The news cycle spins with tales of start-ups that accelerate from zero to $60 million.
And while that speed of success can seem dizzying, in reality, it doesn't happen overnight.
What often goes unmentioned is the role that angels play—angel investors, that is—in providing the funds and advice that help some fledgling companies grow from an idea to a capitalized venture to a successful and salable business.
The Angel Capital Association estimates that roughly 300,000 people have made an angel investment in the U.S. over the past two years, and their ranks have the potential to grow to 4 million.
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Which is great news if you're a would-be tycoon hoping to launch that next successful business. Or someone with investment cash burning a hole in your pocket.
For insight into how angel investing works, we turned to Linda Holliday, a serial entrepreneur and partner in the New York Angels.
LearnVest: How do angel investors differ from venture capitalists?
Linda Holliday: Angels are amateurs, while venture capitalists (VCs) are professionals—meaning they have raised funds from outside partners and run an organization that vets and manages investments, essentially as a committee.
In my experience, angels are more emotional; they get connected to ideas and entrepreneurs. VCs at least try to make more financially driven decisions.
As an angel, you’re usually with your companies for several years, helping to navigate follow-on rounds [of funding] and business hurdles. And sometimes, as an angel, you fall for an entrepreneur and become a coach and mentor as well as an investor. It can be very satisfying to help them through some of the inevitable challenges and to watch them succeed.
Ultimately, both groups of investors can be very trend-driven—always looking for the next Pinterest or Uber. And that is why it is much easier to get an iterative idea funded than an original one.
At what stage of a company’s life cycle is it best to approach an angel investor?
As the competition for seed money gets more intense, most angels now want quite a bit of “de-risking” before investing.
So that often means that [they want to see that] the product has already been built and tested with some users. You should definitely have a good team together, and enough assets to be able to convince strangers you can pull something off.
It’s usually only too late to approach an angel if you’ve already pushed the valuation for the company beyond seed level (say, $3 million to $8 million). But even that is flexible and changing.
How does angel investment compare to borrowing from a bank?
Bank loans need to be collateralized, meaning that you pledge assets such as patents, inventory or receivables. That makes it extremely difficult to obtain debt financing for seed companies. But if you can get it, it prevents significant dilution [of your equity in the business].
Raising money from investors, on the other hand, is an equity transaction—you're actually selling a portion of the business to the investor in exchange for money or help. The investor's downside is that it's not secured by any tangible assets, and they can lose everything. Also, the entrepreneur and the investor both stand to get further diluted by additional rounds of investments that will probably be subsequently raised.
What have you found to be common misconceptions among entrepreneurs who seek angel investments?
Most entrepreneurs are shocked to find out just how much equity they have to sacrifice to raise angel funds.
Usually each round sells 20% of the company. (If you sell 20% for $500,000, for example, the company is worth $2.5 million.) Ultimately, though, the risk to an entrepreneur of not raising money [to launch the company] is much greater than the risk of being overdiluted in the event of a success.
How can an entrepreneur make a company or concept more appealing to an angel investor?
Angels always want a clean balance sheet. We want to know that the money’s going toward future value creation, not paying down past value creation.
It is also important to remember that it really is a buyer’s market for investors. Entrepreneurs will have only one shot at an investor, so you have to have everything buttoned up. Everything. That often means having a core team that includes a serial entrepreneur who has had experience at a company that was sold or went public and made a lot money for its investors. It’s the greatest predictor of success.
Entrepreneurs also really need to be out there making a splash and trying to crescendo attention at the closing of a round. Of course, this is very hard to do—especially without the benefit of expensive communications professionals.
So watch and learn from other entrepreneurs. GoldieBlox [which makes engineering-themed toys for girls] was particularly brilliant—it capitalized on stereotypes about girls and provoked a lot of attention with its use of copyright-protected music in promotional videos. The controversy actually landed them a sponsored spot in the Super Bowl. That’s a 10!
What do you personally look for in an investment?
When I evaluate an entrepreneur, I ask myself: "Would I hire this person to run a $10 million department? For five years? Unsupervised?" That’s the level of confidence you need to have in somebody. And that clears things up pretty fast.
Overall, my three important invest-ability characteristics are: an idea that’s riding a more important tech trend; an entrepreneur who is plausible with a well-considered game plan; and a concept in a sector that I consider myself qualified to evaluate.
Should would-be angel investors focus on any particular business sectors or scenarios?
There are many ways to be an angel investor, and there are interesting companies to choose from in every sector. The tech sector is obviously very hot; so is e-commerce. So being an angel in those areas could lead to a vibrant professional life.
It’s also a good idea to think about the life cycle for the company and whether or not you have the patience or, as we say, the “powder” for it. You may want to stay close to the industries you understand most or that most interest you, as many angel investments will require follow-on rounds.
Some angels are looking for investments that will exit relatively quickly. A $2 million valuation now for a $20 million exit in two years is one desirable formula. Other angels are looking for a “Hollywood hit” (one giant success that will put them in the black) and want to make many bets.
What should angel investors keep in mind when it comes to the risk factor?
Angel investing is usually the most alternative kind of investment high net worth individuals make. It can return 100x, but more than half of the companies will fail—losing the investor's money entirely.
All young companies are risky, and that makes it advisable to diversify your portfolio. I'd recommend doing three to five investments a year for a few years (investments can be as little as $5,000, but are typically $25,000 to $50,000 per company).
While it’s easy to fall in love with ideas, it is really execution that makes the difference between success and failure. Past execution is a good predictor of future execution. That’s why angels are always looking for entrepreneurs who've had a successful exit.
Angel groups are also super important [in mitigating your risk]. It's time-consuming to evaluate business plans, entrepreneurs, deals and markets. And businesses that don't fail often require follow-on investments, which are equally hard to evaluate. Doing enough due diligence as an individual is pretty onerous, while a group can perform that role en masse.
In your years as an angel investor, which would you count as your most memorable experiences?
The most memorable was giving a young C.E.O. advice on how to handle a predatory partner. It was a life or death moment for the company in a conflict over rights and rates. He took the advice, executed it perfectly and saved the day—he’s a natural.
You make lots of little saves and lots of introductions as an angel, and all of them are satisfying and memorable. It’s kind of like being a parent, I guess.
What parting advice would you offer to prospective entrepreneurs and angel investors?
To the entrepreneurs: I'd say that every day is a struggle to separate the important from the urgent from the e-mail! It’s incredibly hard to keep doing the most important work when one is faced with such a seemingly endless amount of work.
To the angels: I'd say read my friend David Rose’s book “Angel Investing: The Gust Guide to Making Money & Having Fun Investing in Startups.” If I’d read it five years ago, I might not have had more fun, but I definitely would have made more money.
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