Sizing up angels and exiting businesses gracefully

The MIT Enterprise Forum of Pittsburgh sponsored a special educational seminar designed to encourage and facilitate angel investment in the Pittsburgh region. Session topics included evaluating investment prospects, pitching companies to prospective investors and anticipating and resolving conflicts between angel investors and entrepreneurs.

By:
Steven N Czetli
Pittsburgh Post-Gazette

In a session directed at both angel investors and entrepreneurs, Tripp Peake, managing partner with venture capital firm Long River Ventures, identified key issues investors use for evaluating investment prospects. They are: Good, growing markets; differentiation of product or service against the competition; evidence of demand in early adopters, early revenues; strong management team; viable business model; reasonable launch and long-term strategy; and good parameters for an investment deal.

Sometimes, businesses can meet these criteria, but fall short in other ways. Signs of trouble identified by Peake included:

* Absence of a business plan or operating plan.

* Failure to monitor and track operations against the plan.

* Incomplete or inaccurate financial statements.

* Infighting among founders or funding team.

* Unpaid company payroll tax withholdings or delayed tax filings.

* Large and/or late accounts receivable.

* The savior mentality — "All we need is a new VP of sales, and the business will turn around."

* The miracle mentality — the optimistic point-of-view that some unforeseen future event will save the business.

* Rolling pipeline — the sales pipeline appears to be continually robust, but prospect names roll past and fall off the end.

* Constantly changing scope and time frames in the development process (scope creep, scope shrink, milestone redefinition).

Whetting the appetite

"When an entrepreneur identifies a potential investor," a session for entrepreneurs, helped to answer the question: How can you most effectively sell your investment? Panelists included Nick Kuhn, CEO of ALung Technologies; Andy Hanna, CEO of PolyTronics; Babs Carryer, president of LaunchCyte; and Paul Vittone, chief investment officer of Innovation Works, with Jack Roseman of the Roseman Institute moderating.

Roseman noted that, to an investor, a company is a black box that produces money. If your company is likely to produce a given rate of return, how much is an investor willing to pay for it? Roseman added that investors evaluate two primary factors: upside potential vs. risk.

Kuhn stressed the importance of having a business plan, and suggested that entrepreneurs look for angels in similar fields. "Use your network to look for angels. After you acquire interested angel investors, they often bring their network to you — angels will sell their friends on investing in your company."

Carryer suggested that entrepreneurs have a story — a compelling, complete story with a beginning, middle and end. "Angels, as a group, are risk-averse. Deliver a compelling story that has the effect of lowering investors’ perceived risk."

Hanna said an entrepreneur’s ability to raise angel capital is directly dependent on the angels’ confidence that the company will succeed in raising the next round of financing. Investors want to know the prospects for a company if and when the company hits its milestones.

The secret lives of angels

Who are the "real people" behind angel financing? What is the typical profile of an angel investor? Where can an entrepreneur find an angel investor?

At last week’s MIT Enterprise Forum day-long seminar about angel investing, Bob Meeder of Pittsburgh Gateways Corp. provided a profile of the typical angel investor and helped to set entrepreneurs’ expectations about angel financing.

Statistically, angels look like this: 48 to 59 years old, white, male, with a postgraduate education, often in a technical field.

Most have previous management experience and have started, operated and/or sold a business.

Most angel investments are between $25,000 and $250,000, though more frequently at the lower end of that scale. Most angels are active in fewer than four deals at any given time.

Typical income for an angel investor is more than $100,000. Income, however, is not as important a qualifier as net worth. Many are self-made millionaires.

Most angels learn of investments from friends and trusted associates. Efforts to facilitate communication directly between angel investors and entrepreneurs are usually unsuccessful, according to Meeder. Personal connections remain the most prevalent way that angel investors initially find companies in which to invest.

Although angel investors seek a return on their investment (typically 22.5 to 50 percent), financial gain is not the only, and in most cases not the most important, motivation. Angel investors enjoy participating with other financially sophisticated individuals, and tend to prefer deals that match their expertise. They tend to actively participate in the companies in which they invest.

If you’re researching the market for your business –any business — you’ll find plenty of useful information on the Internet. But if you’re serious about getting the inside scoop about customers, competitors, suppliers, industries and individuals, you’ll need to go beyond Yahoo!, Google and anything out there for free. And that can get expensive.

However, if you make use of your local public library system — and take advantage of the state and regional grants that have been used to buy them licenses to a variety of premium information services — you can learn a whole lot more for little or no money. Not only that, just by using your regular library card as a password on the library’s Web site, you can log into many of those services from your home or office PC. And if you don’t have a current library card, you can apply for a free one online.

At a workshop last week at Pittsburgh’s Carnegie Business Library on Wood Street, librarians Roye Werner and Dorothy Kabakeris introduced part of the rich assortment of electronic directories and online databases, as well as special CD-ROMs and printed documents which patrons of their library, and of various other public libraries throughout Allegheny County, have available free. And, of course, the library’s own professional staff, who use those sources every day, are also on hand to show neophytes how to find what they seek.

Graceful exits

Departing a successful business can be frustrating or satisfying. The difference often depends on the planning you do and the advisers you pick to help shepherd the process. Three specialists in specific aspects of the exit process offered tips to obtaining maximum value for your enterprise at a Carnegie Business Library luncheon lecture last week.

Consultant and business author Suzanne Caplan warned against counting on family succession to solve the problem.

"Too many owners simply grab the nearest child and pray they won’t run it into the ground," said Caplan.

The problems with succession in businesses are staggering, she said. Only one in three second-generation businesses succeed, and it jumps to one in 16 for third-generation successes.

"On top of that, too many owners simply say, ‘You run the business and send my checks to Florida,’" said Caplan. "And when the business doesn’t go well and the checks stop coming, you not only have a financial crisis but also a family crisis."

Caplan said if the succession option is used, owners and their successors should establish a fixed payout schedule with everything in writing.

Another exit strategy is sale to an outsider. This could be an asset sale — if the assets of the business are worth more than the whole — or a stock sale, meaning the entire business is sold, Caplan said.

A third strategy is to merge with another company. According to Caplan, one interesting advantage to a merger is the possibility of future employment for the old owner, either in a continuing role or as a consultant.

Yet another possible exit strategy is to sell it to insiders of the company, either through an established buy-sell agreement or — if the company is large enough — through an employee stock ownership program.

Last on Caplan’s list was IPO — which is an option for only those companies with large and growing markets. "Going public is a very costly and complex process involving a lot of professional fees," said Caplan. "Really, going public is best geared for really high-growth companies, like biotechs."

Protect value

Attorney Alan Cech advised identifying and securing all assets that add value to the business. Trade names and logos are one area that has immediate value, said Cech.

Other key assets that many owners overlook are such things as business telephone and fax numbers.

"I probably have 10 phone directories in my office and at least two of them are over a year old," said Cech. "If your business has been in existence for any length of time, you have no idea how many phone directories, Rolodexes, auto dials and other listings your business number is in. That makes it an asset."

Another area of potential value is a company’s current employees.

"A new owner may want the security and knowledge that employees will stay, and won’t become competitors," said Cech. In a case like that, employment contracts — particularly with key employees — would be valuable assets.

But Cech warned that employment contracts can be a double-edged sword, particularly if a new owner does not want to be burdened by employment contracts and existing employees.

Establishing value

CPA Dave Wilke said there are three valuation methods used in selling a small business:

Asset value

Cash flow, or EBITDA

Market value approach

Asset value looks strictly at the value of assets held by the company. Cash flow looks at a company’s earnings before interest, taxes, depreciation and amortization (EBITDA) and seeks to sell the business for a multiple of that cash flow. Market value takes into account sales of similar businesses.