Why Angels? Why Now?

When Rich Hansen looks at possible business ventures, he studies the financial reports and the market potential for a young company. He looks at the business model and the management team.

By:
Jennifer Pittman
Silicon Valley Business Journal

Like all good angel investors who are risking the game of early entrepreneurial funding, he does due diligence.

Entrepreneurs need early cash to move forward, but they need a lot more than that. They need business experience, connections, and people to actively pursue leads for future funding rounds.

In addition to mentorship, angel investors, or angels, help them ground an entrepreneur’s passion in market realities. For these reasons, angels are often invited into young companies based on their own entrepreneurial experience.

Like many seasoned angels who are emerging from the dog days of the economy with a cautious outlook, Mr. Hansen, who’se invested in eight companies, says it’s an excellent time to invest.

"Some of the best companies in the world today were funded in the worst downturns," he says Mr. Hansen, who co-founded Monterey Bay Band of Angels. "Companies that get funded today are very likely to be the stars of tomorrow."

He offers only one caveat: It can be extremely difficult to secure a second round of funding. If Round Two doesn’t come in time, angels risk losing an investment. That brings him back to the importance of due diligence.

Angels provide some of the earliest seed funding that young companies ever see. They risk the most investment. Unlike a silent partner in an equity investment, there are no curbside seats for angels. They usually climb into the boardroom, hold hands with a CEO and shepherd entrepreneurs through a maze of strategy sessions toward the next round of funding.

"Angels do it as an avocation," says Fred Hoar, co-founder of the Band of Angels in Palo Alto, the first angel investor group of its kind in Silicon Valley. "Generally it’s more ‘patient’ money. In some ways, it’s more forgiving. It’s a compliment to, not a supplement to, the venture capital community."

For angel investors who have been in the game awhile, taking advantage of opportunities today is hampered by the lack of liquidity events for previous investments. They often have to decide between making new investments and supporting their old investments with more cash.

Investments that were often between $25,000 and $250,000 in recent years have dropped to as small as $5,000 to $25,000 in any one round, several angels say.

Yet the number of entrepreneurs has more than doubled and the deals have rarely been as positive for angels, according to Hal Nissely, founder of International Angel Investors in Los Altos.

Mr. Nissely has invested in 54 startups and served on the board of directors of two dozen for-profit companies.

Deals are better than ever for angels because entrepreneurs are more seasoned as managers, he says. Likewise, angels are wiser, Mr. Nissely says.

In spring of 2000, the average angel or seed round was approaching $2 million. "Today, if the entrepreneur gets money, it’s about $500,000 for the average round," Mr. Nissely says. "Not only do the angels get far more equity for their $500,000 but also the angels, through their various associations, have better terms."

Angels now insist that entrepreneurs put back 80 percent of their equity into escrow accounts that vest over 60 months. They reserve bargaining leverage by investing in convertible notes with equity attached so they have the option to demand principal back in three years and still keep equity in the company, based on interest payments in the form of common stock into the company.

Angel investing "is a family matter," says Mr. Nissely. "[Angels] have to be willing to cancel a weekend at Palm Springs for golf and spend a weekend with a troubled entrepreneur."

http://www.bizjournals.com/industries/banking_financial_services/venture_capital/2002/09/02/sanjose