Spin hating, honesty loving, thrills of learning, UKBAA Angel of the Year

Podcast transcription - 11th may 2018

Peter Cowley:                  Welcome again to another Invested Investor podcast. This time we have Rajat Malhotra. Rajat, I've known for about six or seven years. He's become a friend. I've learned a huge amount from him. Let's talk through his journey and the vast amount of angel investing he's done. Rajat, talk about your background.

Rajat Malhotra:               Thanks, Peter. Thanks for inviting me on. I'm Rajat Malhotra as you said. I have a background as a lawyer, I practiced EU and competition law for a decade or so, a valuable commodity these days, although I'm glad not to be doing it. Wren Capital, which I'm now the managing partner of, which is an angel investor. My partner Richard and I founded it in 2011. It's our seven year anniversary I think pretty much to the day.

Peter Cowley:                  What led you to do that? I know that you had worked in Brussels before you came back to London. What led you to go into angel investing?

Rajat Malhotra:               It was a chance conversation in a pub more than anything. A pub in Hammersmith, I don't remember the name, so I can't direct people to it. Richard is a friend of mine from university. We both studied at Cambridge together, and the germ of the idea was definitely his. The conversation was roughly along the lines of, "I think this'd be fun. You're always telling me you're bored or you want a change, and I think it's going to involve lots of people. I don't like people that much. So how about we do it together, we go into partnership, and you front it and run the thing?"

                                             I thought about it, pondered it, didn't know - it's worth saying - didn't know anything about angel investing, didn't really know it existed very much from scratch. Researched it, thought about it, discussed it a lot more with Richard, and over a period of months I think - I think the conversation was a kind of six month conversation roughly - thought yeah, this might be fun.

Peter Cowley:                  Richard's not in the room here, though I do know him. You have law background, he has a technical background. Can we just give a little bit of flavour of that, and how he contributes to you too as an angel?

Rajat Malhotra:               Yes. We're very much a duo, we're absolutely a partnership, a team, we make all our decisions together unanimously to invest or not to invest. He is a mathematician primarily by background, but he's just one of these exceptional, brilliant people. I think of him as a polymath. He's an exceptional computer programmer as well as a mathematician. He's got a background in trading and statistics and that sort of thing. He is Wren's science brain, as we'll come to I'm sure later. Wren's primarily a science investory, and he provides that basic science grounding that we need.

                                             Whilst I front Wren on a day to day basis, he meets all of the companies with me that have made it through our filtering process. As I said, we make all of our investment decisions together, we make all of our follow on decisions together, and we're quite disciplined actually about reassessing companies for follow ons, and he's fully involved in that process. But I am the day to day, liaising with companies, networking, finding deal flow, negotiating terms, dealing with other investors, I guess all of the topics we're going to talk about anyway.

Peter Cowley:                  He has a day job, doesn't he? He runs a business, a successful business, here in London.

Rajat Malhotra:               That's right.

Peter Cowley:                  Okay. Is it in the public domain how much you invest per year?

Rajat Malhotra:               It's not in the public domain. We think it's fair to say one of the larger angel investors around in the country. We have made 43 investments in seven years.

Peter Cowley:                  Forty-three investments you've made, and you've lost how many, and how many have you had positive exits?

Rajat Malhotra:               We've had three positive exits, and we have, including insolvency and those that we have, in terms of our own balance sheet, written off to zero or let go of, 10. That's not an exact science, because as you know these things can sometimes come back from the depth of despair, but at the moment I'd say-

Peter Cowley:                  Same as me. I've had four exits and ten failures so far. Tell me first of all when you decided to do it together, clearly you had no experience of angel investing. You presumably talked to people. How did you start finding the deals?

Rajat Malhotra:               I, as you say, didn't know anyone, and would be the first to admit, especially hindsight's a wonderful thing, naïve, didn't have a lot of knowledge, et cetera. Wren very much started that face to face angel networks, because by the very nature of their business model, they work on new members coming in, so actually you'll always be welcomed as a potential new investor to those kinds of networks. I remember particularly got a warm welcome and still attend London Business Angels. They're not called that any more actually, are they? They've got a new name.

Peter Cowley:                  They have.

Rajat Malhotra:               Whose name I forget. I did the shoe leather thing, trod the pavement, and went to lots and lots of angel network meetings. People are generally pretty open and friendly. I'm quite relatively gregarious, forward type of person, so didn't find it difficult to strike up conversations and talk to people. Actually, as I reflect, the folks running those various networks were also pretty generous, actually, with introducing me to other investors.

                                             The other area or source where I got some original introductions back at the beginning was from the firm of lawyers and the firm of accountants who helped us to set up Wren.

Peter Cowley:                  Set up the entity. I think London Business Angels is now called Newable, from memory.

Rajat Malhotra:               That's it. Newable. That's right.

Peter Cowley:                  Tell me about the first deal, because this is where you have to suddenly - and you're a lawyer background - you have to take some risk. How did you find it and get comfortable before you wrote that check?

Rajat Malhotra:               Maybe that's why I'm possibly more suited to this than being a lawyer. I've never been massively risk averse. I remember as a lawyer I used to get told off by my partners because I'd want to give clients commercial advise. I remember a particular instance, I won't name the bank, but it's a kind of worthy anecdote. We were giving some very early advice to a major household name bank on this whole issue of whether overdraft fees and credit card penalty fees were going to  be illegal or not. We were giving it advice. I remember saying, and I got in a lot of trouble afterwards, I remember saying to this guy who was head of risk management or whatever it was, "Just scrap them. Make it your USP. Make it your competitive advantage. Don't spend millions of pounds on legal fees. Scrap them and make a big song and dance about it."

Peter Cowley:                  Right.

Rajat Malhotra:               The point of that story is I guess I've never been in that centre typical lawyer, and probably what perhaps tipped me over the edge is when I was discussing Wren with Richard in that six month period. At the last law firm I was at, we had one of those bright Briggs Myers personality assessment things. The entire team came up blue or green or some other kind of introvert, get away from me, I don't want to talk to you kind of thing, and I was red. So perhaps-

Peter Cowley:                  It's almost the writing on the wall of you being a lawyer, possibly, at that point.

Rajat Malhotra:               Yeah.

Peter Cowley:                  So, the first deal, what was that? Do you remember which-

Rajat Malhotra:               The first company we closed an investment in, still going today, it's a company called Camstent. How did we get comfortable? We didn't lead that. There were other angels involved who had done one or two deals before. But to some extent I think Richard and I felt that you just have to do one where you can mitigate your risk. It was, compared to the amounts that we usually invest now, as a first check in a new company, it was relatively small. So we mitigated risk that way. But you've just got to do one.

                                             When I talk to new angels or people who are saying, "Should I get into it, what should I be wary about," human beings I don't think learn that well just from being told things. I can tell somebody who comes to meet me 12 things you mustn't do, or 13 things that ... Silly, foolish mistakes, banana skins to watch out for.

                                             The reality about people is, to really drive those messages home and to actually take the learnings, you have to make some of those mistakes.

                                             I think it's not so much how did we get comfortable to do a deal, it was an understanding that to really learn you just have to do one.

Peter Cowley:                  Yes, okay. In fact I'm invested in that as well. Its meditate business which take a long time, and it's still alive, which is great news, isn't it?

Rajat Malhotra:               Yes.

Peter Cowley:                  How well it's doing we shouldn't discuss on this podcast, but it's still alive. That was your first one. How many months or weeks after was the second on? Just getting a feel for the momentum that you built up.

Rajat Malhotra:               We went for it in the first year. We started in January 2011, hence the seven year anniversary right about now, and we did eight deals in that first year. It remains the largest number of deals we've ever done in a single calendar year.

                                             In terms of learning for your listeners, that was too many. We threw ourselves in probably too much.

Peter Cowley:                  Was that too many in the first year, or was that too many in any year, because there's a big difference there.

Rajat Malhotra:               Too many in the first year. Wren typically does six new deals a year. this, 2017 it was five, 2016 it was seven, and I think the three years before that it had been six on the nose. So I think it was too many for the first year, but in terms of our model and the way we structure things, it's very much about the right number. But the first year, like I say, particularly with hindsight, there was not much knowledge there. It was too many. I think we may get lucky with two or three out of that first cohort, but there are-

Peter Cowley:                  There's some failed companies already in there, I'm sure there are.

Rajat Malhotra:               Yeah. More importantly than the fact that there are some failed companies in there is the fact that there are some companies that were clearly uninvestable. Horrible-

Peter Cowley:                  With hindsight.

Rajat Malhotra:               With hindsight. But the point about eight being too many in the first year is that just by being karma or a bit more careful or whatever the right word is, we would have avoided a couple of those.

Peter Cowley:                  That's an important part, and we'll come back to that is what you've learned from those seven years. Okay. Can we just talk about what you invest in? We've got about a dozen in common, so we obviously have got similar tastes. But you've done things I wouldn't even dream of doing, including your good exit last year. So talk through A, what you were investing in, and B, how that's developed to what you're doing now.

Rajat Malhotra:               It's a good question and it's an important part of our story. We started off absolutely generalists. We had - again, hindsight's a wonderful thing - and this was something that we did not give enough thought to at the beginning and I regret. We started thinking this was notionally a good idea and notionally a place where value could be found and returns created, but we did not have a meaningful investment thesis. We do now. I realize with experience that having a meaningful investment thesis is very important because it really allows you to focus, it gives you a critical framework against which to test your thinking, and it drives efficiency, too, because rightly or wrongly, some things will fall out of your thesis, out of your criteria, and that just helps you filter.

                                             I don't worry about that too much because, as I say to a lot of people, angel investing is about your positive predictive value and not your negative predictive value, and what I mean by that primarily is the good ones that you happen to have said no to don't matter a jot. What matters is the proportion of companies that you decide to invest in that turn out to be good.

Peter Cowley:                  Yeah. We'll put something in the show notes about that, because that's a very interesting point. And I missed Swift Key, you went around at Swift Key. That's a prime example of that.

Rajat Malhotra:               We have several colleagues, acquaintances on common, who even now kind of tear their hair out about ... I think the classic one is, we know several people who said no to Deep Mind or Mystique Mind or whatever the case may be. I always tell them over a beer, doesn't matter. Doesn't matter a jot. If you think about choosing to invest or not to invest, as the analogy being, a diagnostic test, this is not a rule out, negative ... We're not predicting negatives. We're trying to predict positives, positives being good companies. It's not about the ones you say no to.

Peter Cowley:                  I know one of your investments that failed, which I actually used to buy, was an FMCG. It was a drinks brand. That doesn't fit in with deep tech at all, so presumably the deep tech has crept in over time, I'll say.

Rajat Malhotra:               Yes. Wren, as I say, we started off generalists. We had no particular thesis, we invested in all kinds of things including two drinks brands, both of which failed, and by the end of year two, certainly by year three, we had developed a distinct investment thesis, and in terms of the sectoral focus of that thesis, the headline is science, engineering, and software.

Peter Cowley:                  Which I'm surprised you didn't do to start with, because Richard's background is strongly that, and your background isn't that relevant in terms of choosing which investment.

Rajat Malhotra:               It's a product of those things we spoke about earlier. It was a product of who we knew, where we were getting our deal flow from. If you go to your common or garden angel network, the deal flow is fairly generalist. The better quality deals for example, in science, engineering, and software for example, good companies being spun out of the better universities, those companies don't need to taut their wares around most of the angel networks, with all due respect to angel networks. Accessing those deals requires network, requires relationship, requires credibility in the market. So it was a natural process as we acquired those things, network, credibility in the market. Then we were able to access and have that deal flow come to us, so there was a natural progression I should say in the sources of our deal flow. That helped to hone that investment thesis.

Peter Cowley:                  There must have been more than that. There must have been something that you felt uncomfortable about investing in. It wasn't just the deals coming to you, it was the fact that some of the deals that you were doing didn't seem to fit in with your longer term thesis.

Rajat Malhotra:               Yes, I'm not sure. You probably give us too much credit in how scientific, forgive the pun, that was. For example, we don't do anything B to C, which again-

Peter Cowley:                  Any longer. Any longer.

Rajat Malhotra:               Any longer, which of course excludes all of these brands and retail and lots of e-commerce and that kind of thing. There's several reasons, actually. One, which I think you've eluded to Peter is, there was no particular expertise or insight within Wren to evaluate those deals.

                                             Two, the market particularly in London for early stage investors is saturated with investors who are experts in assessing those kinds of deals and can add considerable value in how to do distribution for those kinds of companies. They know how to bring the right kinds of investors in, they know how to do marketing, all of those things.

                                             The third reason is that - I accept this is a generalization - by and large, those companies are really execution plays, and you're betting more often that not really on the strength of their marketing expertise, advertising expertise, what kind of distribution channels they end up with. It's all really that side of things. We feel that is a very difficult thing to evaluate. We are uncomfortable with businesses where to some degree success is dependent upon ... All businesses, success to some degree is dependent on the quality of the sales force, but when it's really all about have you got the best sales guys and the product is almost secondary, that makes us uncomfortable.

                                             Some businesses are just dependent upon trend and fashion and what's the thing right now in all kinds of sectors. That again we found very ephemeral, very difficult to assess.

Peter Cowley:                  That shouldn't put anybody else off, of course. There are plenty of examples of successful journeys funded by angels in fields that either you or I wouldn't touch.

Rajat Malhotra:               Exactly. I look at the jam jar guys who are the Ex Innocent founders, but again I think a common theme is there is an insight there, there is an expertise there, those guys know how to develop a brand.

Peter Cowley:                  Before we go on to some specific examples and also how you got involved with the journeys of the entrepreneurs, you're more stage agnostic than I am. You'll invest at later stage.

Rajat Malhotra:               That's absolutely true, Peter. We have invested right from first seed, university spin outs are a great example of that. I would say that the latest we'll go into a company is probably series B. But anywhere along that spectrum, Wren is completely comfortable with, I'm just looking for good value deals. In terms of a new investment, I think the lowest pre-money investment we've made in a company is 3 or 400,000, pre-money, and the highest pre-money we've invested at in a new company is 125 million pre-money.

Peter Cowley:                  Yes. That's a huge range.

Rajat Malhotra:               That's a huge range. So yes, I don't get hung up about stage.

Peter Cowley:                  Right. Good. Let's talk about one or two successes, and then a few failures. Obviously you can only say what you want to say, but can you talk about the successful exit you had last year?

Rajat Malhotra:               Yes. The exit was a company called Monica Health Care. It was originally a spinout from the University of Nottingham about possibly a dozen years ago, even. It had had a long journey. The company exited in spring 2017. We first invested in mid-2014. It was a very good exit. In fact, within the EIS three year holding period.

Peter Cowley:                  Hence not getting the reliefs.

Rajat Malhotra:               Hence not getting the reliefs, but that's fine with me. The things I'd like to pick out about that company, one is generic about the journeys of these particularly science based companies, and the second one is about med tech, actually. I don't know if that's a bit too niche, but I think it's worth saying.

                                             Monica in my view had quite a typical journey for that kind of company. It is a company whose main product is a wireless foetal monitor for women in labour. This was a dusty corner where the incumbent technology was very old Doppler sensors invented in the '60s or even earlier, very uncomfortable, and this is a completely digital wireless sensor, which is stuck on the lady's abdomen and allows the labouring mother complete freedom of movement, and just a lot more comfortable. The company was sold to GE Health Care.

                                             The generic point that I think is worth drawing out is that, again, without giving away anything confidential, it was a long journey. It was version three of their product, I think, that actually really had that good product market fit. I think that's very typical, especially for a medical device and often in other areas. I think for any hardware, actually. I don't think it's restricted to medical devices. I think you'd be hard pressed to find a hardware company that nailed product market fit with version one. I think Monica was version three.

                                             Of course, that's important for investors to know that. When you see a business plan, think about what the funding journey and financing journey might look like to actually get ... Because they'll present you with a plan that's basically version one in sales.

Peter Cowley:                  Takes off rapidly.

Rajat Malhotra:               Yeah. Re-write or recast that plan with version one, failure, version two, failure, version three, hooray.

Peter Cowley:                  These are product failures, of course not company failures.

Rajat Malhotra:               Correct. Ask yourself, and ask the management team what does the business plan look like in that scenario, because that's a lot more realistic scenario.

                                             That speaks to time as well. I think for Monica, again we were a relatively later investor in that company. But I think for Monica, version one of the product came out probably five or six years in, maybe four or five years in, and version three, the version that eventually really took off was seven or eight years in. That gives the audience some sense of timelines.

                                             One of the things, again, that's very typical that comes out of that is the company had a chequered funding history. There were restructurings of cap table, refinancing, valuation.

Peter Cowley:                  New CEO?

Rajat Malhotra:               No, Carl was there.

Peter Cowley:                  The whole way.

Rajat Malhotra:               Yeah. Carl was there the whole way, or from very early on. Again, a typical think for university spin outs, the successful CEO was not the academic founder, which again, no disrespect to academic founders, and Monica had a superb academic founder. Has a superb academic founders. But the person to really drive the business was a much more commercially focused person.

                                             These down rounds and restructuring and all of those things, they are part of the journey. I think people shouldn't be afraid of them. There's also an opportunity for value. We came in in 2014 at a time when the cap table was restructured, and that drove our return. We made a much higher return than the investors who'd been with it from the beginning, and that's just a fact. Again, it's one of the reasons why Wren is stage agnostic, because we're not afraid at all of those situations.

                                             I'll often joke in the pub, I love a down round. Some VC investor pulled 100x down round on us last year, and I was weirdly delighted.

Peter Cowley:                  And you contributed then as you had done before.

Rajat Malhotra:               Wren now owns far more of that company than we ever did before, and I think it's going to  be a great company.

Peter Cowley:                  Before moving on to failures, I think there's something else you wanted to talk about, med tech.

Rajat Malhotra:               I did. It's just to say that - and I'm really talking about medical device companies and diagnostic companies in particular here and not talking about therapeutics, which is they find market penetration very difficult as independent companies. My observation is that most of these companies either try and do distribution themselves, which is very expensive, or they try and use independent distributors. My observation is that those strategies fail far more often than they succeed, and I generally encourage my medical device and diagnostic companies to pursue a therapeutic type of strategy, which is to partner with an incumbent. That worked beautifully for Monica Health Care.

                                             Monica had a distribution agreement with GE, and the success of that distribution agreement was, as far as I can see from the outside, the catalyst for the acquisition. That I think is a better strategy than really trying to penetrate these markets themselves.

                                             These device and diagnostic markets generally are controlled by massive behemoths, and you are better off getting in bed, in some way, with one of them, whether it's a JV distribution agreement, something of that nature is much more likely to A, get you actual commercial penetration, and B, you're front of mind then for an exit.

Peter Cowley:                  Good, yeah. JV being joint venture. Let's talk about failures. We've had a few failures together, but let's talk about that generically.

Rajat Malhotra:               It's often about the people, and it's often about this nebulous concept of product market fit. Some of this is from business 101, but it's time and again the case that the management team, the investors as well, have not worked hard enough with listening to the market and researching the market and finding out exactly what customers really want. It's not just what they want, because again, if you talk about something, for example, in the scientific or medical field, aspirationally a customer, they want marvellous things, they want better results, they want more efficiency, they want just better science in the generic sense. They want that, and that's rational. But what you will then find when you dig much more deeply and get to a granular level is what they want and what they can actually buy are two different things.

                                             As a start-up, what you care about is the thing that you can make or sell or provide that can actually be bold. So you need to understand supply chains, you need to understand decision making processes, you need to understand budgets. It's in the weeds, it's in the nitty gritty, I think, where product market fit actually goes wrong, whether it's not understanding NHS supply chains, or budgetary pressures.

                                             A very typical example from medical field would be you are asking department A in a hospital or other health care provider to increase their expenditure so that actually department C down the road gets the saving, or the efficiency, or the other benefit. That is a complex multi stakeholder, multi-level sell, and you need to be very sophisticated to get that right. Too often, that research, that understanding, that thinking, just isn't there. I've seen that be a meaningful contributory cause to failure on many an occasion.

Peter Cowley:                  But you've invested in businesses, even though probably you could have foreseen that, couldn't you?

Rajat Malhotra:               Now you're really putting me on the spot. Yes.

Peter Cowley:                  Or maybe this is part of the learning journey to be on.

Rajat Malhotra:               It's part of the learning, as I get older and greyer and as my wife would say a lot balder, I am warier of those things. It's one of the reasons why I'm very strong about wanting - again, for example in life sciences - experienced management teams. I want a CEO or a management team that have actually served their 10 or 15 years penance in a big device corporation, or big pharma, or whatever it might be, and who know how to distribute these products, and they know where the banana skins are in selling to the NHS or Kaiser in America or whatever it might be, and they understand reimbursement - again, talking about life sciences - reimbursement. Who pays, and why will they pay. It is of crucial importance.

                                             Actually, understanding of payers in health care systems is generally very much lacking in founders of life science companies. They understand payers at a very superficial level, but they don't really in fact understand it at all. So yeah, as you get older, the more experienced you get, where you have more understanding and you are more cautious about those things. But we've certainly made those mistakes.

                                             It's not just in life sciences. That product market fit element is crucial. I'm thinking of one failure that you and I had together that actually Wren was always quite reticent about investing in, and finally took the plunge. I was always concerned that there were so many stakeholders that would need convincing about this product, no matter how good it was, that it was going to  be tough. Just vested interests. I never underestimate the power of vested interests. People just want to protect the business that they have, and if you're an incumbent in the market, you will have tools to do that, and you have the ability to some degree to block better products.

Peter Cowley:                  Okay. Before we go on then, just finalize with a few tips for entrepreneurs and angels. You mentioned age a few moments ago. I know that you just turned 40, you've got a young family. What are you going to be doing in 10 or even 20 years' time?

Rajat Malhotra:               I have no idea is the most honest answer to that question. I certainly am not done with Wren yet, that's for sure. I've enjoyed changing careers entirely. I do say to myself that I've got one more entirely new career in me.

Peter Cowley:                  Good. Maybe a teacher. Maybe an academic.

Rajat Malhotra:               I'm not sure either of those institutions would have me. But my biggest thrill in Wren is, aside from meeting and interacting with the most phenomenal people, founders, fellow investors, et cetera, is the sheer thrill of learning something new from the bottom up, and I'd like to do that one more time.

Peter Cowley:                  Excellent. Rajat, you mentioned for angels one of the most important things to do is grasp the nettle and invest. That was great. Have you got two or three tips for entrepreneurs?

Rajat Malhotra:               I think I've got at least one, and it is this. Entrepreneurs need to be able to absolutely clearly elucidate and understand their market. What I mean by that is an entrepreneur needs to be able to tell me who's going to buy their product, how are they going to buy it, and why. That for me will show or not show whether they've really done that granular research that we were talking about. Particularly we were talking about it in a life sciences context, but it applies across the board.

                                             You'd be surprised, actually, how many entrepreneurs really stumble with that, because their focus is the product, their focus is their technology. Their focus is not the customer. A technology without customers is just a technology, it's not a business.

Peter Cowley:                  Yes. There are times where that has worked out. I would invest even if that wasn't completely defined, because they work it out during that initial journey. Secondly, there are of course occasions where the pivot has to occur because of getting to the market didn't work. I personally wouldn't have that so strong as you seem to.

Rajat Malhotra:               That's very nice.

Peter Cowley:                  Because we're different. Excellent, Rajat. This has been really good spending some time with you. I've really enjoyed it. Your friendship and the knowledge I've got form you over the years, may that continue forever.

Rajat Malhotra:               Here here.

Peter Cowley:                  Thanks for listening to another Invested Investor podcast. You can subscribe to all future podcasts via our website, investedinvestor.com, or via a number of online podcast platforms. Be sure to follow us on Twitter, LinkedIn, and Facebook to get the most up to date, interesting, and insightful content.