Working with Angel Investors:A Shared Experience from Northeastern Minnesota

Community development venture capital funds and the nation’s private individual investors, or "angels," share many investment preferences: for early and seed stage companies, within a defined geographic region, and generally in amounts less than $1.0 million.

By:
Kelly Williams
Community Development Venture Capital Alliance
Duluth, MN
http://www.cdvca.org

There is increasing evidence that both groups also prefer to co-invest, when it is possible, and to that end, a few CDVCA member funds have set out in recent years to develop relationships with wealthy individuals in the communities they serve. Northeast Ventures, in Duluth, Minnesota, has taken this concept a step further. It has established a network of experienced angel investors and wealthy individuals in its community, who if not already experienced investors, can learn about this activity and its potential impact on Northeastern Minnesota and then hear about investment opportunities in companies that offer good jobs in the region, all while enjoying a nice lunch in a relaxed and pressure-free atmosphere.

Northeast Ventures Corporation ("NVC") is a community development venture capital fund that serves seven counties in northeastern Minnesota. NVC and its nonprofit affiliate, Iron Range Ventures, have a combined capitalization of approximately $15 million. Nick Smith, NVC’s founder and Chairman, Greg Sandbulte, NVC’s President, and Mark Phillips, NVC’s Vice President, each have in excess of 25 years of business experience in the community and each maintains a large list of contacts that helped start the angel network.

Trends in Angel Investing

The primary source of capital for early-stage companies has always been individual investors, and, in spite of the turmoil in the private equity markets over the past two years, there are signs that angel investing and angel networks in particular are gaining in popularity. Jeffrey Sohl, a professor at the University of New Hampshire’s Center for Venture Research, estimates that in 2001 angel investors numbered 350,000, and invested between $30 and $35 billion in close to 50,000 ventures in the United States.

While the number of active angel investors peaked along with the stock market in 2000 at approximately 400,000, there are significantly more individual investors today than in the years prior to 1999, and the number of organizations dedicated to offering angel investors services and investment opportunities, or "portals," grew by an astounding 60% between 1998 and 2002. Venture forums and personal networks are the most common types of organization, which, according to Professor Sohl, is evidence of the importance of personal connections in building a successful network and the hands-on nature of this type of investment activity.

Reaching out to local angel investors can enable a CDVC fund to leverage its own capital to achieve its social mission. Further, angel investors are typically "hands on" types, often entrepreneurs themselves, who can bring with them particular industry expertise and contacts that the fund itself cannot provide. Entrepreneurs often state that the value of an angel’s expertise often exceeds the money put into the company.

CDVCA’s 2001 Annual Survey of its member CDVC funds revealed that the average investment by a fund was between $250,000 and $400,000, in either a seed or early-stage company. Professor Sohl’s research shows that in 2001 "Start-up" and "Early Stage" are still the most popular kinds of investment by a typical angel investor, and that the average investment size was $806,042 and the medium was $450,000. Co-investing is also a common preference of CDVC funds and angels: 92% of CDVCA’s respondents said they hope to do more co-investing in the future or maintain the same level of co-investing, and, according to Professor Sohl, 84% of traditional angel investors preferred co-investing to going it alone in a deal.

NVC’s Experience

Over the past three years, Northeast Ventures has hosted a series of investor luncheons and networking events that has led to the compilation of a list of approximately 100 angel investors who will consider equity investments in northeastern Minnesota. To date, more than $300,000 in equity financing has been raised through the network for NVC portfolio companies. NVC hosted two networking events in 1999, five in 2000, three in 2001 and six in 2002, in various parts of Northeastern Minnesota served by NVC.

After a period of trial and error, NVC has settled on a format that begins with 30 minutes of informal networking, and then two company presentations during a lunch followed by a short talk by one of the investors, who talks about his or her experience as an angel investor. Because there are no other angel networks with operations in NVC’s community, the events have focused on the concept of angel investing as much as the actual deals. Presenters are NVC portfolio companies, other local companies seeking capital, and sometimes non-local companies that are seeking money for operations to be located in NVC’s service area, such as Airmax Airlines, Inc., a start-up seeking to inaugurate service between the Twin Cities and airports in northeastern Minnesota. Lunch is free and by invitation-only. Attendees are encouraged to refer acquaintances for future events.

The most recent meeting was December 9, at the Kitchigammi Club Dining Room in Duluth, Minnesota. Twenty-four accredited investors enjoyed fettuccini alfredo with seafood and heard presentations from PureChoice, Inc., a web-based monitoring company with patented technology for the measurement, transfer, storage and presentation of indoor air quality information to customers via the Internet, which was seeking $12.0 million of subordinated debt financing for expansion. PureChoice is not an NVC portfolio company, but was referred to the network through SoftCenter, the technology center in Duluth, Minnesota, where, if they are successful in raising money, they would consider locating part of their operations.

Also presenting was Motherlode North America, based in Grand Rapids, Minnesota, which provides web-enabled products and services that streamline transactions between companies in the forest products and mining industries. Motherlode was seeking $500,000, and was referred by a software consultant who is also an angel network member.

NVC portfolio companies that have made presentations at past events include Kasson Manufacturing, Inc., the nation’s third-largest manufacturer of pool tables, Accelerated Payments, Inc., an outsourcing provider of back-office functions and Sinex Aviation Technologies, an on-line provider of airline maintenance services.

What it Takes to Make an Angel Network Succeed

Since the inception of this program, NVC actively solicited feedback from attendees, which was quickly incorporated to improve the events. "Attendees prefer brief presentations, an opportunity to schedule private meetings with entrepreneurs, and clearly defined term sheets with easy to understand valuation information," said Mark Phillips, NVC Vice President and an organizer of the events. While every effort is made to keep the events pressure-free, informative and enjoyable, experience has taught the organizers that some follow-up can be useful and welcome: "Investors appreciate a phone call or brief written follow-up to gauge their interest, in case they were unable to attend the presentation," says Mr. Phillips, " We try to keep people informed and connected, without pressuring them."

Mr. Phillips attributes the success of the network’s fundraising for NVC portfolio companies in part to efforts to encourage the companies to structure proposals likely to appeal to angel investors. Specifically, investment opportunities have been structured as subordinated debt, or as preferred stock with put and call options. Kasson Manufacturing, for example, was seeking a Series B round of preferred stock with put and call options and an automatic conversion to common stock at a future date if neither option had been exercised. Mr. Phillips believes that their investor group is less likely to be interested in a deal that is structured without an exit possibility or an interim return.

To be certain, establishing a network of angels is not without difficulties. First, it takes an extended effort to start an angel network. Nick Smith, NVC’s Chairman, estimates that it took at least two years to really get the group rolling and give it the momentum that it now has.

Second, expectations need to be realistic, especially at the outset. Professor Sohl estimates that in 2001, the percentage of investment opportunities brought to the attention of investors that resulted in an investment (called the "investment yield ratio") was approximately 10.79%, or one in ten. 2001 may represent a significant retrenchment from previous years, however, and yield rates in the future might be higher: in 2000, at the height of the Internet stock bubble, yield rates at angel investor networks were as high as 23.36%, while in 1997 and 1998, the years preceding the bubble, yield rates were 12% and 14%, respectively. Also partly responsible for the low yield rates in 2001 might be the fact that 2001 survey results of angels also show that angels are lengthening the time devoted to due diligence, from an average of four months to five, or 25% more time, compared to 2000.

Mr. Phillips estimates that NVC’s investment yield ratio is about the same, or slightly higher, than the networks studied by Prof. Sohl. While NVC closely tracks investments in its portfolio companies, because the network is informal it is less certain about how many companies outside its portfolio that have made presentations to its network have received money. Nonetheless, NVC believes that the overall impact on the region has been significant and it plans to continue the network well into the future.