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.

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