Angel Investing Trends for the New Year

There was a recent article on the Fox Business website about Angel Investing Trends for 2012. I have to agree with the fact that investors must be getting frustrated with seeing the same type of startups over and over again.  One investor mentioned they are very tired of seeing companies related to social networking, group commerce and music sharing. One trend they did mention that I also think is going to be big this year is technology geared toward baby boomers. Especially with the growing aging population in the U.S., this is a great segment for new companies to target.

Also, the use of such websites as Gust and AngelList have grown significantly in the startup and angel investing community, so if you’re looking to raise money or connect with early-stage investors and company founders, these are great resources to start using.

CEC Startup Meeting

The CEO of the startup I am working with and I recently met with the Chicagoland Entrepreneurial Center (CEC ) to tell them more about our business and the people we have connected with in the community. When we told them we are looking to raise money soon and mentioned the amount we thought we needed in order to last us through another six months, the feedback we received actually encouraged us to think more about a 12 month runway for the amount we were looking to raise. For angel rounds, you typically want to be raising enough funds to last you for the next 9 to 12 months and for your Series A you should be looking at a runway of 15 to 18 months.

We were also told to strongly consider raising convertible debt since the terms can often be very entrepreneur friendly and most of the angel groups in the area are willing to do convertible debt deals. The key to meeting and working with a lot of the angel groups is to find internal ambassadors within the group to champion your deal. Also, it’s important to realize that each angel group is unlikely to do the whole deal themselves and they will often syndicate it with some of the VC firms who also do seed stage investing.

It’s also important to keep in mind that when you decide you want to raise money through angels and VCs, you want to make sure that your deal is not out in the market unfunded for too long (i.e. 3-4 months) because then investors get suspicious or worried about why nobody else was interested in investing or doing the deal.

One of the biggest pieces of advice that we learned from this initial meeting is that as you’re getting ready to reach out to the investor community, start to put together an online depository of all the information that the investors may ask for such as customer testimonials, good articles about your industry or target customers, your financial model, etc. Those of you familiar with investment banking and private equity know that this is very similar to a data room for your startup so that your potential investors can easily and quickly start their due diligence on your company. Getting this online data room organized in advance can really inspire additional confidence in your company.

For the upcoming year, we learned that the CEC has approximately 120 classes that they are planning for the exclusive group of pre-screened startups. We were just added to the mailing list, so we are looking forward to attending a few of the sessions on marketing, pitching, putting together the business plan and financial projections. Another great advantage of the CEC is that they help bring serial entrepreneurs, early stage investors, and C-level executives in as speakers, advisors and mentors to their group of startups, so this should hopefully be another great resource.

What exactly do angels look for?

Below are some specific characteristics that the angel investors at the panel event had mentioned they look for:

-          Unique technology or technology that is patentable or a trade secret (i.e. something that doesn’t need to make it solely on marketing)

-          Good people who know how to work in capital-strained environments and can do a lot with very little resources

-          Entrepreneurs who are flexible and know how to fail early or “pivot” their business model if they need to

-          Demonstrate that you really know your industry and business

-          Having a history of other early ventures can be a huge benefit. Even if the prior companies weren’t a success, showing that you learned from your mistakes and knowing how to not make them again is a big advantage.

-          Market validation and customers who are willing to pay for your idea/product

-          Angels are often looking for pre-money valuations that are less than $3mm and they expect the entrepreneur to come in with an idea about the valuation of their company. Although in the end, the angel investor will just end up comparing your company to other deals they have seen and the growth/risk profile of those companies. Typical investments for angels have pre-money valuations between $1.5mm and $4mm and this has remained pretty consistent over the years. Valuation does end up being a negotiation, but don’t try to come into the meeting talking about DCF and public comps because it’s often less relevant for seed stage investing

-          Remember that angels are not necessarily investing in your product or your management team. They are investing in your company’s future cash flows.

 So before you get too caught up about making sure you have an amazing business plan or marketing materials, aim to have a minimum viable product that proves your idea or product is the most important product/service for a specific customer.

Also, remember that angel investing should be a two-way street. You should be doing your own due diligence on your potential investors just as much as they are doing their diligence on you and your company. The benefits of accessing experienced angel investors is that you’ll have smart money backing you and you’ll have access to a much larger investor network.

Positioning Your Company for Securing Capital

The following factors can help increase your chances of success in securing capital for your early stage venture:

1. Aim to bootstrap or self-fund/partner fund for as long as you can until you reach key milestones
2. Build your product first and be sure to get customer validation. Very few ideas that are just brainstormed on the back of a napkin get funding these days.
3. Be sure to have a strong management team and advisory network. Consider getting well-respected or well-known advisors and have them invest a bit in the company to show they also have skin in the game and believe in your idea.
4. Try to stage your capital raises to be around the same time or right after key milestones.
5. Look into grants and government funding whenever possible.
6. Raise capital whenever you have the opportunity to and aim to have at least 18 months of cash to last you through the capital raise process
7. Continue to always leverage and expand your network. Referrals are much more likely to get you a meeting with investors. Also, be sure to follow up and be aggressive with the people you meet. With each new contact, try to get five new names from them for additional people you should meet.

How to Fund Your Idea – Part 2

The different types of funding can consist of yourself (both your savings and IRA), your friends & family, angel investors, strategic investors, private equity/VC funding, and going public.

Most people don’t realize that if you really need the financing, you can also invest your 401-k in yourself or your business with a self-directed account without having to pay a penalty. I view this as more of a back-up plan option if all your other options don’t seem to be working and you think you might not even make it to retirement if you don’t do something now to save your business.

Angel investors have typically made their own money in their own businesses and have a desire to transfer that knowledge to other businesses. Keep in mind that angel investors typically like to run together, so if you’ve found one angel, you’re likely to get seven or eight that would like to tag along with them and each one will invest anywhere from $25,000 to $250,000 each.

Strategic investors are people or companies that will receive a benefit from your business more than just their investment. For example, both your suppliers and your customers would be considered strategic investors. If you’re looking to potentially do an M&A deal, you will most likely be selling to a strategic investor, and so if they’ve invested in you, then they will be more likely to acquire you down the road. The reason most strategic investors will consider acquiring you is because you’re also selling to their competitors and they want to control your product/service in order to get a leg up.

Private equity and venture capitalists look for companies that will really make it big and then they help those companies either go public or sell to a strategic or other financial investor later on. They typically expect to get 3x-10x their money back in a five year period and they often expect only one out of five of their investments to really be a home run. Keep in mind that both the private equity and VC industries tend to be a very closed loop of people and they will often be very vocal about your business and ask for board seats.

Going public is often the ultimate goal for most companies, but it’s actually like creating a second business because there is a lot of added effort going into the process including government reporting, reports to shareholders, reporting to the markets, etc. However, it remains one of the best ways to raise big chunks of money and exit out of your investment.  It can be a very expensive and long process though (expect it to last at least 6 months and cost more than $100,000).

Another option to consider would be a reverse merger, where you would team up with a company that has been public a long time, but the business has been shut down, and it has decided to still keep the filing process going. In a reverse merger, one company acts as the shell corporation and your company aims to absorb the shell and reverse the name of the company (i.e. it’s a “reverse” merger because your company takes over the business and name). The reason most companies might not operate anymore but continue to file is because they know that the shell has value and it’s beneficial to other companies because it saves time and money when doing an IPO.

Funding (My favorite topic…) – Part 1

90% of startups don’t make it because they are underfunded.  And 75% of businesses are funded just from the entrepreneur’s own savings, retirement funds or borrowing capacity. Most startups don’t have a great understanding of all the funding options that are available to them, so that's why I think it's actually one of the most important topics to become well informed about. There are two (or really three) main types of funding:

(1)    equity – selling a portion of your company

a.       common stock – all shareholders are treated the same

b.      preferred stock – shareholders get special treatment (potentially more voting power) and get an additional interest rate paid to them

(2)    debt
(3)    hybrid of debt and equity – convertible debt

It’s important to understand the advantages and disadvantages of your funding options before you choose one over the other.

For equity, the main advantage is that you share the risk with your shareholders. However, the disadvantage is that you will also be sharing your profits. You will also have other owners (who might be a pain to deal with or very helpful) and they will have their own opinions and need to be informed about your business. The other thing to keep in mind is that it is 5x easier to raise money from your current investors/shareholders, so be sure to treat them as well as you treat your customers.

There are also several types of debt: personal debt, home equity line, credit cards, etc. Entrepreneurs can choose to borrow money based on their own credit worthiness, but it’s often better if you can get a commercial loan on the business itself. If you choose to take a loan on your personal guarantee, the bank can come after you and everything you own. For commercial loans, most banks will generally give you the loan for your business if you have collateral or assets that can act as a guarantee.

Many banks will choose to loan to startups and small businesses because 2/3 of America is actually employed by small businesses, so the Small Business Association will often write a check to the bank for 75% of the loan if you’re unable to pay the bank back. These loans often tend to have reasonable interest rates as well.

The main thing to remember about funding is to get the money long before you actually need it. If you wait until you really need it, then most people can smell and see the desperation, so the rates and terms won’t be nearly as good.

Convertible debt has become very popular with investors, but it’s often the entrepreneurs last choice for funding, since it’s usually tipped in favor of the investor. The investors are able to get the benefits of both debt and equity since creditors are higher on the food chain and they get paid first. They also get steady interest and if your company makes it big, then they can convert to equity and you will have to share the profits with them as well. If convertible debt is the only way you can get money from your investors, then you will most likely take it either way. The conversion price of the debt will often be the valuation of your business, so you will need to decide how much your business is worth and you will want that conversion price to be as high as possible. Be sure to keep a look out for the post that is coming up on how to determine the value your business.