From NYPD To VC: The Story Of A Successful Angel Investor With Sunny Singh, Part 1

 

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Welcome to another episode of The 7 in 7 Show with Zack Ellison, which features full length interviews with the world’s leading investors in innovation.

The guest this week is Digvijay “Sunny” Singh, an entrepreneur, investor, academic and technologist. After serving in the New York Police Department, Sunny earned two Master’s degrees and Ph.D. in Electrical Engineering and Computer Science from UCLA. He then founded, operated and successfully exited two startups and later became a very active startup and real-estate investor.

Sunny was past president of Tech Coast Angels, the largest angel investing network in the United States that has been running for nearly 25 years. He is currently Managing Partner at Alleyway Capital, which acquires e-commerce software startups.

In this episode, Zack Ellison and Sunny Singh discuss:

1. Evolving with the Times: Navigating the Changing VC Landscape
2. Beyond Tech Hubs: The Power of Geographical Diversity
3. Uncovering VC Gaps: Underserved Sectors and Founders
4. Down Rounds Dissected: Signals to Investors
5. Strategic Venture Debt: A Shield Against Down Rounds
6. Protracted Funding Challenges: Surviving the Startup Journey
7. Investor’s Toolkit: The Art of Diversified Innovation Investing

From NYPD To VC: The Story Of A Successful Angel Investor With Sunny Singh, Part 1

Welcome to the 7in7 Show with Zack Ellison. I have with me Sunny Singh, my longtime friend and former president of Tech Coast Angels and now a Managing Partner at Alleyway Capital. Sunny, thanks for joining.

My pleasure, Zack. It’s always good to be here with a friend.

Career Journey

You have an amazing story that I’m keen to help you tell. Let’s start from the beginning. Your background before you even got into business is fascinating. Talk to us about that.

I have a bit of an eclectic background, a little unconventional. I was with the NYPD when I was a youngster right out of high school. That changed my perspective and outlook on life about helping people and how things work. When I was at the NYPD, I saw some not-so-great things and I saw some good things. That changed my perspective. It made me motivated to go to school. My parents always used to say, “Just go to college. Why do you want to do this?” I tried it. I did not like it as much. I then started applying to college. My dad was always an engineer, so I started thinking of becoming an engineer. I applied to a bunch of places, got accepted at UCLA, and moved to Los Angeles, and I’ve stayed here since then. It’s been quite a journey.

What got you interested in the NYPD when you were in high school?

 

 

It was all the racial tension and the violence that I saw growing up. For those of you who don’t know, I’m Indian. My background is Indian. We have some racial tensions now in India, so I bring it up. It’s been something that I’ve noticed in New York City as well. I had a close buddy who was violently attacked because he was of a certain race, and then a certain gang wanted to recruit him. That got me very motivated to try to help people. I was naive at the time. I didn’t understand that I could have a much larger impact on the business side of things and with more financial control and power than I could that just being in the streets. That’s what motivated me but then it was a learning process. I graduated from there with great experience, but I think college was the right step after.

You were a quant, if I’m not mistaken.

I was, yeah.

You told me offline years ago about how you transitioned from the NYPD to becoming a quant, and then you got into one of the best schools in the world. Tell us about that.

What happened was when I was a police officer, I started realizing that I had a talent for numbers. It’s just doing these desk jobs, getting relegated to desk jobs every once in a while for the way I used to report stuff and talk about it. They would delegate me to desk jobs often. I wouldn’t follow instructions very well. It’s my personality growing up. I realized that I was good at case numbers, putting pieces together, and doing investigations. That’s how I started realizing I had a talent. I started exploring that option more. Immediately, my dad was like, “You’re good at this. You have to become an engineer.” That’s how I went to work in computer science and electrical engineering. I started applying to a lot of schools.

I was surprised by how much the university has appreciated my background and talents. I thought people would look down on what I’ve done. I had that misconception, but it seems like having an eclectic background becomes an advantage. The diversity and everything else that comes from it becomes an advantage. I know people think that if you’re diverse or you have an eclectic background, it’s probably harder to fit a mold and get into a good school. That was not the case. That was not my experience. I felt like coming from a different ecosystem with different experiences strengthened the outcomes than just following that vanilla cookie-cutter sort of background.

You have two Master’s degrees and a PhD. Is that correct?

Yes, that is correct. I have a Master’s in IT and I have a Master’s in Electrical Engineering. I have a PhD in Electrical Engineering and Computer Science, which is a mix because I was building systems when I was in my PhD.

Becoming An Entrepreneur

You’ve also founded a number of successful companies and had exits. Start from the beginning in terms of how you became an entrepreneur.

When I was in graduate school here at UCLA, my professor, who was my advisor, was very entrepreneurial. That’s how the chips fell. It was lucky for me. A lot of professors can be extremely academic. He was academic, but he was also very entrepreneurial. He’d launched a bunch of companies before.

We came across this problem in the medical area, where we realized that doctors are able to train themselves and tell that a patient is going to get ill or have a pathology in the future. I was amazed by this because they could listen to the sounds that were coming out of a patient’s bowel or look at the conditions, the way they were walking, the gait that they had, or the way they were speaking. They could tell this person is going to have a stroke, going to have stomach issues, or going to have this. They had this sense that they had been trained over the years.

The first thing that came to my mind was whether we could use AI or some sort of training method to have a machine do exactly what the doctor’s doing. If it’s programmatic and trainable, can a machine do the same thing? The question in my head was, “Why not?” The doctors were like, “That’s just how we’ve learned it. We don’t understand all this technology stuff, but if you can build something like this, great.”

My professor is very encouraging. He is like, “You shouldn’t look at this as an academic exercise. Try to turn this into a product so that you can be part of a company that has this as its primary product.” That set a light bulb off in my head. I was like, “This might be a startup. This could be a startup.” I started looking at it that way. I partnered with the doctor who told me about this sort of methodology that they used, and then my professor got involved. We built a device that you could put on your stomach and your abdomen, listen to the ambient sounds coming from the stomach, and tell if there was a pathology present in your gastrointestinal tract.

We did some clinical trials. We trained the device. We went through the FDA approval process, and the device did very well. That was the startup and it had a great exit. That was my first taste of entrepreneurship as a tech leader, but the thing was that I got so much business experience watching the other guys execute and it made me hungry for more.

As soon as I exited that, I sat on the sidelines for a year or so, then I started another company. This one was solo, by myself. It was an IT cybersecurity company. This was not venture-backed. The previous company was venture-backed. We raised some Angel funding and some venture funding. This company was not venture-backed. It was bootstrapped. I wanted to do the whole bootstrap thing because I know there are different experiences. We started doing IT work for some Department of Defense contractors. The company started to grow and it was acquired by a PE firm. That was my second exit and then that led into everything else.

You’ve had two exits. What do you focus on now at Alleyway?

At Alleyway, we acquire software companies mostly in the eCommerce space. My buddy, Mahesh Balakrishnan, who I met through investing, and you were part of that group as well. We can talk about it right after. He and I look at software companies that don’t have an IPO or private equity exit. They’re too small but we think that they have potential for growth. They don’t have the ability to raise VC or venture debt. We believe that they still deserve a good exit for the founders, but we have the ability to take those smaller companies and grow them. That’s our sweet spot. Anywhere from about $1 million to about $2 million or $3 million in annual recurring revenue, software as a service or SaaS mostly in the eCommerce space. That’s what we’re acquiring.

It’s good because I’ve seen a lot of companies where I’ve invested early stage that go to zero. They have value. They’re not able to raise their Series A or B. They have value in what they’ve created. They just never got the traction and don’t have enough time to ride the wave of the market. It could be a number of reasons, micro and macro. Those companies still have value. If we’re able to acquire them, it’s a great exit for them. At least they didn’t go to zero. It’s good for us because we can still put the resources into continuing patiently growing the company.

A lot of companies have value in what they have created. They just never got the traction due to lack of time or their failure to ride the wave of the market. Share on X

I remember when you were contemplating starting this and we were talking about it and you were telling me about how there’s this gap in the market that you had identified. I thought your thesis was spot on then and is still spot on now. I know that there’s an opportunity there. There’s a problem that’s not being solved by others, but you and Mahesh are solving it.

It’s probably even more prominent now, given the macro environment in the economy and even more companies not being able to raise equity rounds. Many of them don’t even understand the other options that exist. They think, “Either I raise equity or die.” For those companies, an exit like ours is great. Raising venture debt is great and we can talk about that more. There are multiple options, but these companies are not aware that that’s a problem. They say, “We’re out of cash. We can’t raise the next equity round. We have a top line, we have all of these things going, but we’re just going to kill everything.”

Let’s take a half step back. Folks don’t know your background in Angel investing. You went from PhD in Electrical Engineering to becoming a two-time founder with successful exits. You eventually got into Angel investing and became the president of Tech Coast Angels here in LA, which is the largest Angel investing group in the country. That’s where you and I used to do a lot of stuff together. You were a membership chair there. You were vice president and then you eventually became the youngest president ever in the history of Tech Coast Angels. Talk about how you got involved with TCA, how you’ve helped build that organization, and what you’ve learned as an Angel investor.

I started with TCA in 2016 or 2017, if memory serves. TCA, for those who don’t know, is Tech Coast Angels. It’s one of the largest groups of Angel investors. Angel investors are typically high-net-worth individuals who come together to invest in companies in certain sectors, early stage, typically just starting to gain traction or revenue, sometimes even pre-revenue. This is where most VCs would not invest in a company.

 

The Angel investing ecosystem comes in and we put money into companies we believe in. Those companies then go on to raise money for more institutionalized investors, which could be Angels, family offices, etc. The ecosystem has changed and it continues to. Sometimes, venture capitalists will come downstream and sometimes, when the economy is not so great, they’ll move back upstream and say, “We don’t want to be part of the early stage anymore.”

That changes. Angel investors typically stay early stage because that’s where the larger turns are. Tech Coast Angels is a group of Angel investors with multiple chapters in Los Angeles and Orange County. We even have Pasadena Angels as part of our network now. There are a number of different groups. All these groups are under the TCA, Tech Coast Angels, umbrella.

I would guess that we have over 500 Angel investors that are part of this network and it’s growing. It’s the largest in the nation, and I would think the whole world, but I don’t have all that data. It is the largest in the United States. We do about 50 to 60 deals a year. Being part of the leadership at the Los Angeles chapter was a great experience for me because when I joined, I was very young. I was in my early 30s and I felt very inexperienced. I had an exit. I had already had an exit by then when I joined, but I still felt very inexperienced.

As an entrepreneur, you just don’t get the discipline and the mechanics of the investing side because you’re sitting across the table. You don’t understand the decision-making and the mindset that the investors have. There was this big gap in my knowledge. The only reason the group accepted me, even though I was fairly inexperienced and young, was that I had entrepreneurial experience. I could contribute technically to what they were doing.

If there was an engineering company or a computer science company that came in, I had lots of technical expertise. I started learning the ropes and became membership chair, vice president, and then president of the Los Angeles chapter. That was a phenomenal experience. I will be chairman of the board of the whole entity. At least that’s what’s expected unless something goes horribly wrong.

I don’t think it will. I think you’ll they’ll do a great job as chair. When I say you guys, I mean we because I’m also a part of Tech Coast Angels. Tech Coast Angels is now looking to expand more across the country. Talk a little bit about the growth plans.

A few different growth plans. Tech Coast Angels historically have been on the tech coast, which is the coast of California. Now we’re trying to move over because I feel like the rigor and discipline of Angel investors coming together and investing is very good for any high net-worth individual or family office. Typically, they don’t have the expertise or exposure that venture capital firms have.

We joined forces and I felt that there was a gap mostly in Central parts of America, some in the Southeast as well. We’re thinking Florida could be a great option. Texas could be another great option. Colorado is another place when considering expansion. By expansion, we don’t need to go and start another TCA chapter. It could be joining forces with a group that already exists and could benefit from some of the expertise.

TCA, as a group, has been around since ‘99 or ‘98. It’s one of the earliest Angel groups to exist. Given how California has rapidly expanded in the venture ecosystem, we have quite a few large exits and a lot of experience with the members. They’re fledgling Angel groups that have barely gone through one startup life cycle and don’t have any major exits. We already have half a dozen big exits and some of those are $10 billion-plus exits.

That’s the kind of experience we can bring. There can be some real positives by bringing innovation to these underserved ecosystems and bringing all that investor expertise that a group like TCA brings. These underserved groups can bring out more innovative companies, and we can bring the experience to help them invest better.

Are there regions of the US that you think have a lot of potential going forward? You mentioned the Midwest, Florida, and Texas. Are those the sweet spots?

Those are the sweet spots. I feel like a lot is going on in Austin already. It’s a saturated ecosystem, but other parts of Texas are underserved and starved. At the same time, I feel Colorado and Florida are great. Iit’s because the diverse geographical climate and the population are different in different areas. They think differently. They have different challenges and problems, and they can incubate companies and look at entrepreneurship in a slightly different way than people in California look at. That’s something that you can’t replicate.

Someone growing up in Los Angeles doesn’t think the same way as someone growing up in Dallas. They’re different people. They have different values and mindsets, and they look at problems differently. I believe that sort of diversity leads to good companies that serve different segments of the market. It’s important to have that.

Agricultural Produce

We’ve talked about some of the investments you’ve made in diverse geographical areas like Bakersfield, California on the real estate side, and you’ve done quite well with that. You mentioned how there are a lot of interesting Ag Tech startups coming out of places like Bakersfield. In Bakersfield, you’ll know the market better than I do, but if I’m not mistaken, it’s the fruit basket of the US. I think half of the agricultural produce comes out of that region in the US, if I’m not mistaken.

That is correct. California produces the majority of the produce for the United States. Off that, the overwhelming majority of California’s produce comes from Bakersfield, the Kern Valley. Kern County is a county by itself, North of Los Angeles. Bakersfield is the major city in Kern County. The Kern Valley produces so much agricultural produce that it’s mind-boggling.

It’s crazy because it’s only two hours from LA and I didn’t know this until I traveled there on a whim. I went up there. You cross over into the valley and it’s completely different. It’s a different environment, a different place, lots of farmers, lots of oil, and a different ecosystem. Bakersfield has typically been underserved because people in San Diego, Los Angeles, Sacramento, or San Francisco look down on Bakersfield as one of those cities where it’s a Baptist community, etc.

 

When you go there, you realize that a lot is going on here. That focus on only specific areas by venture capitalists or other investors is doing an injustice to problems that need to be solved in these underserved areas. That’s when we started seeing that some great companies are coming out of Bakersfield.

One of the companies that came out was using millet, like the grain. They were using that grain to make vegan ranch sauce, which tasted amazing. Now they’re on the shelves in Whole Foods. They’re doing a number of different things. Vegan ranch sauce is not from a substitute or filler but from actual whole grain, and you can’t tell the difference in a taste test. I couldn’t, and I love ranch. How would an innovation like that happen in Los Angeles? It can’t. We don’t have millet here. We don’t have farms here. We don’t have any of that. There are certain things about specific ecosystems that lead to solutions that are impossible in some of the larger cities.

That’s part of our thesis at ARI as well. There are a lot of underserved areas geographically, but there are also stages of development that are a bit underserved, sectors that are underserved, and also groups of founders that are underserved. I always think of it as the gaps within the gap in the sense that venture debt is already a gap in the market in the sense that there are not a lot of folks that provide venture debt. There’s a lot more demand for this capital than there is supply.

Within venture debt, there are huge opportunities because there are founder groups, which are women, minorities, and veterans that are completely underserved by the current ecosystem. You have some tremendous talent that doesn’t have the same access to capital as they deserve. There are opportunities there, and then there are sectors that are very underserved.

As you know, money in VC travels to whatever is hot at the moment. Crypto is hot, it goes there. FinTech is hot, it goes there. Now, it’s all going to AI. They follow the leader. They’re throwing a lot of darts against the wall. It’s easy to raise capital in hot sectors. Ultimately, most investors wind up losing a lot of money in situations like that. That’s the way it is.

What I like to do is look at sectors that are not necessarily hot. You go find the leaders in sectors that are a little bit less sexy and don’t have that like pizazz at the moment but have good businesses and nobody is calling them. I love those types of companies. Also, to your point, find companies in geographies that are producing something unique based on that geography. People in Bakersfield are going to have a huge edge in Ag Tech, just like a lot of folks in Texas that I know as well who are doing stuff in cattle, for instance.

There’s no way to do cow research sitting in San Francisco. It’s not going to happen.

Macroeconomic Environment

We’re aligned in terms of seeing these gaps within the gap. I want to take a step back and talk about big-picture trends in VC and where we’re at now. From your perspective, what you’re seeing, which is quite a lot, you see from the very early Angel stage all the way to the later stage but are predominantly focused on what you’re doing at Alleyway and the Angel stage. What are the themes that you’re seeing and how is that affecting VCs and founders?

I’ve seen two major trends. One, the macroeconomic environment has people scared in general. That has a trickle-down effect on every single industry. VCs don’t tend to be as risk-averse as other asset classes. They’re risk takers, but even they can sometimes hesitate when the macroeconomic environment is not that great. It does have that effect. There’s a bit of a numbing effect on the VCs where they’re like, “I’m not so interested anymore. I just want to take it easy.”

VCs do not tend to be as risk-averse as other asset classes. They are risk-takers, but they sometimes hesitate when the macroeconomic environment is not there. Share on X

That’s an overall effect I’m seeing everywhere. Everyone is slowing down the velocity of their due diligence, taking more time dotting the I’s and crossing the T’s. Rounds are taking longer to close. That’s the macroeconomic effect. As far as specific trends in the VC industry, what I’m seeing is that initially, because a lot of these IPOs had closed off, and quite a few of these exit pathways were gone for later-stage companies, their valuations started to drop almost instantly.

The early stage is very resilient. It takes time for it to drop all the way down to the early stage. Early-stage valuations continued to be robust and later-stage valuations started to drop. You can understand that the later stages are dropping down. The early stage is the same. There’s this crunch point here where in certain rounds, especially B, C, and D, we’re seeing weird behavior going. You have no way to go up here, but the valuations here are staying steady. Founders would hit this wall at series B, C, or D where they raise the capital and then get stuck. They had nowhere to go.

Now things have started to align back to a bit of a normal curve again. I’m seeing early-stage valuations also starting to drop. There’s again this gap, but overall, this whole thing has come down. Everything has come down. Valuations in general have dropped across the board. There’s a bit of crunch there for a little bit, maybe 6 to 9 months.

Now early-stage valuations are also trending down. That’s the major issue. They’re more investor-friendly terms coming in. There’s more downside risk protection for investors. Liquidation preferences are back. There’s a lot of that. Overall change in more investor-friendly terms, valuation is trending down, and then the overall numbing effect of the macroeconomic environment where people don’t want to make moves very quickly.

I’ve seen all of that as well. It seems like everybody is a lot slower to do anything. I don’t think that’s even VC or startup land. I think it’s everywhere. I don’t know if that’s a post-COVID trend or what, but people are not on the ball anymore. They’re slow to do anything. No execution.

It’s amazing that you mentioned COVID because that might have a part to play. I don’t know what it is, but deal makers are lazier.

It’s not even deal makers. I think it’s everybody. The quality of execution across the board is unbelievable to me. I complain about it every day. My biggest gripe in life right now is how poorly people execute. On the other hand, it presents a huge opportunity. People who can execute now are absolute all-stars. Showing up to work and blocking and tackling puts you in the Pro Bowl.

Most people that show up right now are already going to win.

Down Rounds

You’re seeing valuations decrease. A lot of startups have been going under recently because they can’t get that next round done, or they can’t get it done on terms that they want. Talk a little bit about what down rounds are and how down rounds factor into the funding environment.

For those who don’t know the startup ecosystem, we have a number of stages. This isn’t formal, but it’s something that came out of VC jargon over the years. A company would start and they get funded by friends and family, then they’d raise the next round, which would typically be called seed, where you’re seeding the company. Now, there’s another round in between called pre-seed. You have friends and family, you have pre-seed, and then you have the seed round. Typically, around seed is when you start looking to get your product out and get some traction. You raise a series A once you have some traction. By traction, I mean revenue, users, and anything that shows that the market appreciates your product and wants to use it.

There’s one big exception. In certain industries like biotech, traction means that your science and your research are coming to a point where it’s provable and safe, etc. You don’t have end users yet. Maybe you’re creating a drug and you’re doing animal tests and that proves to be safe and effective. That’s traction. As traction goes up, you raise your series A, then you get more traction, you raise your series B, you raise your series D, E, F, whatever. Eventually, you either get acquired or you do an IPO, or you become such a massive company that you start becoming the big dog in the space and become operationally positive. You dominate the market. That’s what typically happens.

What a down round means is that between two different rounds, say series A and B, your valuation drops instead of going up. Typically, in this cycle, your company’s value should continue increasing because you’re either improving your traction or your innovation is getting better. You’re getting a larger chunk of the market. Your value should go up. The down round is when you’re valued at $10 million for series A and then you’re valued at $8 million for series B. That’s terrible. That’s unfortunate. I’ll tell you why it’s unfortunate.

It tells the investors in the next stage that instead of your company going up like this and then exiting, your company is going to go up, and now it’s starting to peak and falling down. That’s the peak for your company. That’s a signal to the other investors that you’ve peaked. Their initial estimations were wrong. You’re not going to be the billion-dollar company that you are. At this point, it’s just people on a sinking ship trying to salvage whatever they can. That signal is unfortunate because now, other venture capitalists don’t want to invest. It’s a vicious cycle that you’ve put yourself in. That’s why you must avoid down rounds whenever you can. It’s a very bad market signal. It’s something that’s looked at very unkindly in the VC world.

It’s a bit unfortunate because sometimes it’s not the company’s fault and they’re doing quite well still. They were overvalued initially. I think the last couple of years is a perfect case study of what can happen when you have a bubble. 2021 and 2022 were irrationally exuberant years, particularly 2021 when companies were getting funded at irrational valuations. There was an over-exuberance everywhere. People were doing a lot of dumb stuff with their money. Look no further than the cryptocurrency market and FTX, which I have always pointed out. I thought that was completely insane from the start. I still think whatever is left is insane. Eventually, it’ll all go to zero. We’ll see.

Long story short, there are a lot of people who had good companies that they built that they funded at insane valuations. Now the problem is as they go and do their next round, which typically comes three years later than the previous round, in most cases, anywhere from 2 to 4 years is when folks are doing their next round. Anybody who did their round in 2021 is now coming back to the market because they’ve burned through a lot of that cash.

If you want your business to grow in 2024 or 2025, you need to look at all available alternatives. Share on X

Venture Debt

Most VCs look at their companies and say, “You’re probably worth 20% to 30% of what you were marked at two years ago.” Not only are there negative optics around that, but financially, it means that the founders are going to have to sell a lot more equity to raise that cash also. They not only lose momentum and have this huge negative signal with new investors, but their own economics get crushed and their existing investors also get crushed so nobody is happy. This is a nice segue into why a lot of folks are looking at other alternative funding options, namely venture debt. We’ve talked for years about venture debt offline, but for folks who don’t know, how do you think about venture debt from a founder’s perspective and how it complements equity raises?

Two things. Venture debt, by definition, is debt. For people who are unaware, the capital stack of a company essentially says how you’ve raised your money. To put it in simple terms, how you raise your money. You could issue new shares. You could give away pieces of the company for money and that’s called an equity raise. You put a value on every share. Essentially, when you raise with equity, you have to put a valuation on your company. You want to avoid valuing your company in a bad environment. We discussed why a down round is a very bad idea. In an environment like this where your company might have been overvalued, you go and try to do an equity raise. You have to put a value on the shares that you’re issuing to the new investor and then you end up in a down round.

One of the alternatives and one of the best alternatives is to use venture debt. Venture debt is raising money through a debt instrument without having to value your company. You’re going to raise debt based on the other optics of your business. It doesn’t have to be the value of the shares itself, but the type of cashflow you have, the pipeline that you have, the business potential, which might already be great, but because you were overvalued before in terms of equity, you’re being penalized now even though your business might be doing well. You want to avoid that by going towards this debt instrument, where you raise money against the other business metrics, not your share price.

 

It helps founders avoid down rounds, which is huge, which is why we’ve seen massive demand. Talk a little bit about how it fits into the capital structure of the company in terms of being a much less diluted option and cheaper option than equity.

Zack brought up a term, dilution. Typically, as you issue more shares, you’re giving a larger percentage of the company away to investors. Your own equity stake as a founder is getting diluted. You’ll have a smaller piece of the company left for yourself. When you exit, the idea is that you can make a decent amount of money based on the sale of your shares at that exit.

If you give away all your shares along the way and you’re left with a pittance, you don’t make anything. As a founder, that can be a disappointing result. You have to be very careful and very strategic in how you raise capital. If you raise capital only by issuing shares, you might end up in a situation where you have nothing left.

That’s another advantage of venture debt. The money is lent to you. You borrow that money not by selling shares, but based on the other business metrics that your company has. That helps because then you’re not going to get diluted. You can probably save enough equity so that when you exit, you’re happy with the result.

You explained it well. That’s why we get a lot of demand from founders because they want to keep the companies they built. ARI’s tagline is, “You built it, ARI helps you keep it.” The whole concept there is if you wind up selling the majority of your shares, you might build a very valuable company, but now you have such a small stake in it that. It isn’t the outcome that you thought you would have.

That’s a reason that I think venture debt is going to continue to be prominent and grow as a percentage of the total funding pie. As more founders learn about their funding options, they realize that once they have a company that’s got revenue, has good traction, and has the ability to support interest payments, then 10 times out of 10, they should have debt in their capital structure because it’s a lot cheaper than equity.

Equity Capital

The all-in cost of financing on debt is typically 1/3 to 50% of what equity would cost. You also maintain your equity stake so that when you do exit, you have a much bigger piece of the pie at the end. That’s why we continue to see a lot of founders looking into venture debt as a funding option. We’ve also seen a lot of folks doing convertible notes. It’s equity. Technically, it’s a dead instrument, but it’s a hybrid. There are a lot of folks doing those, but you can only bridge to the future for so long until you have to go out and do a big traditional equity raise to get you to the finish line. I think we’re going to see a lot more of that in 2024. What’s your thought on timing in terms of when the market is going to start to loosen up and we’re going to see more equity capital start to flow again?

This is just the start of all the troubles, unfortunately. These issues have been a long time coming. People have been expecting it for a couple of years now. We’re finally seeing the issues in the market trickle down to the startup ecosystem. This is just the beginning at least a couple more years, where equity financing is going to be hard. I’m expecting more than that.

Episode Wrap-up

In 2024 and probably 2025, you should brace yourself to survive. If you want to grow, you need to look at alternatives. You can’t just go with equity financing. Venture debt is one of the great alternatives unless you want to exit and sell your company, which is a different situation. In these desperate times, if you try to sell your company, you’re not going to get the exit you’re expecting. If you can survive and you can continue to thrive and you have a great business and can’t raise your next round, people should be looking at venture debt at least in 2024 or 2025. The environment is going to continue to worsen, potentially in 2026.

 

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About Sunny Singh

My background is in business and computer/electrical engineering. I have been on the founding team of two startups in the medtech and IT/cybersecurity spaces. I now focus on acquiring software as a service (SaaS) companies at Alleyway Capital along with startup (Angel/VC) investing and real-estate.

As an angel/venture investor, my venture investment portfolio consists of a few dozen North American companies in the technology space with a few $1B+ startup exits. I was also the founder and the managing member for the first Tech Coast Angels LA venture fund and President then Chairman of the TCA Venture Group.

My real estate projects are based in Southern California (Los Angeles, Orange and Kern Counties). I still have strong connections to my Indian roots with a substantial IT and real estate presence there.

For hobbies, I like PC gaming, lifting weights and mixed martial arts. I also swam competitively, hunted and debated during my younger years.