund. Evaluations clearly have dropped 30–40% and may do so for quite some time. Not only have multiples gone down, but most companies are just going to show that period of time in the financials when their growth stopped or they declined, and so it may take them a year to get back to where they were in February, and that’s a lost year. You’ve burned a lot of capital, your capitalization, the waterfall stack becomes heavier, and the businesses only worth so much. And if you apply a market multiple to the future revenue stream, and that gives you X amount of enterprise valuation, but there’s also debt, that lowers your equity value and you could look at participating preferred stock or stock that has warrants or dividends and things like that. That all is debt.
So it’s an unfortunate opportunity, but it’s an opportunity nonetheless for our third fund because we have the capital and we are going to be making investments over the next two years. It’s not something we did, it’s just we have capital, and lots of companies are going to need it. The balance between supply and demand for capital has completely shifted.
It’s Microsoft, Amazon and Google. They all have trillion-dollar market caps right now, so I think if you’ve invested in them and held on over the years, you would’ve done pretty well. Apple might be in that next, too. Although, if you remember, at one point Microsoft bought 10% of Apple. If they still hold on to that, that would be amazing.
I think there’s so much information out there right now that I would recommend to most startups: you can read almost too much. You can get bogged. If all you did was read about the pandemic every day, but you weren’t a biochemistry major or you had never taken any science classes or whatever, you can become overwhelmed. Candidly, if you get your news source from FOX, and then turn around, get your news source from CNN, or even the BBC, everyone is going to tell a different story. There’s no way to validate what’s real and what’s not real now. I think journalism has hurt everyone in that way.
And what I think of blogs and podcasts, I would just say: try to find peers in your geography or, at a bare minimum, in your industry that you can bounce ideas off, that you can ask questions. Maybe the best thing an entrepreneur can do is surround themselves with a good advisory board. If you can get a good technical advisory board or medical advisory board, or even a customer advisory board, that might go a long way to helping them out.
Most entrepreneurs start reading too many things about venture capital or this, or that. Venture capital is just a corporate finance tool. It’s just the means to finance your business to the next stage or next level. And you don’t have to be an expert in that. If you’re an expert at your company and you’re an expert at providing technology to your customers that they can’t live without, everything else takes care of itself.
I do. I’ve been doing this now for 20 years. I’m 48 years old, I’m learning new things every day, I have a passion for entrepreneurialism and helping them out. I’m getting good returns, it’s a nice side benefit from that because it helps my family and everything. I take more satisfaction in the returns I generate for my investors, but that’s even secondary, it’s the returns generated at those portfolio companies.
To see a team come together and work tirelessly blood, sweat, and tears, and take the business that theoretically, on paper, might have been worth 10 or 20 million dollars when the money came in, but the reality is it wasn’t – that’s just the arbitrary number out there. You’re only worth something when people are willing to spend the money to buy you. And when you can turn that business into a 2 000 million dollar exit or 2 billion-dollar exit. Or even if the capitalization of the business is right, its 20 million dollar exit means you can make a lot of money for your shareholders and your team and have very happy customers, if you have a 20 million dollar exit and you don’t raise that much money. But the more money you raise, the higher the threshold goes.
So for me, I love what I’m doing, I love helping entrepreneurs, I spend a lot of my time trying to guide entrepreneurs to funding sources or people or areas if they can get non-dilutive capital. Because I want to see good companies grow in this region. I think there’s a little bit of an economic disparity between the Coast and the rest of the country, and it’d be nice to see more home-grown entrepreneurialism, especially here in the Midwest. And especially here in Ohio, where my children go to school and where I live.
So that’s my passion and everything else is a side benefit.