Alan's Thinking Cap | Q2 2024 Capital Markets Update

Mario Casabona: Okay, Alan, so first thing is I'm delighted to be here. You've been a long time friend and I appreciate your advice in the past and your friendship, so thank you for having me on.

So my career path has been long pivoting a few times, but I started out as a electronic engineer initially working for a biotech company. I don't know if you knew that, Alan?

Alan Wink: I did not, interesting.

Mario Casabona: But it was a biotech company. And then soon after that, after a couple of years, I went to work for a large defense contractor and then went off with a spinoff company called Kirson Altman and again, in the defense industry. And then a few years after that, a company, Kirson Altman was purchased by Raytheon, and I didn't agree with the Raytheon management philosophy. I was used to the entrepreneurial aspects of that startup.

So I left at that time, Raytheon and I started my own company, Electro Radiation Incorporated, and we initially provided... And we bootstrapped, so it was not with investors. So I had choices, right? You either bootstrapped, you go to the bank and give away or collateralize your house, or you go to angel investors, then you have got to give up some equity and that. But bootstrapped it primarily, we started primarily as a service contractor and then we started developing products for the Department of Defense. We did it both for the Department of Defense and the major contractors, prime contractors.

And then after a good 20 years of being in the business, I said, "Okay, it's time to do something to sell the company." By the way, I was having fun, enjoyed the defense industry. It was very interesting. So it took me actually about four years to develop IP and a product that was needed in the market, defense industry. And I tried to, how can I put it, sell the company to the CTO or I knew the companies, Boeing's of the world, McDonald's and not McDonald Douglas, I should say, the ITTs. Even internationally, we had international work.

But it turns out that my contacts were not the right contacts in the corporate development world. So I hired a investment banker. He ran my butt all over the country. We got three bids. Honeywell was fantastic. We sold it to Honeywell Aerospace in 2004.

Left Honeywell in 2007, took a couple of months vacation. I wanted to clear my head and then I said, "Okay, now what do I do with myself?" And I had choices actually, well, three choices, sit in a rocking chair, okay, which there's no way I could do that. I could start another electronics company in the defense industry, or I can become this what they referred to as angel investor.

So I chose the angel investor route primarily because it would allow me to invest seed startups, learn, I'm learning, okay? And then eventually, hopefully make some money out of it. So that was really my adventure, my experience going from being an engineer to now an angel investor.

I have, or I've invested in about 50 tech startups. I would say 30 of them are probably gone. The other 30, I wouldn't say 30, 30% are gone, 30% are stragglers. And then the other 30%, I really have some high hopes, okay?

And of the 30% leftover, if any one of them, one or two of them now at this point, they'll pay me back for the whole 50 that I've invested in.

Let's see. Does that answer you? I think that answer.

Alan Wink: So your stats are probably no different than the typical VC fund today where it's a game of thirds.

Mario Casabona: Game of thirds. Well, the reality is one out of 10, right? It's a 10% probability that you're going to hit a high return and that one pays back for the other 10, okay? Now we can have an argument, Alan, that says, "Who has a better return? Angel investors or VCs?" Okay.

Well, if you go to the VCs, they say, "Oh no, we have a much better return. The angels are taking all the risk. They give us all the companies that have survived. They de-risk the companies." And in the meanwhile, us angels, we say, "Oh, no, no, we have a higher return. We try to prevent anti-dilution. We try to do all these things that help us to survive in all the different rounds."

So it all depends who you talk to. I like to believe that I get a better return than the VCs.

Alan Wink: So let me ask you a little bit about your investment philosophy and we sort of your investment philosophy dictated by your corporate experience, the industries that you were involved with, the type of electronics company you started. And in addition to your investment philosophy, tell me a little bit about what you need to see in a company or in the team that convinces you, "That this is a company you want to invest in."

Mario Casabona: Yeah. So at the start, my investment philosophy in general has been tech-enabled companies, right? Not restaurants, not consumer focused-companies, retail, okay? So that in general is tech-enabled and primarily technology, not fiber, not biotech or pharma. Not that there's anything wrong with it's just that it requires more capital and the exit horizon is much longer. So just tech-enabled.

Then what do I look for when I invest in a company? It's all about the team, okay? So by the time I see it as an angel investor, there'll probably be a minimum viable product. They may have some traction, but the number one quality that I look at is the team.

So first thing is the team. Does it have working experience with the other team members? Do they have the industry experience? Do they have the knowledge in their market? Okay, do they understand the technology and the market better than I do? If I've got to tell them about the market and I've got to tell them about the technology, then I should be running the company, okay? Are they able to execute on the plan? Now, this is all management related, and is the team dedicated, committed, and enthusiastic, right? Nobody likes boring, although most engineers, I would like to say, including myself, we're boring.

Now, the second major thing I look at is market need and size. If the market is $10 million, that's not exciting. If the market's $100 million, it's not that exciting. Now, if you look at $1 billion, $2 billion, that's exciting because by the time it trickles down to that startup, if you get 100 million, you're very happy, okay? So the second thing I really look for is the market need and size.

The third is, do they have competition? If they are market makers, in other words, there's nobody out there except for them for that technology, they're going to make the market for somebody else to come in and take it over, not the company, the market.

The fourth thing that I look at is do they have an exit plan? Is this a team that wants to exit?

The fifth thing I look at is the technology uniqueness, right? Number five, right? Not number one, number five, okay. And then the question is, do they really have IP? Is it a trade secret? And then that's really the fifth thing I look at, because by the time they get to us, they have the technology already. Well, they don't have the full, but they mostly have the technology.

The last thing I look for is there's always exceptions to what I just said. You get that, right? Right? Because yeah, the management team may not be so hot, but the idea is fantastic, the market need is there. So what do you do? All right, so you have a problem there, you help out. So the team is number one.

Alan Wink: So Mar, let me ask you a question on the team. You had a good staff when you created ERI. Did any of the people in ERI after Honeywell bought them and maybe they left the company, did any of your former team members, start businesses? And did you fund any of them?

Mario Casabona: No.

Alan Wink: Okay. Just out of curiosity.

Mario Casabona: Yeah, no, no. Looking back, Alan, to be honest, yeah, number one, I wish I did start another company. It's fun. I started tech launch. So yeah, maybe I would have, but I did not. I had my fill of the defense industry, by the way I miss the defense industry now, looking back, I still have friends. I'm still on the board of a defense organization. And so no, the answer is no. I did not fund any spinoffs.

By the way, all my employees, I mean, I had a really great team. You talk about team, all my employees when they were sold to Honeywell, they were all hired. Even my temps were hired by Honeywell.

Alan Wink: That's great.

Mario Casabona: Yeah, so proud of that.

Alan Wink: Let's talk a little bit about the current venture capital market. It seemed like there's a return to normalcy in the second quarter, in the pre-seed and seed stages, about $3.3 billion were invested in those stages, which was in line with where the market was pre-pandemic. The one change is that there's been a shift towards larger size transactions. And maybe the reason for the shift is that even VCs are becoming more cautious in their investments.

As an investor, are you becoming more cautious, Mario, because of what's going on in the market? And we said earlier, "Are we looking at investors investing in quality, not quantity, and maybe as a portfolio theory out the window?"

Mario Casabona: So the quick answer to that is quality over quantity. And the portfolio theory, the basket, I call it the basket theory, is out. And the reason is because again, I started back in 2007, yeah, I did some seed funding prior while I had my company, but I really started being an angel investor. And it turns out it is really high risk, okay?

So what I have noticed over the past decade, 10 years, 15 years, is that the VCs are moving more upstream on mitigating the risk. They're moving more upstream. The angels are moving more upstream as well, okay?

So what happens is there's a void very early on, and what's filling that void? The friends and family round has always filled that very, very pre-pre-seed stage. But now what's happening is you got accelerators coming in, right? You got huge accelerators, and they have fantastic funding behind them. And you've got incubators. So that fills that gap where then what the angels would've done normally, typically.

Alan Wink: You froze.

Mario Casabona: Now the accelerators. So now it's the accelerators and incubator.

Alan Wink: Mario?

Mario Casabona: Yes. Did I lose you?

Alan Wink: Astrid, I think he's having a technical problem.

Astrid Garcia: Hi. No.

Mario Casabona: I'm still here.

Astrid Garcia: Mario?

Mario Casabona: Yes, I am still here.

Astrid Garcia: Keep speaking, go ahead and keep speaking. It looks like Alan's having technical issues.

Mario Casabona: Ah.

Alan Wink: Hello.

Mario Casabona: Okay, so Astrid, can you hear me?

Astrid Garcia: Yes, I can hear you.

Alan Wink: Mario, do you hear me?

Astrid Garcia: Yes, Alan, we could hear you.

Mario Casabona: Okay. Should I continue?

Astrid Garcia: Yes, please. Mario, go ahead and continue.

Mario Casabona: Okay, so as I said earlier, and sorry for the interruption. So as I said earlier.

Alan Wink: Mario?

Mario Casabona: Yes? Alan, I'm just going to continue.

So the VCs have gone upstream, angels also, and then what's filling in that void for the pre-pre-seed is the incubators and actually the accelerators.

Alan Wink: Hello?

Mario Casabona: And the accelerators are also providing some of that angel funding.

Alan, you back on? Okay. So.

Alan Wink: Mario, do you want to disconnect and dial back in?

Mario Casabona: So Astrid, is it my issue or Alan's issue?

Astrid Garcia: No, please Mario, please go ahead and continue. It looks like it's Alan's issue. I am trying to reach him right now. So please continue with the presentation.

Mario Casabona: Okay, great. Great, okay. So over the past decade I've seen the trends in the risk reduction. So again, VCs moving upstream angels and avoid filling in by accelerators and incubators.

So what else? For instance, the burden of demonstrating the team performance. Team performance, market need and traction would've usually have fallen in on the series A round, but now it's falling more into the angel round, the burden of demonstrating minimal viable product for instance, market fit team execution would've been filled in by an angel round, but now instead it's being filled by let's say an accelerator.

And by the way, the accelerators provide funding as well. They'll provide the 50, $100,000, they'll provide connections to angels and other funding opportunities. So again, we've all moved upstream.

I think the next question that Al would've asked is, for companies in the pre-seed and seed stage, how much money should they be rising? Raising? I'm sorry. And how should the capital be deployed? And how long should the capital last> and how much equity should they expect to give up? Well, that's interesting. So depending on your industry, geographical location, what I'm about to say is probably going to vary.

So in the pre-seed and seed stage.

Alan, you back on?

Alan Wink: I'm back. You went dark for about five minutes, so I apologize. I don't know if it was my system or yours?

Mario Casabona: I hear it was on your end.

Alan Wink: Oh, okay.

Mario Casabona: I'm the techie. You're the accountant. It's got to be you. So Alan, I think I answered your question and I was really moving on to the next one.

Alan Wink: Okay.

Mario Casabona: Number four.

Alan Wink: Okay.

Mario Casabona: See, that's the difference. Alan, he very organized. I mean, that's an accountant for you, so thank you for that.

Alan Wink: Let's kind of talk about the topic of valuations. Because I think the VC market went through a period the last 18 to 24 months where valuations were trending down. And I think for the first time in a while, valuations across all stages of venture capital are up in the second quarter.

Matter of fact, pre-seed and seed, were probably up five to 10%, which is a pretty nice number. Everyone still talks about the present fundraising market as being challenging. What's causing these increases in valuations, do you think? And are you seeing that as an angel investor?

Mario Casabona: Number one, I get the same feedback, Alan, as you've seen as far as fundraising is a challenge. And frankly, Alan, fundraising has always been a challenge, okay?

Right now, maybe it's a little bit more difficult because of some political aspects, or maybe now the markets, it was up yesterday, the volatility, market volatility. So it becomes a little bit more challenging, but it's always been challenging. There's no such thing as free money, right? Valuations.

So valuations last year were reasonable from an investor point of view. They're becoming less reasonable. And I think the reason is because there is money on the sidelines and it needs to be deployed. On the VC end, there's other reasons, but on the angel, on the seed and pre-seed we're feeling a little bit more, at least I'm feeling a little bit more comfortable about the economy. Maybe because I had a run-up in my investments, but I've got deployed capital.

I want to get involved with the ecosystem, with the startups, with the community. I want to get involved with the advisors on the board of directors. So keeping the money on the sidelines is okay, but it's not exciting. So you look at most angel investors, they're probably people that are financially secure to some extent, although I'm always paranoid, but we're financially secure. So these are discretionary funds. So there's money on the sidelines.

So going back to your valuation question, it's always been that the market sets the valuation. And what I mean by that is I've seen pre-seed, seed stage companies that come in with valuations of $10 million. How did they get to $10 million? Well, they had a friends and family round and promised their family they were going to be worth $10 million. Okay, well, that's going to be difficult because now you're going to have to go back to your friends and family and tell them you're not worth $10 million. And they'll come in and they'll really get to the realization that they're not worth the 10 million, they're going to be worth 3 million.

And then the reaction is going to be, "No, no way. I want to raise 10 million." Our reaction is, "Okay, go ahead. When you raise that round or not raise, when you get your first lead investor, let us know." The reason I'm seeing the company, or I'd be interested is because I like the company. I like the team.

So valuation again, there are metrics, especially for pre-seed and seed stage companies that you can evaluate the company based on IP years. The team, do they have an MVP? I think there's about six or seven items you could use. And frankly, I just forget the name of that valuation methodology. But I look at it and say, "It's whatever the market is." Am I not going to invest in a company because I think it's worth 6 million and they're looking for an 8 million but I like the team, the product, and the co-investors, right?

Alan Wink: So let's talk about a topic that I think is certainly worthy of discussion today, and that's artificial intelligence. And actually for the first six months of this year, in the stages that you typically invest in, Mario,, 50% of the money invested across the country went into AI transactions.

What is your impression about artificial intelligence? Where do you think the opportunities are? Is this going to be a fad or is this real?

Mario Casabona: Well, no, no, we're in it. I think it's going to be part of our lives, everyday lives. We're going to live with it for the next whatever it is, until some other technology comes in. So we're in it.

My concern is there's large companies that I think control the AI industry, if you would. There are the startups that try to create their own AI platforms, that I stay away from. If it's a company that has a lot of data available, then AI is very useful, so I would invest, and I have. I've invested recently in AI enabled companies. If the company says, "I'm a med tech and I use AI," I'm saying, "Okay, what's the AI for? What does it do? How much data do you generate?" If it's a low data volume, I don't know why they need AI.

There's ChatGBT now, which is more focused on language data, where typically in my mind, AI should be used for managing excessive data that could not be managed before.

Alan Wink: And I've read that, I guess there's going to be ChatGBT 5, which is going to just knock the socks off everything that's out there presently.

Mario Casabona: Yeah, yeah. But I am waiting until things settle down a little bit, right?

Alan Wink: Okay.

Mario Casabona: There's a bubble. There's a bubble, so.

Alan Wink:

So let's talk about exits, because everyone in the venture capital space has struggled to find exits for their companies. Let me ask this one preliminary question, which actually came through the chat. As an investor, Mario, how many times do your money do you look for in an investment that you make? What are you hoping to get?

Mario Casabona: Well, as an example, a few years ago, I invested in a company called Ray Sat. In 18 months, I got five times my money. Unusual, unusual, unusual. I knew the founder, I knew the CEO, I knew the company, it was in my sweet spot. But if we can get two to three times our money in four to five years and go along for the ride, I think that's a good return.

Alan Wink: Let me ask just one other follow-up question. In your years of investing, and you don't have to name the company, what's been the biggest multiple of capital invested that you've gotten back?

Mario Casabona: That was it. That was it. Five times my money. Yeah, five times my money. Well, if I go back to my company, that was my real big exit, ERI. Well, I started out with vacation money. Okay, the rest is lucky, fortunate.

Alan Wink: And I guess when we look about exits, how do you expect liquidity to occur in the companies you invest in? I mean, if the end result of an IPO is years away from when you invested, where do you expect your exit and return to come from?

Mario Casabona: From a strategic partner that's primarily, strategic partner. IPOs, they're not realistic, okay? Yes, of course, but they're not realistic. So it's really more strategic partners, private equity in some cases.

But it's really typically the companies. The return that I've seen, I've gotten, is you get a startup that has a 40, $50 million exit by a strategic acquirer and as long as your dilution is not too much, that's a pretty good return.

So what I'm looking at is an angel investor that has an exit on a company of 50 to $100 million. That is a home run.

Alan Wink: And as an investor, I guess the three types of securities you would typically invest in would be a convertible note, a safe note, or a price round. Do you have preferences, how your money goes in?

Mario Casabona: Sure. So the first preference is a priced round. Second preference is a convertible note. Third preference is a safe, okay?

But what's happening recently in seed and pre-seed is they're going for safes. I've seen more safe rounds than anything else unless you're what I call a super angel that can invest a million, 2 million in a seed stage, now you're dictating, okay? Typically it's either a safe or convertible note, and then perhaps in the later stage you'll get a priced round.

But typically priced rounds are a late angel round or a Series A and B. But I'm seeing a lot [inaudible 00:31:34].

Alan Wink: When you do invest in a priced round, what is your expectation of the percentage of equity that you're going to receive at this early stage?

Mario Casabona: Okay, so whether it's a safe or whether it's a safe or convertible note, I look at the cap table, fully diluted cap table.

But to answer your question, a company typically in an equity round should expect to give about 15 to 20%, that's typical. What should they be raising during that round? Well, probably 250 to about $1 million. Now, I've seen startups come in and say, "I want to raise $1 million," but they're really not there and then valuations low. They don't expect that kind of loss.

So we'll say, "Look, do it in stages. Do milestones raise 500,000 at this point, achieve your milestones. And then when you achieve those milestones, now you can go in for higher valuation." Okay? And there's less dilution that comes with that. So typically 250 to about $1 million, 15 to 20% of equity they should think of giving away.

Alan Wink: So we're a little bit over time, and I'll take responsibility of that because of the technical difficulty we had. But Mario, let me ask you one final question. It's always my favorite question, and it's interesting to hear investors answers to this question. You've been doing this for a long time after you sold your business, what's the one deal that got away from you or the one opportunity presented to you that you said, "No," to, that you wish you had that one back?

Mario Casabona: So I knew you were going to ask that question, right? And Alan, I've given this thought, I think gave you my reaction, it's going to be the same reaction. So I sold my company in 2004, stayed with Honeywell until 2007.

So 2004, I'm feeling really great as far as I got cash in the bank, but still I'm not familiar with, I'm not an experienced angel investor. I was meeting with someone, another angel investor. I get this call, I'm in the parking lot at a restaurant. I get this call and this individual is selling me on an electric car. This is back in 2004, maybe 2004. I just sold my company. He's telling me about an electric car that the industry and all the climate issues and all that. And I'm thinking to myself, "Come on, come on. This is no way I'm driving a gas car. I'm not worried about the climate right now. And electric cars. You realize how many stations you're going to have to have charging all that. No, go away." I didn't say, "Go away." I said, "Thank you, but no thank you." You know what that company was? Tesla.

Alan Wink: I assume it was Tesla.

Mario Casabona: It was Tesla. Tesla. So you never know. You never know. And even now, with the past several years, I've turned down investments in companies that have become unicorns or have had really great exits. But you don't know, you really don't know.

Alan Wink: It's a risky game. I don't think anyone could take that away from you.

Mario, I just want to thank you again. You did a great job. I do apologize for the technical difficult that we had, but I think we worked our way through it.

Astrid, I want to hand it back to you.

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