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‘Angel’ Investors Grow More Active, But Now They Are Also More Picky

Since venture capitalists have put the brakes on investing in startup companies, angel investors are in the
driver’s seat — and they’ve grown very choosy about who they’ll bring along for the ride.

By STACY FORSTER
THE WALL STREET JOURNAL ONLINE

Named after the so-called Broadway angels known for funding plays and musicals in New York, these
wealthy individuals give fledgling businesses the time and money they need to grow and mature in return for
stock or a share of the profits.

Many VCs and angels got burned as the tech bubble burst, after throwing too much money at risky business
ventures that eventually went belly up. But while venture-capital money has dried up over the last year,
angels continue to pump money into startups.

"It’s the bottom of the cycle," says John May, head of the New Vantage Group in Vienna, Va., which
manages venture funds for early-stage investments. "The good news is that it’s a broader base of angels …
and a healthier entrepreneurial structure than we saw a few years ago."

There were about 400,000 angels investing some $40 billion in about 50,000 seed-stage ventures a year ago,
the Center for Venture Research at the University of New Hampshire reports. That number now stands at
about 350,000 angels, investing $30 billion in the same number of companies.

Conversely, venture capital has fallen off sharply. In the fourth quarter of 2001, VCs invested just $7.1 billion
in new companies, according to the National Venture Capital Association, down 65% from $20.4 billion in the
same period a year earlier. Venture-capital firms are investment companies that invest their shareholders’
money in startup businesses.

Angels say that while they haven’t cut back sharply on funding they’ve become more judicious in where they
invest, with many listening to pitches from "institutional-quality" companies only. What they’re looking for
from entrepreneurs, says New Vantage Group’s Mr. May, is a recipe straight out of a business-school
textbook: talented management, solid revenue and a proven track record.

Companies that have managed to survive the bursting tech bubble are particularly attractive to angels. Years
of development mean these companies are built on stronger foundations, and much of the risk has been
removed, says Jason Wright, an entrepreneur and principal in New York’s Geer Mountain Holdings.

Elaine Gilde, president of Grove Street Capital, has seen both sides of that coin in recent months. First,
there’s StatCard Entertainment, a Norwalk, Conn., startup that makes smart-card technology used in
computer games for children.

She was impressed enough by the management team’s toy-industry experience and track record with
marketing and licensing games to invest in two different rounds of funding.

But last month, an entrepreneur approached her with a specific idea for improving security screening at
airports. Ms. Gilde talked to him for about a half an hour, but wasn’t convinced he knew enough about the
business and passed on the opportunity. "He had zero idea about the market for security products," she
says. "You can’t invest in something to have someone learn a business — it’s too risky."

The tell-tale sign is the amount of resources an entrepreneur has put into the developing a business. If there’s
no blood, sweat and tears on the ground, they’re not interested, angel investors say.

Ms. Gilde recalls receiving two business plans from the same entrepreneur at the same time. "This isn’t like
funding a movie script," she says. "You can’t say ‘I wrote a few stories, which one do you like?’ "

But if an investor knows that a company’s founders have invested their own personal capital, or gone so far as to recruit equity from family
members, forego salaries or make personal sacrifices, those business plans often are among those that get the green light, Ms. Gilde says.

More importantly, an investor needs to understand the fundamental business or product well enough to consider it a hobby, says John Sanders,
an independent angel investor in Washington, D.C.

Mr. Sanders recently helped round up financing for the husband-and-wife team that founded Metier, a project-management software company in
Washington, D.C., that counts among its customers the U.S. Census Bureau, which used the company to create schedules and coordinate
projects for census takers.

If investors know an industry well enough, they can size up the business’ fundamentals more effectively, industry watchers say. They ask: Is it a
marketable idea? Does the management team know what it’s talking about? Will the company need more funding? It’s much easier to answer
those questions if investors are looking at a company within their own area of expertise, investors say.

Indeed, one sure chance of getting shot down for funding nowadays is when an entrepreneur’s idea for a product or service strays from an angel
investor’s core base of knowledge — a sharp about-face from just a few years ago, when it seemed a business plan need only to include the
word "Internet" to attract funding.

One example: Not long ago, a Hollywood entrepreneur sent a business plan to Grove Street Capital’s Ms. Gilde for a Web-based platform to
manage movie productions. To Ms. Gilde, who focuses on technology applications on the East Coast, the entrepreneur was barking up the
wrong tree. "If the idea makes so much sense, why isn’t he talking to people in the movie-production industry?" she says.

A company’s past funding experience also provides insight about a prospective candidate. A history of financing from venture-capital firms is a
bad sign, says Alex Mashinsky, both an entrepreneur and angel investor in New York. To a potential investor, that signals that even a business’
previous investors have doubts about its future and are looking to stick someone else with the bill.

"If a venture capitalist has already put money in and isn’t willing to put in more, why would I want to jump into his shoes?" Mr. Mashinsky says.

Along the same lines, if a company’s been looking for funding for a long time, and not succeeding, it’s important to find out what’s holding the
business back. Angel investors are always trying to time an investment at the upswing of a hot sector, Mr. Mashinsky says. Their herd
mentality usually means that everyone wants to be in the areas where other investors are heading.

In the Washington, D.C., area, for example, companies gaining the most attention used to be business-to-businesses Internet applications;
now, it’s the eye-catching security or military government-contracting sectors, says Mr. May of New Vantage Group.

When a sector starts to take off, angel investors can be inundated with a number of similar business plans. The deciding factor often is the
maturity of the company, says Hans Severiens, managing director of Silicon Valley’s Band of Angels fund, which manages about $50 million.

Band of Angels last month put together $1.8 million for a $4 million round of financing for Fidelica, a Milpitas, Calif., company that’s developing
an inexpensive fingerprint sensor to be used as a security device on cellular phones or laptops.

A number of companies promising different versions of the devices have searched for funding, Mr. Severeins says, but none of them are as far
along in delivering the product as Fidelica, making it an attractive play. "The technology is under control and they’re able to go into market in six
months," he says.

But no matter how attractive a company’s prospects appear, an element of guesswork remains. For Fidelica, a question mark looms: "It’s an
interesting company, but we have yet to find out if the market is going to buy it," Mr. Severeins says.

Write to Stacy Forster at [email protected]

http://online.wsj.com/article/0,4286,SB1018969104633734800,00.html?mod=TOPIC

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