Thursday, October 15, 2009

Tips for Attracting Angel Investors

Tips for Attracting Angel Investors

Entrepreneurs often find financing their vision is one of the more difficult challenges in launching a new venture.  While bootstrapping is available as a means for many to develop the idea and perhaps even launch the company, most entrepreneurs quickly recognize the need to find investors who believe in their vision and are willing to invest the funds necessary to finance the company’s continued development and growth.  For most early stage ventures, the most likely investors after the friends and family route has been exhausted are angel investors.

Angels are a distinct class of investors.  They are individuals who can financially afford to indulge their love of risk in exchange for the potential of higher returns on early stage opportunities.  Frequently, they seek out early stage investment opportunities that match their individual passions and interests.  To be an angel investor, one must be an “accredited investor.”  Accredited investor is a term defined by various securities laws that delineates investors permitted to invest in certain types of higher risk investments.  In the United States, for an individual to be considered an accredited investor under definition in the Securities Act of 1933, they must have a net worth of at least one million US dollars or have made at least $200,000 each year for the last two years ($300,000 with his or her spouse if married) and have the expectation to make the same amount in the current year.  In Canada, the same prerequisites apply, however one’s net worth must be a minimum of one million dollars not including the value of equity of the principal residence.


It is important for entrepreneurs utilizing angel investors to finance their venture to be certain that they are only approaching and accept accredited investors.  We strongly suggest to entrepreneurs seeking investor capital to use competent legal advisors to assist them with proper documentation and compliance with all securities laws and regulations.


While there has been some contraction of angel investor dollars in the current economic climate, there has been little change in the number of investments funded.  Total angel investments in 2008 were $19.2 billion, a decrease of 26.2% over 2007, according to the Center for Venture Research at the University of New Hampshire.  However, a total of 55,480 entrepreneurial ventures received angel funding in 2008, a modest 2.9% decrease from 2007, and the number of active investors in 2008 was 260,500 individuals, virtually unchanged from 2007.  This significant decline in total dollars, coupled with the small decrease in investments resulted in a smaller total deal size for 2008 (a decline in deal size of 24% from 2007).  In contrast to venture capital, in which money must be invested during the life of the fund and is in part based on the size of the fund, angel investing is an individual decision and angels invest from their net worth.  This data suggests that while angels have not significantly decreased their investment activity, they are committing fewer dollars resulting from lower valuations and a cautions approach in the current economy.


Angels often provide additional value beyond their investment dollars; indeed we encourage entrepreneurs to seek out angel investors with strategic value to the investment being funded.  Strategic value can come in the form of industry experience, executive knowledge, creative ideas, relationships with the target markets, or other contacts that can prove helpful to the company.  When targeting angles we suggest entrepreneurs consider the following guidelines.


  •  Build a convincing case – Angel investors may be willing to take on more risk than most, but they still need to see a well thought out plan with a product that has a documented “must have” need and a competent management team surrounding it.  It is rare that an entrepreneur can raise money from angels without clearly defining the competitive landscape of the business and how the product has a clear and unique advantage over competitor’s offerings.  Investors will want to know how the company will create and exploit barriers to entry.  Namely, how you will keep competitors from being in the same exact business or markets.  Some barriers to entry might include patents, trade secrets, and proprietary processes.  Additionally, it is not enough to have a strong value proposition and attractive market opportunity; entrepreneurs must have a winning go-to-market program that explains how the desired market share will be captured.
  • Create a prototype and line up beta customers to provide validation – Angels do get involved in the early stages of a company, but not usually before there is a working model of the product and potential customers have committed to test the product.  Having a prototype and initial customers signed will greatly increase your chances of attracting angel investors.  Demonstrating that you can get paying customers in the real world puts you far ahead of entrepreneurs who simply have a business plan and an idea.  Later stage companies need to show they have accomplished revenue growth matching target assumptions and have paying customers who validate their pricing strategy.
  • Founders need to have “skin in the game” – If you want to start a business, be prepared to invest your own money.  Entrepreneurs, who expect angels to risk money in their venture, better throw something into the pot themselves.  Those entrepreneurs who are not willing to assume such risk are not considered serious by investors, and will most likely not receive funding.  We generally suggest that the group of founders surrounding an opportunity be prepared to contribute twenty percent of the funding sought.  If the current founders cannot show that this investment has already been put into the business by the founders or are not prepared to make such investment, the likelihood of receiving the investment sought is considerable lessened.
  •  Be prepared to have “sweat equity” disregarded by investors – While investors appreciate the idea, effort to bring it to the current state of maturity, and any intellectual property that has been created, they often assign little if any real value to “sweat equity” in their opinion of valuation.  This is often at distinct odds with the view of entrepreneurs who tend to assign great value to their efforts to date and the idea.  However, we remind entrepreneurs of the “Golden Rule” – he who has the gold, makes the rules.
  • Focus your search for investors - Identifying angels who are suitable for your opportunity up-front will increase your chances of success.  To help you identify appropriate angels when pitching, ask them what they look for in a company, how much they typically invest, and what kind of return they expect on their money.  In addition:
    •  Concentrate on your industry vertical - Angels like to invest in companies whose business they know something about. Many angels, having previously been successful entrepreneurs, will tend to lean toward their prior industry experience.
    • Target investors interested in companies at your stage of development and your deal size - Some angels will only invest in seed or start-up companies, while others seek later stage ventures looking for expansion capital.  Angel investors will have a dollar range they are comfortable investing.  This can range from $25,000 to several million dollars.  We suggest limiting investments to a minimum of at least $25,000 and actually prefer a minimum of $50,000.  Truly accredited investors can meet this criteria and it is simply too hard to complete a raise of any size when taking smaller minimum investments.
    • Look close to home - Angels frequently want to be actively involved in your business and prefer to invest in companies they can easily keep an eye on and communicate conveniently with management.  Make it easy for them to do it in person by looking within a 50-mile radius of your corporate headquarters.  You may have to expand your horizons, but try to stick as closely as possible to your home community or region.
    • Look for risk takers – Since there's no such thing as a national directory of angels, you've got to put together your own list of prospective angels.  Look for other interests that might indicate a risk taker, such as skydiving, motor sports, sailboat racing, or adventure travel.  But remember just because someone is a risk taker, it doesn’t mean that they won’t do a lot of homework to control those risks.
    • First ask people you know The most likely angel investors for your opportunity are people who already know and trust you.  Once you have obtained some of the funding you seek from these people, they may well know others they can refer to your opportunity.  The first dollars raised after the founders’ money is often the hardest.  Momentum is important and early dollars will help to convince others of the soundness of the opportunity.
    • Be prepared for no’s – Experience shows that amongst qualified accredited investors with a history of making such angel investments and assuming that your opportunity is an attractive one, an average of only ten percent (1 in 10) of those approached will say yes.  So, be prepared for the nine no’s for every yes.  Don’t be discouraged but be realistic.  You will likely need a list of ten times as many potential investors as you require at the minimum investment amount in order to complete your raise.
  • Make connections and network constantly - While some investors do read business plans that come over the transom, plans referred to them by a trusted source, such as a business associate, lawyer or accountant get far more attention.  Other options to meet people with deep pockets are to present or at the very least attend a venture capital conference or angel club meeting.  Network to find out about these opportunities.  Look for local entrepreneurial network and support groups and attend meetings and network aggressively and constantly.  If you have a local university or college check to see if they have an entrepreneurial support program and seek out contacts there.  SCORE, Economic Development Associations, and other entrepreneurial support resources should be approached and networked as well.
  • Connect personally - Angels spend a lot of time with entrepreneurs especially in the early stages of building a company so getting along is crucial.  Chemistry covers whether you like, trust and are in sync with each other.  To have good chemistry you have to personally connect, and have similar expectations, vision, and objectives for the company.  Being able to answer angels’ questions without feeling threatened is also crucial.
  •  Be persistent and patient - Entrepreneurs must be committed, passionate, and thick-skinned.  Raising capital is a time-consuming, ego-challenging process.  It is not unusual for a startup entrepreneur to spend 50%-70% of his time raising capital from angel investors, a process that used to average 3-6 months at a minimum and in today’s more challenging economic climate is more likely to take even longer.
  • Do due diligence on the investors - Entrepreneurs should be just as choosy about who they take money from as the investors are about their investments.  Make certain that you really know your investors.  This is a partnership with a long life and it is important that it is a good one.  Understand his motivation and expectations for exit strategy and expected ROI (return on investment).  Know what added value they can bring to the table and make sure they understand this also and are prepared to offer us that value along with their dollars.  Knowledgeable angels with good connections can jump start a company and help it to thrive.  Well-connected angels can even make it easier to get additional rounds of financing from other angels or even venture capital groups with whom they have a relationship.
  • Don’t haggle over terms - Efforts to hoard stock and inflate valuations will make the company less attractive to investors.  Let experienced professionals – capital advisors, valuation experts, lawyers, and accountants - handle terms and valuations.  Heed their advice.  We often encounter entrepreneurs who are reluctant “to give away so much of their company to people who only contribute money.“  This is an extremely unhealthy and unhelpful attitude and often results in entrepreneurs who own 100% of a failed company.  If the company is a success, everyone will be a winner.  We often suggest placing stock in a “bonus pool” to be awarded to management or founders based on performance and results.  This often helps to make the investors more comfortable and retain a larger potential equity share for the entrepreneur if the company succeeds.
  • Communicate with your investors regularly and openly - Angels want to know how the company is doing whether the news is good or bad. Staying in touch by phone, email and even a monthly newsletter will keep investors happy.
  • Think like an investor – We always suggest the entrepreneur try to “think like an investor.”  Keep your investors interests and their perspective in mind.  They have placed their funds and trust in you.  The more you can successfully maintain their perspective the more likely you will maintain an excellent relationship with your backers.
© 2009, Harbour Bridge Ventures, Inc., All Rights Reserved

Friday, October 2, 2009

Financing Strategies - Some Basic Rules for Entrepreneurs

Financing Strategies – Some Basic Rules
When launching a new venture it is important for the founders to understand how to finance the enterprise.  The founding entrepreneur’s principal responsibility in this process is to make sure that the correct financing strategies are in place and well focused.
The founders should make sure that the financing strategies employed meet, at minimum, the following eight criteria:
1.     Now is the appropriate time to seek the financing desired
2.     The financing being pursued is adequate to meet the needs of the company
3.     All the materials required to support the financing request are professional and completed to a high quality level
4.     You have assembled an experienced and competent management team that can deliver on the plan
5.     The right financial instruments are being used and conform to all necessary securities laws and regulations
6.     The right sources being approached
7.     The optimum capital structure is being put in place to sustain the company and allow for future capital raises if they are required
8.     The company must be able to afford the financing being sought

There are many financing options available to most new enterprises.  In fact, in our experience the range of available options is generally much broader than the focus of most early stage management teams.
Many entrepreneurs complain to us of their difficulty in obtaining the financing they desire.  We have often heard from entrepreneurs expressions of not only frustration in obtaining the financing they desire, but also doubt that sufficient capital is allocated by investors to early stage opportunities.  While we understand their frustration, we would like to point out that there is no shortage of available capital.  In fact, in our experience the shortage is actually one of good ideas, pointed at viable markets, with a sound plan on how to tap those market opportunities, and surrounded by talented management teams that can seize those opportunities and execute well.  Even when all of those funding criteria exist, we often encounter entrepreneurs that have unrealistic valuation expectations and are unwilling to surrender sufficient equity to attract the capital they require.  It seems many would prefer to own 100% of a failed enterprise than a smaller percentage of a very successful one,
Our regular conversations with both institutional and angel investors confirm these observations.  We are aware of over a score of investment funds that have liquidated in the last 12 months, returning capital to their limited partners due to a shortage of qualified, attractive investment opportunities.  We regularly speak with VC groups who tell us about their difficulty in finding attractive deals that meet their funding criteria.
Financing Rules for Entrepreneurs:
  1. Get the Timing Right
Is now the right time to seek financing?  As in so many things in life, timing is all-important.  Is the first generation of the product or solution complete and market ready?  Is the product or solution market validated?  Have the first clients been obtained and are they enthusiastic supporters?  Is the company still in pre-revenue mode, or have you obtained some revenues, even if you are not yet cash flow positive?  Has the company built sufficient real valuation to support the financing being sought?  Do you have a sufficiently detailed and professional business plan and financing package to support the financing you seek?  Does your progress and achievement of milestones to date match the projections first described in the business plan?  Does the founding group have sufficient “skin in the game” or are you looking to have your investors absorb all or most of the risk?  We advise entrepreneurs to carefully evaluate the answers to all of the above questions before seeking financing.
In our experience, many entrepreneurs approach financing sources before they are truly prepared for either the conversations required with investors or lenders, or to properly employ the funds being sought to build the valuation of the enterprise at acceptable levels of risk to the investor or lender.  Alternatively, we also see entrepreneurial ventures wait too long to seek financing with the hope that they can bootstrap their way to success.  These entrepreneurs are sometimes victimized by the “hidden flaw” or simply too slow to launch to “break the pull of gravity” and fail to achieve “escape velocity.”  The need for financing suddenly becomes desperate and there is an insufficient fuse on the pending financial or cash flow crisis to allow time to complete a financing.  As a consequence the company fails.  Both of these scenarios are ones we have unfortunately seen promising entrepreneurial fall prey to many times.  Being careful to get the timing of your financing correct can help to assure not only the success of obtaining the financing on attractive terms to all parties but also help assure the success of the company.
  1. Amount of Financing Sought is Adequate
We often find entrepreneurs significantly underestimate the amount of capital required to drive the enterprise to the next level.  This happens for a number of reasons including the following:
·     The financial projections in the business plan are often overly optimistic and assume that everything will go according to plan – which is seldom the case.  We generally encourage entrepreneurs to build three sets of financial projections – best case, worst case, and most likely scenario, along with documented assumptions supporting each scenario.  When determining the financing required we will generally advice using something between with worst case and most likely scenario with a contingency factor built on top of that requirement to deal with unidentified risks.
·     The entrepreneur is reluctant to “give away” so much of his company and therefore desires to finance the business with as little capital as possible.  If the initial capital sought proves insufficient to reach “escape velocity,” it is often much more difficult to obtain subsequent financing on attractive terms.  This often results in a “down round” of financing, dilution of original investors, and ill feelings and unrest among the early investors and founders.
·     The natural and innate optimism of entrepreneurs causes them to assume that everything will go according to plan.  This is seldom the case in the real world.  As we have already said, we commonly advise the addition of a contingency amount to the financing being sought to accommodate unforeseen risks.
·     We have heard many times from entrepreneurs that “I can always get more money, if I need it.”  In fact, if the initial capital obtained is insufficient, the likelihood that more will be available is significantly lower.  In our experience it is always less difficult to raise somewhat more financing than you think will likely be required in the initial raise, than to have to go back a second time to get more capital after missing the targets set initially.
·     Be realistic, but think BIG.  We often see entrepreneurs seeking to build a “nice family-size business” providing a comfortable living for the founders and company management team.  These plans are unlikely to attract any form of serious financing other than a small, personally guaranteed, and secured loan from a bank.  Investors want to see a business with significant upside potential, not just one likely to afford a comfortable living for the founders.  At the same time it is important to be realistic.  You will be held accountable for the performance and projections in your business plan.  You should have a high degree of confidence if the company’s ability to achieve these results.
  1. The Package Supporting the Financing is Complete and of a High Quality
First impressions are very important when seeking financing from either investors or lenders.  If you make a poor first impression, you are unlikely to get a second chance with that source.  The materials supporting the financing request represent your enterprise to the prospective investor or lender.  If they are incomplete, lack sufficient detail, fail to answer the investors’ questions, inadequately explain the business and why it will be successful, fail to identify competition and explain what makes your company’s value propositions different, do not adequately explain your go-to-market plan, or identify risks and appropriate contingency and risk mitigation strategies; you are unlikely to get expressions of interest from either investors or lenders.  Entrepreneurial teams inexperienced in assembling a high quality package to support a financing request should seek professional assistance.  Once the package is assembled we strongly encourage it be reviewed and critiqued by experienced outside third parties prior to being provided to any prospective financing source.  This ensures that the package represents your opportunity well and has the best chance of success.  We also suggest that the presenting team be rehearsed and critiqued prior to the first presentations to ensure they are prepared to put your best foot forward in an effective manner.
  1. The Team to Make It Happen is in Place
Experienced investors place great emphasis on the importance of an experienced and proven management team.  The presence on the team of the “been there, done that” crowd of proven management talent will go a long way to reassuring the investors that the enterprise has the best chance of success come what may.  Don’t leave holes in key positions in the organization chart to be filled later.  Let the prospective investors meet the management team and be sure to point out their prior record of success.  Recruit a strong advisory board and team of professional advisors to support the company from the beginning.
  1. Use the Right Tools for the Job
Seek and take competent professional advice on building a capital plan for the business that not only meets the current needs but also allows for future financing if necessary to support growth.  There are many different forms of both debt and equity that can be used to finance an enterprise.  Additionally, there are many other forms of financing often ignored by entrepreneurs as well.  Among these other forms of financing are favorable terms from suppliers, customer deposits, proper management of accounts receivable and accounts payable, grants, NGOs, asset based financing, outsourcing and solution partnerships, distribution partnerships, and on and on.  We urge entrepreneurs to seek professional advice and broaden their horizons when building the capital plan for the business.  Likewise, it is very important to take guidance from competent advisors to make certain that all financing documents comply with all legal and regulatory requirements.  We have seen many instances where entrepreneurs have done early financing without competent advisors and as a consequence have used non-compliant documents or procedures in the financing.  This may make it virtually impossible or at least very difficult and expensive to correct those mistakes in order to seek or accept later financing for growth even if the enterprise is successful.
  1. Go to the Right Sources for Funding
In our experience, many entrepreneurs waste a lot of time and effort in seeking financing from the wrong sources.  This failure takes many forms.  Often they seek funding from VCs when they are not yet ready to seek institutional capital.  If you have already been turned down by five or six venture capital groups, it is unlikely the seventh or eighth is going to say yes.  Do seek to understand why a request is turned down.  Address these observations in future approaches.  Understand what stage of maturity the company is in and match the funding source to the stage of maturity.  Are you in the founders round, a friends and family round, an angel investor round, or a VC or private equity raise.   Should you seek assistance from an investment-banking firm?  The sources you approach should be appropriate for the size of the raise being conducted, the company’s stage of maturity, and the nature of the business being financed.
We also urge entrepreneurs to remember that all money is not equal.  Some capital is just dollars, other capital comes from sources that bring strategic value or synergy.  The source may have relationships with the market you are targeting, experience in your field or a closely related field, relationships with other potential investors, or some other form of potential value to the enterprise.  Strategic dollars are always more valuable than just investor dollars.  Try to identify funding sources with an interest in your business or market sector, or other form of strategic value.  VCs who do not invest primarily in technology or healthcare opportunities are unlikely to be interested in a retail or manufacturing business opportunity.
  1. Use the Optimum Capital Structure and Allow for Later Financing
We often see initial investors get “crushed” in later financing rounds due to poor structuring of initial financing rounds.  This happens with great frequency, not simply because incorrect valuations were used in the initial allocation of equity, but often because of a lack of sophistication and experience of both the founding entrepreneurial team and the early investors as well.  A company with prospects for significant growth seldom will almost always require additional capital after the initial financing round.  In fact, the more successful the company, the more likely it will require later financing for growth capital.  It is therefore unwise to fail to anticipate these later rounds when structuring the company’s capital base and establishing terms for the initial investors.  This is another area where competent professional advisors can be most helpful to the entrepreneurial team.
  1. Live Within Your Means
Be certain that the company can afford the financing being sought.  Make certain that all debt and equity financing costs, both initial and carrying costs, are included in the financial forecasts, and then allow for contingencies.  Time and time again we have seen instances in our Turnaround Management engagements where the company did not account for all of its financing costs in its budgets or allow for appropriate contingency levels and performance shortfalls.
Entrepreneurs who follow the basic rules in this discussion are likely not only to be much more successful at obtaining financing on attractive terms to both the entrepreneur and the investor or lender, but also more likely to find their company a successful enterprise.

© Harbour Bridge Ventures, Inc., 2009, All Rights Reserved

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