Is downside risk mitigation important to investors?

Over the years I have learned that my assumption that all investors seek to minimize downside risk is just plain wrong. For example, venture investors want to ensure their capital has a chance at generating out-sized returns. They have limited resources (time and money) to make the best investments as possible. Mitigating downside risk doesn’t pay very well because more often than not the investment opportunities with the greatest upside potential have horrible downside risk protection. Partners at venture capital firms have very little time and can only sit on a limited number of boards. They have to be VERY picky about the startups that get their attention. So don’t bother spending much time trying to explain why would be hard for a venture investor to lose his money in your deal. Angel investors, on the other hand, love to hear about how their money is safe. Of course they want the same sort of out-sized returns and they have limited resources (time and money), but there is one major difference: the money they are investing is theirs. Making money is REALLY hard and angel investors don’t like to lose their hard earned money in your out-sized investment opportunity. They really want to know how they can get their money out of your deal if it turns south.

For the past 30 days or so I have been working on putting together a $5MM round for ShopSavvy (our mobile app company) at a $19MM pre-money valuation. We have spent almost a million dollars building ShopSavvy into one of the leading shopping platforms for mobile phones. Today the app has more than 6.5 million users who are actively saving money by comparing online and local prices of the items they buy. Three months ago our biggest competitor with just 2 million users sold their assets to Ebay for $5/user. Using this as a comparable we should be worth at least $32.5MM. I would argue (and I have previously) that if you include our team and our backend systems (Pricenark) we are worth even more. Several potential acquirers have approached us about selling, but we have decided that ShopSavvy could be a billion dollar company in as little as three years. As a search/advertising business we think that each barcode scan our users conduct could be worth between $.05 and $.20 each (each Google search is worth between $.05 and .06 each) making ShopSavvy an important player in the mobile shopping game. Add platform opportunities like our payment wallet, couponing, rebates, deals and warranties and ShopSavvy could become the dominate player. If we wanted to sell ShopSavvy today I have no doubt we could get $50MM or more for the company, but we have convinced ourselves that it makes too much sense not to go for the grand slam. For a mere $5MM and 24 months we will know if we are going to be that billion dollar company – pretty cheap in the scheme of things. Again to reiterate: for a venture investor the problem isn’t mitigating the downside risk, but ensuring the upside opportunity. On the other hand, angel investors love to protect the downside. If ShopSavvy continues to grow at rates even half as fast as our current growth trends it will be worth significantly more than invested capital. This is just the sort of bet angel investors love – lots of upside and very little downside. Turns out it is a lot easier for us to raise capital from angels and super-angels than venture capital firms.

So what does this mean to you? If you have a great way to mitigate downside risk spend more of your time talking to angels and super-angels. If your downside risk story is horrible, keep talking to venture capital firms and the issue won’t even come up.