Entrepreneurship University
College of Entrepreneurial Studies (CES)

Angel Investors

Angels (from the now defunct NVST.com site)

The term “Angel Investor” refers to those individuals who back emerging entrepreneurial ventures.  They are the largest source of real risk capital in the country and the least understood.  In fact, outside the major financial centers, they are often the only source of risk capital for the entrepreneur.

Angel investors are wealthy individuals, often former or current entrepreneurs, who help finance startups in exchange for equity. Although less well-known than venture capital, angels invest more in total than VC firms do: According to the Small Business Administration, in 1997, 250,000 angels invested $20 billion in 30,000 startups, while 600 VC firms invested $10 billion. The resources available to find Angels include industry associations and venture capital seminars. However, the best resources are often your attorney or banker.

The term “angel” was coined on Broadway to flatter wealthy people who invested in theatrical productions. These days it extends to private investors in businesses that have outgrown credit cards and loans from friends and family as a source of new capital but are still too small to attract professional venture capital.

The informal angel market plugs a gap caused by the very success of professionals. The total amount of money managed by venture-capital funds has grown dramatically in recent years, yet it takes as much time to properly research a small investment as it does a larger one. As a result, the average investment of a venture fund has likewise grown to the level where many venture firms won’t even look at a business that needs less than $10 million, even though many ultimately successful high-tech businesses start out at this scale.

Angels are wealthy individuals who will write you a personal check, ranging anywhere from $20,000 to $1 million, to help finance your company. There are many flavors of angels, from the retired dentist hoping to impress his golfing buddies by getting in on the seed round of the next eBay to the former CEO who wants to stay in the game by helping startups grow.

Reaching angels has been simplified by the creation of formal networks. Previously, angel investing was a costly, hit-or-miss affair, with personal connections and introductions being the primary way that investors and entrepreneurs match up. Each investment contract is negotiated from scratch, which means huge legal bills, too. “If stock markets are an extremely efficient capital market, angel investing is at the other end of the spectrum,” says Brian Horey, a New York City venture capitalist who is organizing a local angel network to spur investment in Internet start-ups. Now university-affiliated nonprofit groups are being formed across the country, such as Technology Capital Network at Massachusetts Institute of Technology and Capital Network in Austin, Texas, have had success in teaching entrepreneurs how to raise capital and introducing them to local angels.

At some point some angel-funded businesses will need to approach large venture capital firms, but it will probably not be the first financing they receive. Most VC firms today won’t make investments less than $10 million to $15 million. Yet virtually every Net company needs to raise a seed round of a few hundred thousand dollars to allow the founders to quit their day jobs, create the skeleton of the company, incorporate, build a prototype Website, file for necessary patents, and so on. Taking less initially lets you build the value of your company and lets you give less of it to the big VC fund when you eventually raise that $50 million round.


Six degrees

It is never too early to start looking for an angel investor. Individual angels will write checks as small as the company needs, sometimes in the thousands of dollars. Professional angel groups and small early-stage funds can easily put together anything from $500,000 to $10 million.

To find angels, tell everyone you know and everyone you meet, from your mom to strangers on the street, what you are doing. That six degrees of separation saying is really true. You shouldn’t worry about giving your idea away as much as you should worry about not getting your funding fast enough-especially on the Internet. A good place for the totally uninitiated to start is to talk to anyone who deals with a lot of startups, such as lawyers, PR firms, accountants, and marketing consultants.

The best angels offer more than just money, however. You want your angel backers to provide money and sweat-making business development contacts, finding candidates for positions within the company, landing a good PR firm, helping with that first firing, or negotiating the six-figure license with Yahoo!. So much of the world operates on referral that you also want an angel who is well connected in your local tech community and is willing to pick up the phone on your behalf. If you find an angel with the right background, consider persuading him or her to take a more active role in the company. You may ask that he or she serve as a formal adviser or director of the company-even if it means cutting him or her a deal on that initial financing.

Short and simple

When pitching angels (and VCs!) remember your immediate goal: The purpose of your initial pitch, and your pitch document, is to get them to pick up the phone and schedule a more extensive conversation-not to get them to invest. Keep your business plans to yourself until they are explicitly requested. What you need first is a short marketing document that highlights the problem, your solution, how much money you stand to make, and why you’re the team that is going to make it happen. Highlight the most intriguing aspects of your company (unusually strong team? A killer patent position?) and avoid clouding your message with spurious detail.

The size of the angel investment you can expect depends on who you are and where you are on the value staircase-are you still in graduate school and just have an idea, or are you the soon to be ex-director of marketing at a successful startup? Do you have a product? Do you have revenue? The answers to these question can affect the value of your company, but don’t get hung up on negotiating price with angels. All serious angels know about the value staircase, and they know that eventually it will be appropriate for you to raise millions from a VC firm. So early financing rounds must be at a cheaper price.

The range for an early-stage investment is almost always less than $10 million, and a seed investment is often in the low single millions. It is reasonable to give an angel 20 percent of your company in the first round, but remember that these first initial investors will be diluted substantially in subsequent rounds. By the time of your IPO, their stake may be only a few percentage points.

Special investor rights are commonplace in early stage deals and this is where getting a good lawyer pays off in spades. The key point, however, is to negotiate with your investors in a spirit of partnership. Just like your first employees are often quasi-founders, your first investors deserve a special place. Don’t try to negotiate with an angel the way you would with a VC. Similarly, don’t waste a lot of time with an angel who thinks his $50,000 is all the money you’ll ever need .

Smart angels are often less concerned with valuation and more interested in how the entrepreneur conducts himself or herself. Is she headstrong and strident or reasonable and flexible? Similarly, if your angel rubs you the wrong way during the negotiation, perhaps you should get a financial backer you relate to better. Remember that the tough times may be still to come. Once the angel writes you a check, you’re married to him or her for the life of your venture.

The Internet is often the medium for matching up angels and small companies. Examples of “matchmakers” include:

How successful can any of the Internet matchmakers be? Skeptics say the best deals don’t need to be shopped widely. “If a technology guy has an idea that’s sharp enough, he surely won’t put it on the Internet” where potential competitors could see it, says Steven Galante, editor of the newsletter Private Equity Analyst. The naysayers have a point. But the inefficiencies in the traditional angel modus operandi are so great and the benefits of banding together so clear that organizing efforts are likely to continue.

Wishing you success,

John B. Vinturella, Ph.D.

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