The Secret to Angel Investing

Each day I have the opportunity to talk with energetic entrepreneurs with new business ideas. I hear stories about the difficult funding markets for early-stage companies. Since the technology markets crashed in 2000, it has become increasingly difficult to raise capital, particularly for early-stage companies.

By:
Chris Starr
Innovation Philadelphia

http://www.nasvf.org/web/allpress.nsf/pages/8431

There are several reasons for this. First, venture funds have become quite large by historical standards, and must pursue larger, and generally later-stage, deals to effectively deploy their capital. Second, many venture funds have become quite risk averse, due to the financial markets, and are seeking deals which are more mature and closer to exit stage.

This has created a funding gap which spans between "friends and family" money and venture capital rounds. As a result, there are few places to go when someone is seeking $250,000 to $2.5 million. Such rounds are often beyond the means of friends and family money, but are often also too small (and the companies too early-stage) to get venture capital money. This is where angels come in.

Angels are "high net worth" individuals – rich people. More than that, they are rich people with an interest in investing in young private companies and in search of very high returns. There are over 300,000 active angel investors in the United States investing about $30 billion a year, roughly the same as professional venture capitalists.

Angels come from many backgrounds. Angels may be business executives, cashed-out entrepreneurs, service providers, etc. They also have many motivations for investing in start-ups. Some invest purely for returns, some to support fresh entrepreneurs, some to support their community, and some invest to simply "stay in the game." Most angels invest for several of these reasons combined.

You may want to consider angel investors because the right investor can add significant value to a start-up enterprise. They generally have a great deal of experience and will be able to help you avoid mistakes. Their contacts may enable introductions to potential customers, funding sources (other angels and venture capitalists), partners, and maybe even acquirers. The right angel can add a great deal of credibility. Some angels may even shoulder some of the intense workload of a management team in a young company. Of course, the angels also invest, providing your company with precious cash, but this should not be the biggest factor.

The first step in finding angel investors is to decide which angel characteristics are best for your enterprise. While some may say that anyone with the money to invest is sufficient, you should be more selective. You should assess the strengths and weaknesses of your venture and try to find angels who will add the most value to your company and ideally help fill weaknesses and build on strengths. For example, if you are weak in operations expertise, an angel with industry operations expertise could add great value to your company.

Angels are everywhere. The problem is they usually do not advertise the fact that they are angels. By understanding how angels like to invest, you can devise a strategy to reach the right angels for your venture. Angels tend to be of two major types – solo acts or pack hunters. Solo angels like to invest on their own and are generally highly confident in their ability to select good investments. Solo angels are often difficult to identify and are best approached by referral. The best way to get to such solo angels is through good old-fashioned networking. Angels are often secretive and take calls only from people referred by trusted associates. Lawyers, accountants, and business executives in your industry will know angels that might be a good fit for your venture and may be willing to make the introduction on your behalf.

Other angels prefer to hunt in packs. These angels have formed angel investor groups or invest through angel venture funds. They value the input received by other investors and prefer to share due diligence efforts and share risks among the group. These groups are often easier to identify, as many have a web presence and promote themselves for deal flow. Be sure to receive an introduction from a trusted source. Angels organized in groups are often inundated with business plans, and use referrals as a screening mechanism to identify higher quality deals. Group angels may be particularly attractive because of the access to multiple angels, each with unique experience and contacts.

Regardless of whether you are pursuing solo or group angels, do your homework. Know what types of deals they are looking for to save time. When you do meet, be sure to interview the angels to get a sense for their experience, contacts, and whether they can add value and become a trusted resource to you.

Most angels are looking for similar characteristics in the deals they select for investment. The biggest decision factor that angels analyze is usually the quality of the management team. Just as "location, location, location" are the three keys of the real estate business, "management, management, management" are the keys of the early-stage investor.

Assuming a quality management team, angels look at other factors such as: a large and rapidly growing target market, sustainable competitive advantage, differentiability, evidence of early customer traction, likelihood for future investment, expected time to exit, multiple exit opportunities, compelling business model, etc. If you can clearly address each of these factors, you should have a reasonable chance of raising angel capital.

Understand that this is a numbers game. Investors invest not only based on business judgment, but also on emotion and may reject deals for strange reasons. Do not let this stand in your way. Identify angels that can add value to your business and pursue them all. Do not be deterred by any one angel’s disinterest. The more people you contact, the higher the likelihood of success.

Angels will have expectations based on your promises and discussions during the due diligence process. The key with angels, as with all investors, is to foster a positive business relationship based on trust and communication. Once an angel invests, their interest is aligned with yours – increasing the value of the company. Most will work hard to do so. Without high levels of trust and communication, they will be unable to assist the company effectively. You need to convey information quickly – bad as well as good.

Start-ups are fragile and issues need to be addressed quickly so as to prevent big problems later. Angels expect hurdles and difficult times, and understand the process. They will not, and should not, understand if information is withheld or hidden. Be up-front and direct, and most angels will help you overcome your hurdles.

Angels usually expect to have a say in the way the business is run. They expect it because their dollars are on the line and because they believe their experience is valuable. Frequent communication with your angels will let them know you are keeping them in the loop and that you appreciate their feedback. Additionally, these interactions lead to more trust and better communication.

In an often-difficult funding market, angel investors are an entrepreneur’s best resource for implementing and funding a business plan. The constant competition for funds between growing companies and start up companies lead young entrepreneurs on a world tour trying to locate funding sources. Angel investors help eliminate this problem. By finding, understanding, communicating, and building relationships with Angel Investors, start-up companies can depend less on "friends and family" and rely on accredited and experienced investors.