Why did we make the investments we did? Why didn’t we make the investments we didn’t?
We look at 17 potential investments for each one we make. We do most of our own due diligence, and believe that phone calls, in-person interviews, and site visits tell a whole lot more than business plans and PowerPoint presentations, although both are necessary. Overall, we look at the following investment criteria:
It’s a truism, but this is simply the most important criterion. We look for entrepreneurs and teams with a history of leadership and performance — either in the company's specific industry or in prior entrepreneurial ventures. We also look at the team's passion for and commitment to the new business idea, and its ability to inspire confidence among future stakeholders, including employees, potential customers, and investors. As we will be working together as partners, the team's credibility is essential. Because we are active investors, the team must be open to and comfortable with receiving input provided by an angel investor.
We look for thought out and reasonable revenue plans. We have yet to see a company where the financial plan achieves its revenue projections, so we evaluate plans assuming a revenue shortfall. Therefore, gross margins and cash positions are critical variables to manage.
We invest in solutions that address major problems in a market. The company must demonstrate a strategy to claim a reasonable share of this market.
We look for deals with pre-money valuations below $5 million. We prefer pre-money ranges from $1.5 to $3 million. This gives the investor the potential for a reasonable return at a reasonable exit valuation. It also helps protect against future round dilution. The entrepreneur comes out ahead as well, as it's in his or her best interest to have the valuations of subsequent rounds increase and avoid anti-dilution ratchet-downs.
Use of Investment Money
Investments must be used to achieve the company's milestones that increase the company's value. We’re not keen on funding the entrepreneur’s salary before revenue comes in.
We look for companies that can grow quickly and manage the scale necessary to succeed. The company must demonstrate a plan to generate significant profits beyond the initial product idea.
The company must have some proprietary strengths that distinguish it from potential competitors or provide barriers to entry that prevent other companies from capturing customers with a similar offering. It’s nice when there's intellectual property protection, exclusive licenses, exclusive marketing and distribution relationships, strong brands, scarce human resources (i.e., knowledge and skills), or access to scarce raw materials.
We seek 5X5 returns — that is, returns of at least five times our initial investment, within five years. This level of return on investment is essential due to the high risk and likelihood of failure among early stage ventures. Thus, a clearly articulated exit strategy — how we will obtain such returns — is essential.
We don’t invest in whiners, complainers or those who expect the world to worship at their feet. We don’t invest in anyone without a sense of humor about life and themselves. Or, to be succinct, no quitters, no liars, no jerks.
The Why? of Crosswind's Investments
We invested in Hadapt because we think big data is the next opportunity in IT, because Hadapt has the right approach to big data, and because of Justin Borgman, the CEO. Justin left Yale School of Management in his second year to devote his full-time attention to Hadapt — that's a commitment. He personally dealt with the bureaucratic hassles of getting the technology out of Yale — no mean feat — and made the company happen. Sadly, the other angel investors in Hapdapt rolled over when we got an investment proposal from Bessemer and Norwest; we didn’t need them at the time as we had plenty of money in the bank and the software was ready for commercial introduction. Nevertheless, the other angels agreed to a 50% haircut to fund an option pool to take those VC investments. We (Crosswind Partners) were not happy and objected strongly, but stayed on the same terms as Bessemer and Norwest, despite the haircut, as we truly believe Hadapt is the one to make big data a success. Well, that decision turned out to be stupid. As predicted, the haircut with the option pool required by the VCs meant that we only received a slight premium over our investment on the recent sale to Terradata this summer of 2014. Too bad; this could have been a big one.
Anyone like going to emergency rooms? Didn’t think so. Personal experience said there had to be a better way. We sat in the Doctors Express office in Springfield to watch how they handled clients (patients). Nicely. We like that they can do X-rays and blood work. We like that they actually care about the patients. Fees are one-fifth of emergency rooms, yet service is better and margins are higher. The government is working hard to screw up healthcare, but we like that we are doing our part to make at least one part of it better.
One of our other portfolio companies uses Microsoft Sharepoint, which is a truly awful program. The problem is there is no better substitute and the majority of Fortune 500 companies use it. Vizit makes Sharepoint better — not great; it's still awful, but less awful. They have a great team, revenue, and the right approach. We like companies that improve existing products with a large market share.
Ever try to figure out your health insurance statements? Think about doing that if you are self-insured and have a lot of employees. MicroVu analyzes healthcare bills for overpayments and improper charges. They automate the process, reduce costs and deliver real dollar savings to their customers. They've helped companies and entities in 50 states and always find at least some errors.
This is definitely an investment in the management team. We have no game expertise and don’t understand why anyone would spend two minutes playing video games. Aaron and Paul are extraordinary and have built a business that has a very solid, profitable base-revenue stream, while shooting for the moon on some new games. We like it because even if the new games don’t run circles around Zynga, we get our money back on the base business. VCs usually want a company to focus on the stretch business but VCs are diversified across their portfolio and don’t really care if one of the companies is a loser. We like companies that almost guarantee at least a return of our investment. So there.
IT decision Management was an investment in a management team (brilliant and visionary — not us, them) and certain team members who would never give up if a customer was not satisfied. The company had to reinvent itself a number of times to find a profitable niche in our tough economy (thanks Ben Bernanke and Barney Frank). By spending a lot of effort on systematic approaches to network management, the company became the technology-leading provider of wholesale network support services. ITdM was acquired by System Maintenance Services, a Thomas H. Lee Partners portfolio company, in March 2012. Successful exits are nice because they give us an excuse to buy a $15.00 bottle of wine instead of a $6.99 one.
Proof that timing is, if not everything, a good bit of success. This company had a deal with a major electronics retailer to offer wireless home health monitoring systems that would be sold at retail and self-install. Bad timing for a launch — June 2008. The company’s mission has been repurposed to look at proof-of-concept energy storage devices, as most “green” energy production systems (wind, solar) don’t provide consistent energy output. We’ll see if that works out.