Angel Investors – The Good, Bad and Very Ugly
Posted by Dr. Earl R. Smith II in Venture Capital, tags: adviser, advisory board, angel investor, board of directors, CEO, chairman, coaching, consulting, director, earl r smith ii, earl smith, Executive Coaching, federal circle, federal contracting, funding, Governance, government contractor, investing, investment, investor, Leadership, leadership assessment, leadership coaching, leadership development, leadership styles, management assessment, managing partner, Personal Growth, the federal circle, turnaround, Turnaround Management, Venture CapitalDr. Earl R. Smith II
Managing Partner, The Federal Circle
DrSmith@Dr-Smith.com
Dr-Smith.com
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There is a tendency among entrepreneurs to chase money wherever they find it. The pressure to find the financial resources so necessary to build a business can be over-mastering. Most of the time the partnerships which form between founders and angel investors are productive but, in a few cases, I have seen it turn very destructive. Companies that should have realized success have been held back by investor partnerships that have severely limited their potential or, in some cases, doomed them to failure.
Look Beyond the Checkbook
It may be hard to be discriminating when you are in the heat of the ‘money hunt’ but the sins of omission you commit while chasing investors can return ten-fold to destroy any chance of success. The problem become acute because of the incredible range of circumstances, experience and interests that angel investors bring to the table. Their having money to invest in not enough. You need to understand their basic motivations and what is driving them to act as an angel investor. You also need to understand that all investment money is not the same. Some money will help you succeed while other investments will be a poisoned pill that will reduce your chances of building the business you envision. Here are some ‘sacred cows’ that you need to slaughter:
- Angel investors are in it for a return on their investment: Well, how can you argue with that? You would assume that the primary driver is always a return on investment. But, as you will read further on, that is not always the case. I know angel investors who are simply bored and looking for something to do and others who are frustrated CEO-wannabees. For some investors, it is all about a return but for others the return is secondary. You need to sort these two groups out. Do not listen just to what they say; it is what they do that is important.
- They have money they; must be smart: This is another fallacy. Some of the dumbest and most self-destructive people I have ever met are wealthy. I have found only a weak correlation between wealth and intelligence and a slimmer one between wealth and wisdom. Many a destructive hubris has been built on a fat bank account. Investors have an important role in start-ups but pretense, omnipotence or omniscience can warp an investor’s understanding of that role. Smart investors play their part in a highly professional and constructive manner. Seek them out; they are most likely the winners you want to associate with.
- They have been successful in business so they will know how we can be: Past success is not always a good indicator of wisdom going forward. In fact, great success can be counter-productive when they decide to work with start-up companies. I know one investor who continually regales his CEOs with stories of how he ran his company. Of course, the company was running over one hundred million annually when these stories took place. The CEOs, wanting to emulate his success, take steps that are entirely premature. The result is wasted resources and a dysfunctional corporate culture. Past business success is not a good indicator of professional performance as an investor. Remember, you are seeking an investor, not a shadow CEO.
- They will become my close personal friends and advisers: Not a good idea; the correct focus of investors should produce a tension in the relationship with management. If you want a friend, buy a dog.
The Bad and the Very Ugly
The problem with writing about angel investors is that they come in an amazing variety. I have met lots of them and there is always something different about each. The ease of entry into the field may have something to do with it. The only real entry requirement is wealth beyond current needs. That’s all it takes to become an angel investor. There are no educational requirements, courses to take or certifications to merit. Only a bank account and a decision to ‘invest’ are required to hang out a shingle and open up for business. Watch out for the following:
- The Shadow CEO: I have met investors who purposefully pick weak or inexperienced CEOs to work with. Their real agenda is to run your company from the back seat. These investors are very intrusive and will push you to make decisions and commit resources that will put your company at risk. They are mostly successful entrepreneurs who have built and sold a business. In the process, they have lost touch with the necessary energy levels and passion that is essential to building a start-up into a going business. Mostly they remember the later stages of their company and the extended staff they had. Then they turn the CEO into a kind of executive assistant and attempt to run the company by proxy. Most of the companies in the portfolio of this type of investor remain very small. They generally have very complex Excel spreadsheet projections and poor records in meeting them. Stay away from the Shadow CEO; they are very dangerous investors.
- The Crazy, Rich Uncle: This is probably the most dangerous type of angel investor because they are so easy on the management team. They are mostly retired and living comfortably. Their mission in life is to ‘give back to the younger generation’. A clear indication of this type is the total lack of performance metrics and a weak statement of expectations. They can be very seductive to entrepreneurs but there is a dark side. Without stiff set of performance metrics, the company can develop a culture of permissiveness. That will feel good until the money runs out. A key indicator of this type is the feeling that the amounts of money involved are, at least initially, not sufficient to cause them concern. The expenditure patterns are not carefully monitored and discussions do not turn serious until the money is spent and the wolves are at the door. As an entrepreneur, you need to seek out investors who will be hard on you; insisting on strict performance metrics and precise definitions of roles. Take the easy way out and you will be in for a ride to nowhere with a crazy, rich uncle. Sure you will enjoy the ride but, in the end, you will be let off the bus in the middle of nowhere with a tarnished reputation for failure.
- The Gaggle: Remember the old saying about a camel being a horse designed by a committee? These gaggles are fond of that kind of engagement. The investments that they make are very often selected in a very casual way and supervised fairly loosely. The problem comes as the group itself is very loosely organized. Different participants might have significantly different understandings of what it mean to be an investor and what that status entitles them to. The can range from complete indifference to total immersion in the management of the company. This situation can result in lots of pulling and pushing of the management team without an overarching strategic vision. Investments should be made based on clear and concise understandings codified in a detailed investment agreement.
- The Bottom Feeders: You will meet some investors who are really only interested in your intellectual property. They ‘drag the bottom’ of the entrepreneurial community looking for weak teams with good ideas. Mostly they insist that their funding be used to develop the technology rather than developing revenues. Once the money runs out, they regretfully inform management that they are closing the company down and talking the intellectual property as compensation for their investment.
- The Lead Broker: I have seen these lead brokers promote themselves into central roles in companies without putting much of any of their own money on the line. The net result is that the bulk of the investor group gets involved without much direct knowledge of the business or the management team. In one case, such a broker put together an investment in excess of one million dollars without making any investment of his own. He still managed a seat on the board and a dominate role in the management of the company. Be particularly careful of the broker who can invest but does not. This situation can turn nasty if expectations are not met. Finger pointing and recriminations can come to dominate the relationships among the investors. This could seriously damage chances of follow-on investments by the group.
The Good
Good angel investors always take a highly professional approach to the process and their portfolio companies. They generally focus in industries that they are familiar with. It is a good idea to avoid angel investors whose portfolio companies do not fit a close pattern. The best angel investors will often forgo the option of claiming a board seat and, instead, insist that an independent board member with professional experience be appointed. Beware of investors who seem to see investment in your company as an opportunity to enhance their reputation by sitting on yet another board. Here are some positive things to look for:
- Success Breeds Success: There are angel investors who have the knack to help their portfolio companies thrive; while others seem to doom them to failure or stagnation. I know of one angel who specializes in little deals and has a well developed ability to keep them that way. Other investors seem to have the opposite skill. Their companies grow and prosper. It is a good idea to do some diligence on the track record of the investor. Go with the successful ones even if the deal terms are less generous.
- The Investment Agreement: There ought to be a detailed investment agreement agreed to before any funds are transferred. This agreement should be very specific when it comes to the roles and responsibilities of each party. The best agreements provide for an earn-in by management based on performance. It also sets the ground rules for further investment. Good angel investors will require this as a matter of course. The worst ones will simply require a term sheet and then write a check. Remember that the absence of planning is the road to failure. Think of the investment agreement as a strategic plan for the relationship.
- Strategic Agreement on Roles and Responsibilities: Good angel investors will insist that the roles and responsibilities for each party be very well understood from the very beginning. These roles will be codified in the investment agreement and specify the actions that each party will be able to take under a range of possible outcomes. Although such an agreement can complicate initial negotiations, it will help greatly when performance does not meet expectations and realignment become necessary.
- Use of Proceeds: I have seen investors write rather large checks without insisting that there be an agreed upon use of proceeds. You can imagine what happened then. Entrepreneurs initially like the freedom to simply take the money and spend it as they see fit. But, more often than not, this leads to waste and spending on things that do not connect directly to the success of the company. One company, upon receiving funds in this way, spent a lot of the money on new laptops and cell phones with expensive service plans. They replaced very serviceable units. Another CEO kept paying his salary, even through results fell far below projections, and failed to pay suppliers. The result was a law suit that is almost certain to shut down the company. It is good business practice for the angel investors to insist on a detailed use of proceeds and for control over the spending of their money.
- Insistence on Performance Metrics: As a CEO you should be insisting on performance metrics for every member of your team. That is just good management. Your investors should take the same approach. It may seem initially easier to deal with angel investors who are very lax about this, but it is far from best practices. I am not just talking about Excel spreadsheet metrics. They have to be much more detailed than that. Good performance metrics detail the responsibilities of each member of the management team and the way their performance will be measured. Everybody from the CEO to the receptionist should have a job description with metrics attached. And the metrics should be sufficiently detailed to drive evaluations based on performance. Performance should be the driver in determining both compensation and earned-in interest in the company. Performance metrics are a sign of a professional and productive organization. Start-ups with that culture have a much higher chance of success.
- Focus on Governance Issues and Oversight: “Who’s minding the store?” If the answer to that question is “nobody but us entrepreneurs”, consider that a red flag. In the short-term, it may feel good to be free from oversight but, in the long-term, you are guaranteed to make more mistakes and waste more opportunities. The board of directors has a very important role to fill in any corporate structure and it is not just making sure that the investors get to a liquidity event as soon as possible. Good governance means overseeing the strategic planning process, dealing with issues of succession, audit and compensation, and providing for the protections and expansion of shareholder value. This fiduciary relationship with the shareholders is an important part of the corporate structure. Without it, management is under no effective supervision and the investment looks more like a roll of the dice than an investment.
Keep This In Mind
An angel investment creates a relationship that will help determine how successful you are going to be. Your skill in crafting that relationship is a test of how dedicated you are to the success of your company and team. If you take the easy way out, your chances of success will drop significantly. If you opt for the limp relationship with an inattentive investor, your prospects will suffer. Angel investors, the good ones, bring much more than money to the table. The good ones have helped their companies succeed and will help you do the same.
© Dr. Earl R. Smith II
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Related Articles:
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Presentations from the Investor’s Perspective
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Protecting Investor Interests: Quick Assessment, the Short List
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Helping Companies Adapt to Changing Times – Part One
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Mergers & Acquisitions: Thinking About Selling – Part I: Confronting the Reasons
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Mergers & Acquisitions: Thinking About Selling – Part II: Working Through the Emotions
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Moving the Ball
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Dr. Smith is Managing Partner of The Federal Circle. The Federal Circle partners with teams and existing companies. We help them up their game and win big in the Federal space. We also arrange funding for acquisitions and expansion by acquisition. Our model is based on the belief that, if you select the very best and work with them in a highly professional and focused manner, the results will be truly amazing. He is the author of Amazing Pace: Turbo-charged Business Development – a book that shows how Advisory Boards can dramatically increase revenue. Dr. Smith is also the author of Dream Walk: Parables for the Living – a book of Raven Tales and exploration.
Entries (RSS)
Alan Sporn wrote:
I read your article, Angel Investors – The Good, Bad and Very Ugly and it is literally right on the money (no pun intended).
My situation is unique in that I had invested a great deal of time/money into a company that was pitched to me by (2) broker-dealers from NY. The company at one time had well over $300,000,000 in sales in the dietary supplement business but had filed for Bankruptcy protection after the FTC sued them for making a false claim.
The bottom line is that after I put money in, it was diverted/embezzled. I sued and obtained a 26-page Federal TRO and Preliminary Injunction. Towards the end of 2008 the Defendants settled and I ended up with all the assets, intellectual property, etc.
It is difficult finding both an honorable partner/investor to help re-build what is still the top 5 dietary supplement brand in the USA, has proven an extremely difficult task.
Best Regards
Alan
Mike Anderson wrote:
Dr. Smith, a great comprehensive article. I have to agree with another posting here that Angel groups are a great way to reach many potential investors, most of whom would be somewhat ‘vetted’ through the membership process. In the Pacific Northwest I suggest the Alliance of Angels, Puget Sound Venture Group, Vino Society or another more wide spread organization called Keiretsu Forum. Another valuable ‘filtered’ channel to potential investors can be through lawyers and accountants.
Accepting an investment creates a long-term relationship that the entrepreneur needs to manage, so my advice is to get to know the potential angel as well as you can (coffee, lunch, etc), do some high level background checks and be sure to set expectations before taking the check.
Once you have accepted an investment from an angel investor my #1 rule is keeping them informed on the company’s progress on a regular basis AND that includes both the good and bad news. This can be as simple as a bulleted list every 30-60 days or when significant milestones are reached. I have experienced entrepreneurs who have neglected their angel investors (passive or active) only to regret it later when it comes time for another round of funding.
Mike Anderson wrote:
Dr. Smith, a great comprehensive article. I have to agree with another posting here that Angel groups are a great way to reach many potential investors, most of whom would be somewhat ‘vetted’ through the membership process. In the Pacific Northwest I suggest the Alliance of Angels, Puget Sound Venture Group, Vino Society or another more wide spread organization called Keiretsu Forum. Another valuable ‘filtered’ channel to potential investors can be through lawyers and accountants.
Accepting an investment creates a long-term relationship that the entrepreneur needs to manage, so my advice is to get to know the potential angel as well as you can (coffee, lunch, etc), do some high level background checks and be sure to set expectations before taking the check.
Once you have accepted an investment from an angel investor my #1 rule is keeping them informed on the company’s progress on a regular basis AND that includes both the good and bad news. This can be as simple as a bulleted list every 30-60 days or when significant milestones are reached. I have experienced entrepreneurs who have neglected their angel investors (passive or active) only to regret it later when it comes time for another round of funding.
Ali Zartash-Lloyd wrote:
Hi Earl
Great article and perhaps a bit of the painful truth!
Just a contribution to your excellent advice:
1. Ask for a reference! Strange you may say when you have the proverbial begging bawl out, but the reality is any business relationship is a two-way street. When you are being interviewed for a job (remember those days?), did you ever ask to talk to existing employees? Well may be you should have. You are giving up a piece of your business which you have worked your guts out for, so why should anyone think it is strange to ask for a reference? Talk to other companies they have invested in, get their views and without the person being involved if you want the truth told!
2. Make a watertight contract and as Earl suggests make sure everything is covered. It is better to have a fall out before the wedding than afterwards. Remember divorces cost 10 times more than any cancelled wedding (ask Paul McCartney!).
3. Take professional advice. This is one of those occasions you should not rely on your entrepreneurial skills alone. Angels, non-execs and investors do this for a living, so what makes you think you can match them or outsmart them? Pay someone who does this for a living to put together an agreement that protects both parties’ interests. Remember a good deal is only when everyone wins.
Finally, if you are looking for funds we have investors that are willing to support any sound business that is looking for extra cash to deliver growth or survive tight cash flow situation but their banks are being … eh… well bankers!
Larry Jean-Baptiste wrote:
Hi Earl, I’ ve had the chance to read your article and it is quite enlightening. I am a startup company looking for funding for our project and it is always nice to get advice on how to search for investors. One thing, it seems as if the angel investor community is a secret society. What are the best ways to find these angels and pitch a great idea?
Scott, There is an old saying, “if you turn the other cheek, expect to get slapped”. The purpose of my article and question is to help educate entrepreneurs so that what happened to you happens less in the future. In the end, you need to take responsibility for not paying sufficient attention to the details. My experience is that, if there is advantage to take, investors will take it. Dr. Smith
Tom Mahoney wrote:
Being on both sides of the VC desk for 25 years, allow me to add some comments:
1. Learn early to distinguish between tire-kickers, passive investors, and lead investors. Tire-kickers will never say ‘no’, will always be interested in hearing from you, but never commit to invest. Passive investors are interested but will only commit after someone else steps forward. Lead investors are your most rare, but important investor, as they will take the time to put structure into the agreement.
2. Writen Agreements are fine, but my experience is that no Agreement can take into consideration every struggle and challenge. My usual prescription is to take the time to develop a good working relationship between investors and management. And make sure you have a board you can trust. A PPM is the best protection for both management and investor, but this is only the start.
3. Valuation must be reasonable, but expect it will be challenged. Management must have a basis as to why the company’s and investment valuation, but angel investors will try to drive a hard bargain. Price it too high and it will tell prospects that you don’t know what you are talking about; price it too low and it will send the message that the company will not survive.
4. Don’t give up, but remember to look into the mirror every day. Overcoming difficulties comes with the territory. The entrepreneur’s job is to interpret the angel investor’s rejection as to a serious problem with the business model, or the simple statement that the plan works and you need to continure looking for that angel investor that works.
Hope this helps.
Tom Mahoney
Hilldale Ventures, Inc.
Dennis, I think you are referring to what I labeled the ‘broker’. One rule that everybody should follow is do not pay retainers to people who are going to help you raise money. You might hire a consultant to polish your business plan or presentation. But never pay anything but a success fee for raising money. Most of the people in this business are scammers. Earlier this year we helped to successfully sue one. Once the law suit was filed, all sorts of victims came forward. This particular scammer had made a living taking retainers and delivering nothing. He is now facing serious jail time. Dr. Smith
Christopher Zuzick wrote:
Excellent article!
Dennis Meekins wrote:
Thank you Dr. Smith for a very accurate depiction of the field. Our recent experience exposed another player – the “Masked Angel” – claims to have money but really wants to be paid for consulting to introduce you to his “network” of potential investors. I put them below the Bottom Feeders. Thanks again.
Thanks for the kind words Robert. I am glad that you find them useful. Dr. Smith
Robert Kim wrote:
Thank you, Dr. Smith. Your articles are pure gold.
Marco, Thanks for the comment and compliment. I am glad that you found the article useful. As for your observation about the use of the word ‘angel’, I have always thought that contradicting the established lexicon is akin to yelling at clouds. Early-stage investors are called angels; that is an established fact. I think we should be careful to observe the accepted terminology and make the issue the ideas we are trying to communicate rather than the words others use. I work to bring clarity in areas that I think are frequently misunderstood. I find that difficult enough without having to argue about terminology at the same time. Most entrepreneurs bollix the search for early-stage funding; some very badly. My articles have been an attempt to help them up their game. Dr. Smith
Dr. Daniel Vinovitsch wrote:
Looking forward to your next article which hopefully will be titled: How to FIND angel investors…
regards
Daniel
Gurmeet Singla wrote:
Awesome article and very informative especially someone like me who is working on a business concept and will search for angel investors in very near future.
Thanks Dr. Smith.
songclash.comsongclash.comsongclash.comJuan
Carlos Cruz wrote:
Enjoyed reading your article Dr. Smith.
Performance metrics are the most valuable asset I can re-emphasize on. Having measurable points on everyone’s efforts can really show where changes or adjustments can be made.
Thank you very much for sharing the article with us Dr. Smith.
Best regards,
Juan Carlos
http://www.songclash.com
S N Sharma wrote;
Dr Smith,
It’s one of the best posting I have come across.
Your contribution is of an immense benefit.
GOD bless you !
S N Sharma
John Nistler wrote;
Points well made. Over the course of the last 4 years I have seen an example of all three. At the same time, stumbled on occasion and was blessed on occasion. The point of an investor being liquid should be taken to heart by any founder. Any time an investor talks about how he or she will sell personal property guaranteed to make sure the money is there – it is time to walk. In addition, any investor who wants the lion share right of the block with no management buy in opportunities or ignoring the value of your appraisal, it is also time to walk. Keep in mind it is like fishing. You may have the lure out there and get no bites, at other times – you may need to release a few of them back into the pond for someone else.
P. (Kate) Kathleen O’Hara wrote:
Dr. Smith
Thank you for starting a great conversation with a question.
On another group the question was also asked and after 192 comments it amazes me that one answer never comes up.
Actually two: One is, “get a contract”
Two is sell. Be a sales person on commission.
When I first left a demand resort property many years ago my ex told me that I was not a “sales person, I was an order taker”. (I had sold over 4.2 M on a large GM account and thought I was the bomb in sales)
Well of course I had to prove him wrong and I got a job on straight commission. Needless to say, my new owner and sales manager threw a yellow page book at me and said “here’s your leads, start with die-casting” (I did not know how to spell it ,not to mention what it was or what I was selling.)
One year later, after (starving to death), I turned to my now partner and said, “I am a 20 percenter”. (20 percenters sell 80 percent of the all the business.)
Our company went on to acquire/sell over three thousand clients in the Bay area and over 3M in sales. It was then sold to the largest media company in the world.
This taught me sales, so from there, many start ups later, the main lesson I learned, was “get a contract”, put it in writing and offer to the investor, client a return. This works for angels, VC’s, tycoons, celebrities, politicians, friends and family, grants, etc.
One example;
As the founder of a heavy oil company, we needed a prototype developed. At first we went to Halliburton, they said yes to the prototype development cost but it took 6 months to get the President to commit. In the meantime ,we had gotten a contract for 75 M dollars and we sold our Angel investor (1.5 M) for a 18% return. (as the barrels of oil came out of the ground and were sold.)
Everyone in the investment community thought we were gifted and could not believe that not “One Share” of stock was exchanged for such a huge amount in an un tested and un proven technology.
I can go on and on, but you get the drift, hire good consultants but most especially hire a sales person who is a 20% percenter and listen to them….
Do not blow them off thinking that they are with no scientific, doctorate,medical degree. It is a science to sell and “no’, engineers and lawyers are not made into salespeople, they only turn out to be bad lawyers and bad sales people.
Thank you again for this opportunity to share in war stories that will help some of the most fasinating technologies in the world to get off the ground. Some of these same technologies could be saving lives in Haiti right now…
Erica Drake wrote:
Bravo Dr. Smith! I read your article with a smile on my face – having personally lived through the Angel investors experience many time, (and I have the battle scares to prove it). I have raised millions through Angel investors as an entrepreneur. Now I advise and assist other entrepreneurs in looking for capital. I have a few thoughts to add or supplement what’s already been said:
(1) The entrepreneur must be willing to do whatever it takes to get the job done – unconditionally adapt the attitude “failure is not an option”. With that said, I do agree with others in this discussion that bootstrapping it together is preferable to a point. In my experience, one must creatively think outside of the box to find solutions to further the company from a purely start-up stage to a development stage company. When personal funding is not an option, try cutting strategic alliances, JV or pre-negotiating vender contracts. Cut a deal with a marketing company to start developing your brand/vision. The further along the company, the more likely it is to find an Angel investor.
(2) Be prepared. You never get a second chance to make a first impression. Have your Ex Sum and Financials completely done – and proof read by others! You never know when you may meet the ideal Angel investor. You need to respond to interested prospects immediately.
(3) Don’t let your ego prevent you from learning – as already mentioned, many entrepreneurs may have the skills to run their respective business, but lack the skill set to find the funding. If you don’t know how to prospect, ask for help. If you don’t know what a convertible debenture or dilution is…Ask and learn. To often I deal with entrepreneurs who are afraid to admit that they don’t understand. When all is said and done, you as the entrepreneur must learn this sooner or later to manage your business – and sooner is much preferred.
(4) Structure you deal strategically – To tell an entrepreneur that a prospective Angel investor may not be ideal, is like telling a starving man that the food doesn’t taste very good. As a fellow entrepreneur, the passion and desire to find funding – any funding often out weights a logical business decision. If you must take funding from a less than desirable source, be sure to structure your deal using specific milestones, a strong corporate operating agreement and a pre-determined exit strategy or funding round. By defining the parameters of “success” in advance, you may save the day. Also, if the investor requires milestones to be reached to trigger further funding, be sure this funding is already escrowed. Too often the entrepreneur reaches their goals, yet the Angel investor no longer has liquid capital to invest.
(5) Lastly, prospect, prospect, prospect. You never know where you may find your Angel. Cold call in warm markets. Brainstorm for win-win situations. Think strategically and never be afraid to ask! The line use as an entrepreneur was simple: “my name is Erica Drake and I need $2 million, do you have $2 million? You’d be surprised how many people said yes…
amerwld.comamerwld.comamerwld.com
Dick Brown wrote:
Many definitions and cautions on angels in our book. We’ve just finished a book for any entrepreneur that’s seeking capital for their company or venture. “How to Raise Money, the Truth” is: very “real world”; simple; easy-to-understand; and, CHEAP. There’s even a section on writing a professional business plan! Probably most important, it blows away the “Myths and “Misconceptions” about raising capital and saves entrepreneurs wasted time and misdirected efforts. It also has proven suggestions for reaching and closing qualified money sources. It’s at: http://www.amerwld.com … and, it’s less than $10 and available immediately as an eBook. Dick@amerwld.com
José Carlos Graça wrote:
Dear James, Larry, Earl, Hal and Chris,
I believe that we have come to the conclusion that there is a shifting in the ladder and that seed capital has been left to personal savings, FFF and Mutual Guarantee backed up by state guarantee (at least in my country)
Business Angels moved up from seed to start up and early stage.
VC have moved to EarlysStage and Second Round.
Banks take minimal risk today asking for enomerous type of guarantees to grant their loans.
Would like to point out that many banks have VC with special funds in very attractive markets with high ROI that offer small risk and is out of the reach of the common BA due to high need of investment like the BIO Technology and Renewable Energies.
James I think you are too optimistic in relation to the values because although it has moved up the ladder the amounts are not going with it.
I am working on a new model in order to overcome all these problems we have been pointing out in this discussion by joining together BA, Private Investors, Goverment, Local Goverment, VC, University, Banks, Mutual Guarantee and Incubation Centers.
James Wallis Martin wrote:
With banks currently earning a 200 point spread on 5 year loans vs CDs (the largest in history), borrowing from the Fed at another 400 points spread, and increasing credit cards from an average 800 point spread to a 1900 point spread, there is absolutely no reason for banks to invest like they used to, they can make money essentially risk free (since the government has proven it will use taxpayer money to bail them out).
The VCs that survived this most recent economic meltdown are looking for guaranteed investments (what banks were looking for in the 90’s so they have become essentially like the banks when it comes to risk.
The Angels are hiring gatekeepers who are experts in their field to find high returns like VCs of the 90’s but lower risk like the banks of the 90’s. So many Angels have inadvertently become the worst of both VCs and Banks in the 90’s.
So like Larry mentioned, we need to redefine Angels, and Jr. VCs sounds like the perfect label, but that doesn’t resolve the need for a new type of investor to fill the void left by the Jr. VCs (f.k.a. Angel Investors).
The marketplace is truly a global marketplace, yet investors tend to invest locally unless the company is public, then they tend to invest nationally, but rarely internationally.
However, it is exactly in this space that a new group of investors will truly yield the return found in the 90’s.
So lets break the investors down:
Seed Investors (R&D and first customer stage) [$100K - $500K]
- Industry Seed Investors
- Marketspace Seed Investors
- Local Seed Investors
First Round Investors (Market roll out stage) [$1M - $5M]
- Industry Micro-VC Investors
- Marketspace Micro-VC Investors
- Local Angel Investors
Second Round Investors (IPO or acquisition stage) [$10M - $50M]
- Industry Venture Capital
- Marketspace Venture Capital
- Local Angel Group Investors
Third Round Investors (Public or acquired stage) [$100M - $500M]
- Institutional Lending Banks
- Venture Capital Groups
- Public Exchanges
Industry – I am defining as those that invest in a given industry and are less concerned with geography of the company.
Marketspace – I am defining as those that invest in a given market (which can be regional, national, or local) to where the company is targetting its market efforts (the company may still be headquartered externally but has significant presence in the marketspace)
Local – I am defining as those that invest in a local company (geography is a prerequisite) and where or what industry they are selling in is secondary (albeit still very important)
Feel free to revise my suggestion. It is just a draft.
James, I have seen the same progression for the most part. There are exceptions but most of them are negative. The really professional angel investors have moved up (or back) in the process. Many of them are acting like venture capitalists – including deploying more thoroughgoing diligence and comprehensive investment agreements. The ones who are still playing with small deals generally fall into one or more of the categories which I describe in the articles I referenced in my response to Jose. They are easier on the way in but tend to be destructive in the long run. I have had a good deal of work lately undoing such ‘bad marriages’ and helping entrepreneurs to avoid getting into them in the first place. Your comment on banks resonated. When I was at the Sloan School at MIT, there were few venture capitalists. In fact, it was the banks that provided most of the funding for the Route 128 expansion. It is strange how the world has changed, isn’t it. Dr. Smith
Hal Spice wrote:
I found the comments today of James, Chris, and Earl had a common theme. My observation after 25+ years in the business is many promising companies never get funded because they never developed a “capitalization” strategy for their venture. A key element of such a strategy is to analyze potential investors using the same methodology to properly analyze a market opportunity.
There is not a one size fits all angel investor. To increase the odds of getting funding, segment the local angel community. (Local, because I have met very few individual angels that invest outside their immediate geographic area). In segmenting investors and building a capitalization strategy, recognize that successful investors place their money based upon pre-established investment guidelines. The parameters that comprise these guidelines include:
1. Product – software, hardware (by type), comm, biotech, clean, nano etc.
2. Stage – concept, R&D, prototype, beta, revenue ready, revenue generating
3. Strategic value – does investment relate to other investments or business interests.
4. Ability to add value – good angels want to hedge their bets by having the ability to add value, either by technical or industry knowledge, or their network of business connections.
5. Risk tolerance – This is related to stage, but other risk factors come into play, for example execution risk.
And if you are trying to raise capital right now, you must recognize that for the foreseeable future is is a “buyer’s” market. I have never seen so many high quality deals available at such huge discounts. Also recognize unless your venture has established a revenue generation track record, you have very little leverage in valuation negotiations (another reason by use the convertible note, which takes valuation differences off the table – but that will be the subject of another post).
Successful investors NEVER fall in love with a deal, because we know that great deals are like buses in NYC, another on will come along in about 10 minutes.
regards,
Hal
James Wallis Martin wrote:
Dr Smith,
My twelve years of capital raising experience, have (in gross generalization) seen Angels behave more like VC, VC behave more like Banks, and Banks no longer lending at all! So there needs to be a new group to fill in the void of Angel Investors who have gone on from seed round funding of R&D in the 90’s to Round A funding of market expansion in the 00’s. Chris Maresca mentioned ex-bankers.
For my personal experience, I have been fortunate enough to be able to afford to seed fund my cloud computing applications in which JB Metrics has developed nine different suites, of which six are already on market, have existing reference site customers, we are profitable and have more than doubled our revenue over the past three years. We are only now of interest to angel investors with product in production, customers, and a profit track record. But what about those entrepreneurs who have a good idea and need seed funding of R&D and getting their first customers on board?
I see most of the good Angel Investors have moved on to funding Round A for startup companies like mine, not for what we used to call startup companies back in the 90’s who had a vapor-ware product, a business plan, a team of industry professionals and letters of interest from potential customers (and even further back in the 80’s where they had an idea on a cocktail napkin and a garage of two guys, no business plan, and no customers!). Where do today’s entrepreneurs looking for seed round funding go? (other than the three F’s – friends, family, and fools)?
It is interesting that back in the late 90’s (before the dot-com burst), a startup was considered a company that was under a year old and not making revenue. Now heading into the 10’s JB Metrics, which is now already five years old, with three years of more than annually doubling revenue over the million mark is still being called a startup company.
The bar has definitely been raised for what qualifies for angel investment in my experience over these past twelve years.
dr-smith.infodr-smith.infodr-smith.infodr-smith.info
Jose, Thanks for the comment. You have described the ‘perfect angel’. I wish they are all that way. Unfortunately they are not. See my two articles – Angel Investors to Avoid: http://www.dr-smith.info/angel-investors-to-avoid/ and Angel Investors – The Good, Bad and Very Ugly: http://www.dr-smith.info/angel-investors-%E2%80%93-the-good-bad-and-very-ugly/ . How do you sort these out? It seems to me that that is an important question for entrepreneurs seeking funding. The comment has been made that the funding dance is like a courtship. Deciding who to dance with early on can make or break an early-stage company. Dr. Smith
José Carlos Graça wrote:
Angel Investor is somebody who has a private fund (50 k to many millions),
earned with his ventures and hard working along a long period of time for 10 or more years, gained experience in managing business and creating a network of relationships, has a deep knowledge in one ore more business areas, knows how to obtain additional funding and is a team player, he knows that at the end it is the team that counts and the money is an instrument like many other ingredients. Wants to stay active and loves ventures, he is looking for a fast and high return on his risky investments (would put it on the bank otherwise). Spreads the risk by participating in several ventures, takes part of the management team, is looking for scalable business that can be sold in a period of time of 3 to 5 years or that can be bought back in the same period by business owners.
This is the common situation but as usual there are good and bad Business Angels as in all other things. When you are looking for a Business Angel you should screen his credentails. Remember you are taking a FULL BUSINESS PARTNER and you should take into account his opinions.
When you decide to accept a Business Angel you need to accept that he is a FULL BUSINESS PARTNER and will bring much more to your business other then money alone.
If you are not a TEAM PLAYER do not look for a Business Angel just go to the bank because it is much cheaper and you keep the decision making to yourself.
dr-smith.infodr-smith.infodr-smith.infodr-smith.infodr-smith.infodr-smith.info
James,
I have a couple of questions about your last comment. the first is ‘what is the appropriate role of an angel investor’. My experience is that they are all over the lot. I wrote two articles on the subject. Angel Investors to Avoid: http://www.dr-smith.info/angel-investors-to-avoid/ and Angel Investors – The Good, Bad and Very Ugly: http://www.dr-smith.info/angel-investors-%E2%80%93-the-good-bad-and-very-ugly/ . Many of these negative types push for deep involvement in the management of their portfolio companies; most often with negative results.
I’m not sure that I agree with you that “Cash flow is the difference between being able to become a market leader and staying a market innovator who gets beaten by someone who can bring the necessary cash flow to take the market.” Cash flow is a lagging sum. I have always been a fan of segregating capital and operating expenses. Many of the angel investors that I work with seem happiest when they are providing finds for expansion of existing revenue streams. They would rather avoid funding product development and R&D. Has your experience been different?
Dr. Smith
Chris Maresca wrote:
@james
Good point. It’s worth pointing out that companies will often act as such strategic investors. I’m a member of a group here in Silicon Valley that brings together a bunch of innovation executives from large companies and most of them have programs to seed startups and help introduce them to the marketplace, including helping with warm introductions to their customers and setting up prototyping/manufacturing. They have seed funded companies at $200-$300k or even just paid someone a salary equivalent to develop an idea (I would note that the latter is very, very rare, however).
As far as angels not having the funds, I think that largely depends. Quite a few angels I know are worth in excess of $100 million (and several in excess of $500 million) and a number of angel groups (like Sand Hill Angels) will actually do A-rounds as well. OTOH, you are right, because it is their money, they are more risk averse regardless of how deep their pockets are…
One other route that a ex-banker pointed out to me recently is that potential customers, particularly in finance, may pay big dollars for potentially game changing technology. To get an edge, they will sometimes fund prototype development, which can substitute for angel funding.
Chris
P.S. Happy New Year to all – hopefully you didn’t spend the day catching up on emails and other work like I did….
James Wallis Martin:
Now one thing that I don’t believe has been brought up in this discussion yet, is what is the Angel Investor bringing to the table (besides money)? If an Angel Investor can bring customers or key access to a critical supplier, their value is much more than one that can only bring money. The other question, which is always one of discomfort, but needs to be brought up early on is the discussion of how much the investor can and is willing to bring to bear.
Cash flow is the difference between being able to become a market leader and staying a market innovator who gets beaten by someone who can bring the necessary cash flow to take the market. There have been many arguments that being first doesn’t guarantee getting the market. The main reason always falls back on the availability of cash flow. Angel Investors usually don’t have the funds or are willing to put all their eggs in one basket, when it comes to providing additional funding, should the venture be more successful than projected. Success can be harder on cash flow demands than failure.
Variable costs can easily be trimmed back down if the market uptake is slow or if a few mistakes along the way means it takes longer or requires a bit more money than originally expected. But in contrast, if the market demand quickly exceeds the cash flow, then it is important for the angel investor to have either deep pockets or have connections to others who can throw in more funding and quickly. It is important to know how much an Angel Investor can and is willing to put in at a later stage (assuming both delays and rapid success).
Ricardo Polycarpe wrote:
Happy New Year Dr.Smith,
I’m currently looking for a US (because we’re in touch with a LA-based IP Lawyer) early-stage investor interested to acquire equity stakes of a future new success-story multiplatform (portable into Iphone,Facebook,Wii,…) casual game of cards !
And you can imagine how useful the article will be for us !
Happy Holidays again, Doc
Ricardo
Game Designer & Orange mobile Premium Partner
Mark Montgomery wrote:
A couple of observations that might be useful. First, as I said in other forums and shared in one of my groups, this is an exceptional article. Second, I agree with Chris on the issue of raising capital in this environment — sweat equity compared to any external capital is preferred, and sadly in the U.S. we have little choice but to sell to industry leaders as an exit, or watch another bubble form, which I won’t take– I’ll relocate if that happens perm. I’ts ruining the country.
However, I would add that volume doesn’t a wise investor make, particularly in angel investing & VC– it usually means someone was good once and/or got lucky once, while others who have a track record of several — particularly in bubble years, are based on relationships rather than anything else.
The very small minority are true serial entrepreneurs turned investors who really understand what they are doing, as evidenced in many markets, multiple industries, and multiple environments. These are the folks who are true market makers — they build economies rather than tear them down or skim off the top, and they are very wise folks. Quality is all that matters to me — not how much capital they have, or a one hit wonder, and I avoid arrogance at all cost.
I prefer to surround myself with those who are business builders for the long term, and I do my best to stay away from everyone else until the venture is mature enough for financial investors, who are usually clueless in tech.
That said, some types of ventures simply require a lot of capital, and in those cases I think sweat equity and lean venturing is still essential, but they do need capital– the self-funded model doesn’t work with many sectors– most actually, and those where it does work tend to be way over invested due to the supply and demand dynamics of low cost of entry– like social networking where some angels invested in hundreds of ventures– losing in almost every single one. In most industrial ventures I’ve observed early on, the greatest challenge in capitalization is matchmaking.
For example I have deep relationships in hardware, but they don’t know zip about software. Similarly many corp execs are angel investors– they can sometimes help on exits, but good luck finding any who understand revolutionary new technology, or how to gain adoption– they often find their network useless in that regard.
Generally speaking, it’s the most expensive education in the world to learn early stage venturing– particularly technology today. Cultural prep helps, formal education can hurt or help — I’ve seen both many times — natural inclination /drive/internal motivation is paramount, and experience and mentoring helps — particularly on the investment side.
I am hesitant to share even this much with Linkedins IP grab in the user agreement, which is counter productive in my view, but so it goes. They found a lot of money to grow market share, and I suspect that’s one reason why. The web isn’t an easy game.
.02- MM
Jose, Thanks for two great comments. Your second one brought a smile. I am working on a book that is being written in two sections. The first is focused on the process from the investor’s perspective while the second section looks at it from the entrepreneurs’. the reason for the smile is that, during some of the interviews with both ‘types’ some offered the same observation. Investors wanted entrepreneurs to change while entrepreneurs wanted investors to change. Both offered the request wistfully and without much hope that the changes would occur. My own feeling is that they won’t change. The very nature of their respective professions and world views drive their behavior. But I have experienced a coming together in a neutral space. My PhD thesis focused on developing an alternative to comparative cultural analysis. The core ideas I used have proven very helpful in bringing oil and water together, at least temporarily, into a commodious mixture. Dr. Smith
José Carlos Graça wrote:
Dear Chris Maresca,
Your contribution in this discussion has been one of the most important. I can tell you are an experienced person in this area. I have been around to know that. I have setup several startups myself and also been active as a BA and recently raised a small fund with a group of investors, university, incubation center and goverment to invest in ventures under a new business model which I am building up right know. This model avoids the major risks and problems which goes with it and you have pointed out. The problem is most of the startups are not interested to value the business and sell it at the end. They have no money to share the risk and are commonly bad team players. Most of the ideas are common and lack of potential for risk investment. Those are the common comments I experience from other VC´s and BA.
Best regards,
Jose Carlos
I also believe that BA and VC´s should change their model in order to overcome many of the problems pointed out in this discussion.
David Rippentrop wrote:
I have been matching Venture Capital, Angel Investors, and other funding groups with beverage companies in need of a boost for a couple of years now. The group of investment, financial, and other entrepreneurial type companies and individuals is growing everyday.
To become part of the group as a company searching for funding or a company searching for the new, hot company to invest in, is a free referal type of group. I do not charge either side, I offer this as a free service.
To become part of the group, just send a request to davidr@mrportland.com. After, I will wish to set an initial meeting and then see where it goes…
Dave
Hal Spice wrote:
@André – Thanks for the kind words. One quick clarification. Many investors do not base investment decisions on the probability of an IPO exit. We look for a certain return relative to risk. I like a 10x return. It might be higher or lower depending upon my analysis of the risk premium involved. Currently, if you invest early stage, you are probably looking at 5-7 years to get to IPO. This is a very long duration, and to me long duration equals extremely high risk. There is a myriad of variables that the company cannot control, that can derail or crater a company over a long duration.
Right now, I like companies that have proprietary IP, swim in a blue ocean, can generate revenue within 12 months of my investment, and can exit via acquisition within 24 months of revenue generation. This are guidelines, and really compelling deals are processed on a case by case basis.
regards,
Hal
Chris Maresca wrote:
@curtis – I’ve worked with 60+ VC/angel backed startups, done 8 myself and was part of a venture group started by an angel who funded eBay, Paypal, Google, Ask and about 100 other startups (he was one of the founders of Angel Investors). I think I might have a reasonable perspective on this…
The answer to your question is like asking a couple “why does your marriage work”. Every couple will give you a different answer, there are no ‘top 10s’. And, just like in every relationships, culture, society, politics, economics, past experiences and future expectations all play a role. What I do know for sure is that among the myriad of reasons why startups fail, the top three that I have seen are:
1) Not doing whatever it takes (and I do mean whatever)
2) Lack of focus
3) Forgetting that at some point, you must exit
And, I agree with Hal about paying for experience although I disagree about taking outside dollars – I only know of maybe one or two where this has been beneficial to founders (note – founders, not investors or the company, there is a difference), but for most, in my experience, the ROI is not good. In general, the ROI of VC/angel invested money is incredibly bad. Here’s some analysis for you: http://redeye.firstround.com/2009/10/company-math-vs-vc-math.html
Most VCs and angels do more harm than good with the companies they invest in. The best investors, IMHO, are the ones that will be aggressive and good at selling the company when the time comes, but will mostly restrict their role to providing guidance on achieving the best future valuation. Among the best, I think, are John Hamm and Peter Fenton, but there are a few others.
And, @André, few companies go public in the US anymore, that’s a pipe dream. The rules are structured against SMB IPOs, so sales are the most common exit. Because of this, a founder will get more $$$ selling at $15 million with little or no outside investment than selling at $50 million after 2 rounds (usually). That said, my friend Andy Kau over at Walden has taken 4 (?) companies public in China, but that’s behaving more like a PE fund than a VC.
On the other topic of paying for advice – experience counts for a lot here, but few people are actually willing to pay for it. That’s the thing about startup entrepreneurs (and startups) – they think they know everything (or can learn it over lunch) and they have no money. VCs, I would hasten to add, are no better. Here’s a great blog post about being a ‘Startup Specialist’ – http://smartstartup.typepad.com/my_weblog/2009/12/10-great-reasons-to-be-a-startup-specialist.html
After almost 15 years of doing startups, my advice would be to bootstrap even if it means a ramen diet and 3 jobs for several years.
Chris
André D. Henderson, Sr. wrote:
And a valuable two cents… I happen to agree Hal!
Those outside dollars can also help pre-IPO opportunities go public and can truly generate significant gains… which is typically the incentive for any investor.
There is truth to it takes money to make money!
Hal Spice wrote:
@ Curtis – I can give you the specifics and 100 examples. What rate are you willing to pay? There is a lot of sharing here, buit you are going to have to do some of the heavy lifting.
@ Chris, generally very good comments and insights. However I have to disagree with your viewpoint that outside investment reduces exit dollars. I have empirically found this to be a myth. If a company can self fund, the point is moot. However taking in outside investment versus a slow bootstrapping process is generally far more lucrative.
The question that I put to exec teams or founders that believe the investment money is too expensive or will lower there payoff at exit is, “Please calculate for me how much money you are losing everyday by not being in business” or how many customers / sales / opportunities did you miss today, and will miss everyday, by not being in business.
The second question asked is how big (or small) is there “window of opportunity” Some deals are like yogurt and only have a certain “shelf life” Reach the expiration date and the value of your deal will quickly drop to zero.
Thus, my experience is that outside investment often increases exit dollars by making creating a high valuation via a quick start (a far larger pie for everyone) particularly when the exit strategy is acquisition (or merger) where “exit dollars” are based upon some multiple of EBITDA.
Just my 2 cents.
regards,
Hal
ceospace.net
George Ishee wrote:
Dr. Smith thanks for posting a “real life” article on angel investors. I have been involved with an incredible group that attracts hundreds of angel investors and we find that there is usually two major challenges with the early stage business.
1) The CEO/owner/inventor is usually the brains behind the idea and the business is their “baby”. But there is another role that must also be added and that is a leader who know how to run the business. These roles usually are two different people
2) Most early stage businesses looking for that seed capital do not understand the “language of capital” or how to attract an angel investor.
Thank you for your article because it provides an insight to the good folks looking for angel investors to begin to understand what it is all about. As you probably know, the start up companies struggle where and how to find that first or second round of seed money.
Curtis Johnson wrote:
Thks for the responses… Im looking for specifics… glad a book is coming… if you can rememeber to let me know when its complete it, maybe Ill get one. however for now, Im looking for tangible specifics, (thks but I know its like getting married.. not really very helpful).. Give me 10 examples would be a good place to start (or a good article).. CJ
Larry Jean-Baptiste wrote:
I just wanted to commend you on your article, I was actually approached by a broker that required $220,000 to fund us. It sounded quite rediculous but after reading your article it solidified my opinion. Thanks for the help.
MARCO Cardoso wrote:
Dear Earl,
You are a recognized authority in world of providing capital. I feel that your leadership role could incorporate that corrective action.
I am nothing the in the world of providing capital. Whenever in our little deals I have the pleasure of meeting persons that call themselves angels (or call others angels) I try to reason with them and so far all of them agree with the need to change the use of the word. Recently friends of mine that are establishing their vehicle to operate in providing capital industry are thinking to change de name of company as clear indication to the market that they are not what “angels” are.
If I would not understand you as reference in the providing capital industry I would not have share this humble though.
Have a great week.