Angels and Informal Investors

Who They Are

Wealthy individuals are probably the single most important source of capital for start-up and emerging businesses in America today.4 To meet accreditation standards, angel investors are required by the Securities and Exchange Commission to have assets of at least $ 1 million.5 Accord­ing to the Center for Venture Research at the University of New Hampshire, there are approximately 400,000 active angels in the United States. In 2000, as tech stocks sank, U.S. angels invested an estimated $30 billion in start-up financing, compared with about $50 billion by venture capitalists.6

New Hampshire's Bill Wetzel has found these angels are mainly American self-made entrepreneur millionaires. They have substantial

business and financial experience and are likely to be in their forties or fifties. They are also well educated; 95 percent hold college degrees from four-year colleges, and 51 percent have graduate degrees. Of the graduate degrees, 44 percent are in a technical field and 3 5 percent are in business or economics. According to Scott Peters, cofounder and co-CEO of AngelSociety, 96 percent of angels are men. One growing movement to involve female entrepreneurs and investors is Springboard, a not-for-profit organization that organizes a series of meetings with venture capitalists. Springboard venture capital forums in the United States have showcased more than two hundred companies and helped raise nearly $600 million in 2000 and 2001.

Because the typical angel will invest from $10,000 to $250,000 in any one deal, informal investors are particularly appropriate for the following:7

• Ventures with capital requirements of between $50,000 and $500,000

• Ventures with sales of $ l-$2 million and the potential for $20 million within five to ten years of the equity investment.

• Small, established, privately held ventures with sales and profit growth of 10-20 percent per year. This is not rapid enough to be attractive to a professional investor, such as a venture capital firm, but can be attractive to angels.

• Companies who project high levels of FCF within three to five years

These investors may invest alone or in syndication with other wealthy individuals, may demand considerable equity for their interests, or may try to dominate ventures. They also can get very impatient when sales and profits do not grow as they expected.

Usually, these informal investors will be knowledgeable and experi­enced in the market and technology areas in which they invest. If the right angel is found, he or she will add a lot more to a business than just money. As an advisor or director, his or her savvy, know-how, and con­tacts that come from having "made it" can be far more valuable than the $10,000-$250,000 invested. Generally, the evaluations of potential

investments by such wealthy investors tend to be less thorough than those undertaken by organized venture capital groups, and such noneconomic factors as the desire to be involved with entrepreneurship may be important to their investment decisions. And in fact, there is a clear geographic bias of a one-hour radius of the investors to the ven­ture's location. A wealthy individual, for example, may want to help build businesses in his or her community.

Finding Informal Investors

Finding these backers is not easy. One expert noted: "Informal investors, essentially individuals of means and successful entrepreneurs, are a diverse and dispersed group with a preference for anonymity. Creative techniques are required to identify and reach them."B The Internet has provided small business owners with an effective method of locating such investors. Formal sources like Garage Technology Ventures, Business Partners, provide invaluable advice, assistance, and infor­mation regarding potential investors and help forge the link between investors and small business owners seeking capital. Specialized assis­tance for women include and the Center for Women and Enterprise.

Invariably, financial backers are also found by tapping a small busi­ness owner's own network of business associates and other contacts. Other successful entrepreneurs know them, as do many tax attorneys, accountants, bankers, and other professionals. Apart from serendipity, the best way to find informal investors is to seek referrals from attor­neys, accountants, business associates, university faculty, and entrepre­neurs who deal with new ventures and are likely to know such people. Because such investors learn of investment opportunities from their business associates, fellow entrepreneurs, and friends, and because many informal investors invest together, more or less regularly, in a number of new venture situations, one informal investor contact can lead the entrepreneur to contacts with others.

In most larger cities, law firms and private placement firms syndicate investment packages as Regulation D offerings to networks of private investors. They may raise from several hundred thousand dollars to sev­eral million. Directories of these firms are published annually by Ven­ture and discussed in other magazines such as Inc. Articles on angel investors can also be found in Forbes, Fortune, Wall Street Journal, Business Week, Red Herring, and Wired and at their respective websites.

Contacting Investors

Obtain permission to use the name of the person making a referral when contacting the prospective investor. A meeting with the potential investor can then be arranged. At this meeting, you must make a con­cise presentation of the key features of the proposed venture by find­ing answers to the following questions:

• What is the market opportunity?

• Why is it compelling?

• How will/does the business make money?

• Why is this the right team at the right time?

• How, as an investor, does one exit the investment?

It is noteworthy that in this era following the crash of the dot-coms, investors throughout the capital markets food chain are returning to these fundamental basics for evaluating potential deals.

However, we recommend that you avoid meeting with more than one informal investor at the same time. It is unnecessary to hear negative viewpoints raised by one investor to be reinforced by another. It is also easier to deal with negative reactions and questions from only one investor at a time. Like a wolf on the hunt, if you isolate one target "prey" and then concentrate on closure, you will surely increase the odds of success.

Whether or not the outcome is continued investment interest, you need to try to obtain the names of other potential investors from this meeting. If this can be done, you will develop a growing list and will find your way into one or more networks of informal investors. If the outcome is positive, often the participation of one investor who is knowledgeable about the product and its market will trigger the par­ticipation of others.

Evaluation Process

An informal investor will want to review your business plan, meet your management team, and get to know your business by talking to employ­ees, customers, vendors, and bankers. The investor will conduct back­ground checks on your venture, usually through someone who knows both you and the product. The process is not dissimilar to the due dili­gence of the professional investors (see pages 120-21) but may be less formal and structured. If given a choice, you would be wise to select an informal investor who can add knowledge, wisdom, and networks as an advisor and whose objectives are consistent with your own.

The Decision

If the investor decides to go forward, he or she will have some sort of investment agreement drafted by an attorney. This agreement may be somewhat simpler than those used by professional investors, such as venture capital firms.

Most likely, the investment agreement with an informal investor will include some form of a "put," whereby the investor has the right to require the venture to repurchase his or her stock after a specified num­ber of years at a specified price. If the venture is not harvested, this put will provide an investor with a guaranteed cash return.

Venture Capital: Gold Mines and Tar Pits

There are only two classes of investors in private companies: value-added investors, and all the rest. If all you receive from an investor, especially a venture capitalist or a substantial private investor, is money, then you may not be getting much of a bargain at all. One of the keys to raising risk capital is to seek investors who will truly add value to the venture well beyond the money. Research and practice show that investors may add or detract value in a company. Therefore, carefully screening potential investors to determine how specifically they might fill in some gaps in your know-how and networks can yield significant results. Adding key management, new customers or suppliers, or refer­ring additional investment are basic ways to add value.

Private investors should provide critical assistance like introducing the founder to other private investors, to executives (who become investors and provide help in sales and strategic alliances), to the appro­priate legal and accounting firms; serving as a sounding board in craft­ing and negotiating early rounds of investments; and identifying potential directors and other advisors familiar with the technology and relationships with foreign investors and cross-cultural strategic alliances.

Numerous other examples exist of investors being instrumental in opening doors to key accounts and vendors that otherwise might not take a new company very seriously. They may also provide valuable help in such tasks as negotiating OEM agreements, licensing or royalty agreements, making key contacts with banks and leasing companies, finding key people to build the team, and helping to revise or to craft a strategy. Norwest Venture Partners brought in Ashley Stephenson to grow a portfolio company and then backed him in a second venture. "Most venture capitalists have a short list of first-class players. Those are the horses you back," says Norwest partner Ernie Parizeau.

It is always tempting for a small business owner in need of cash to go after the money that is available, rather than wait for the value-added investor. These quick solutions to the cash problem usually come back to haunt the venture.