Nov 112014

Dr. Earl R. Smith II


I want to state at the very beginning that most angel investors I have worked with do not fall into the categories that follow. For the most part, they are honest, professional and dedicated to helping their portfolio companies thrive. To the extent that they have foibles, they are no better or worse than the rest of us. This article is about that small percentage of angel investors that can really give you heartburn and seriously damage your chances of building a successful business. Here are some of the types that you should avoid.

The Shadow CEO: The Shadow CEO is often a retired executive who has had significant success in the past. Some of them have run very large organizations successfully and retired with fat separation packages that they are using to fund their activities as an angel investor. To be clear, I have seen such people act very effectively as angel investors. But there are a small percentage of them that are control freaks. Their tendency is to invest with inexperienced or weak CEOs and manipulate them much as a puppeteer would. They pull the strings and, at critical moments, assert their dominance. The basic problem with this type is that they never allow the CEO or management team to grow. The team is always ‘my kids’ and dominated by the Shadow CEO. One characteristic of the portfolio companies of this type us that they tend to stay small and have limited success. Quite often, they simply limp along until the Shadow CEO looses interest and stops funding the company. One particularly insidious characteristic of the Shadow CEO is that, in the end, it is all about them. If the CEO or team begins to get too much of the limelight, they are likely to slap them down and reassert their dominance.

The Crazy, Rich Uncle: These are the toughest angel investors to walk away from. One of the reasons is that they are generally so accommodating and easy to get along with. A good early indication that you are dealing with a Crazy, Rich Uncle is the almost total lack of insistence on any performance metrics for you or your team. At first the freedom from performance metrics might feel pretty good, but the long term effect is that it is much harder to get your team to perform at its best. The reason is that their performance is not a factor in the continuing funding decisions made by the Crazy, Rich Uncle. There are some dark sides to this type through. Many of them are micro-managers and want to constantly second guess your smallest decisions. They might style themselves as a ‘mentor’ but their real intention is control much like the Shadow CEO. Their ‘mentoring’ can absorb substantial chunks of your time and energy. A second type of Crazy, Rich Uncle is the has-been who is seeking to relive their early life successes through the next generation. I call these the ‘Little League Dads and Moms’. They treat their portfolio companies and the management teams as their children who they are molding in their own image. Well, I suspect you can see where that will lead you.

The Gaggle: One of the most significant trends in angel investing has been the professionalization of the groups of angel investors. Most of them have adopted policies and procedures that are common with the larger and later-stage venture capital funds. Some of the most effective and successful angel investors are part of these groups. But there are still echoes of the past to be found here and there. Successful angel investors are prudent, disciplined and professionally organized. The Gaggle is completely the opposite. They seem to fly by the seat of their pants and make decisions based more on emotion and gut feel. This is the source of one of their principal weaknesses. They are often committed today and looking for a way out tomorrow. A good indicator of The Gaggle is a very unstructured and unprofessional decision and diligence process. This signals a lack of seriousness and business savvy. They generally give themselves away through the questions that they ask. Most are superficial and are not followed up with deeper probing. A Gaggle will often waste your time and energy with an extended diligence process that ends up with them deciding not to invest. For many of these groups, this is their social time and you are their entertainment for the evening. Look out for loosely drawn ‘investment criteria and policies’ as they are a clear indicator that you are dealing with a Gaggle.

The Bottom Feeders: Bottom Feeders are predatory from the very beginning. Their real focus is on control of the intellectual property (IP) that you have or are developing. Often they will supply just enough funding to support the development of the IP and little or none for the monetization of the value proposition. The reason is that any monetization will work against their primary goal. Their goal is not to try to help your company grow; instead they make their money through intimidation, threats and lawsuits and eventual control of the IP. Bottom Feeders know you do not have the resources to fight them; mostly because they are controlling the resources you have. They know you will have to settle and, most likely, meet their demands. One of the best indicators of a Bottom Feeder is a history of bringing lawsuits against the principals of their portfolio companies. As a matter of course, it is prudent to do a search of the court records in the jurisdictions that the investor’s portfolio companies operate. A bloom of suits will be a good indicator that you are dealing with a Bottom Feeder.

The Lead Broker: This is a particularly insidious type. The Lead Broker often puts themselves forward as a wealthy investor looking for good companies. Their initial pitch may be focused on their own ability to provide investment funds. But, as your conversations continue, the emphasis shifts. One form of Lead Broker will end up asking for a retainer. Once they have demonstrated some enthusiasm for your company, they suggest that the funding requirements exceed their capabilities. But not to worry; they will fill the need in return for a monthly retainer and success fee. They often promise to put their own money in along with their ‘friends’ investment. I have known Lead Brokers who regularly put in as little as ten percent of the total funding but try to keep themselves in a central position on the board of directors or as spokesman for the investor group. The truth is that you do not need these guys. If your company is investment quality, take it directly to the angel investor groups in your area and avoid the overhead.

The Good News

The good news is that there are a lot of highly professional angel investors around. They do not fall into any of the above categories and consistently bring real value to their portfolio companies. One very useful rule is to avoid individual investors where possible and gravitate towards those highly professional groups of angels. It is often very easy to identify them. Most of these groups have websites which describe their interests, investment policies and portfolio companies. This makes your diligence much easier. If you focus on credible, professional investor groups, your chances of developing a productive relationship with a source of funding goes up considerably. Remember to push your diligence beyond the investor group. Good angel investors, once they have decided that they have an interest in investing in your company, will always facilitate your diligence. Most professional groups will be glad to introduce you to the senior management of their portfolio companies. This is your chance to find out what it is like to deal with the investment group from people who have first-hand experience.

© Dr. Earl R. Smith II

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