Angel Groups

Building Angel Groups / Networks.

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Building a new Angel organisation may be divided into two elements, Network Design and Establishment, and Network Manager Training.

The final design of the network will influence the nature of training required for the Network Manager. For example a “manager led” network, in which the manager has primary responsibility for deal sourcing and deal making, will require more in-depth management training than would be required for the manager of a network designed to be more of an introductory service, where the individual members are expected to do the majority of the work in relation to due diligence, deal completion and post investment support.

Any project intended to assist the establishment and angel organisation should help to design the most appropriate structure and operating process to meet the specific needs of the local Angels. Based on local needs the areas of assistance to be provided may need to include:

  • Refinement of the operating budget for the network.
  • Funding sources (membership fees, sponsorship etc.).
  • Development of the network manager’s role and job description.
  • Meeting structures / timing / frequency.
  • Public relations.
  • Establishment of investment criteria.
  • Membership rules / Code of ethics.

The assistance should provide guidance as to how to maintain network momentum and membership to ensure future sustainability. The life cycle between initial investing and successful exits can be long. Depending upon the nature of the investee company, and the form of investment, an exit can take many years, a considerable time to keep members interested and active. Tactics to build long-term momentum may include:

  • Ensuring appropriate attention is given to the social aspects of the network
  • Practical issues such as the timing and location of meetings to encourage membership participation
  • Participation in other wider group activities
  • Ability to leverage the group for personal and intellectual development such as judging entrepreneurial competitions and mentoring young entrepreneurs
  • Active participation of members in the investment process, through membership of screening committees, due diligence teams and participation on portfolio company boards.

The specific activities relevant to any individual new Network will depend upon the nature, motivation, objectives and availability of their members, and may change over time as membership grows and develops.

The level of investment knowledge and skill required at the outset of a Network will depend upon the degree to which the manager is expected to “process” investments and the amount of work individual members are able / willing to take on. This will depend on the nature of the initial members, and may well evolve over time. The following sets out the range of training that we have delivered in the past, depending on specific network needs and available time:

  • Day-to-day operation of the network.
  • Member recruitment & relations.
  • Deal flow management.
  • Investment screening evaluation and post pitch processes.
  • Managing the membership (including how to get rid of inactive/disruptive members!).
  • Building and maintaining the network culture
  • Developing a suitable ongoing training program for the network Angel members.
  • Meeting structures / timing / format.
  • Public relations
  • Getting investments done!
  • The development of various documents and guidelines including (LINC have an extensive library of examples which we will share):
    • Investment screening criteria.
    • Confidentiality agreements.
    • Guidelines for presenting companies / “standard” pitch decks.
    • Scoring criteria for investment opportunities.
    • Term sheets and other legal documents.
    • Due diligence schedules and process documents.

 

Building a viable angel organisation does take time and resource. Given that the prime source of funding for new high growth potential businesses, and the associated economic benefits, are organised angel groups it is appropriate for government to invest in ensuring their viability and effectiveness.

Angel Decision Making – How do they get to Yes?

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Reading the available  academic research and discussions with experienced Angel investors suggest that “technical” subjects (valuation, financial modelling, technical due diligence) play a relatively limited role in the overall decision-making process, significantly due to the lack of “hard facts” in so many aspects of an Angel type investment. It is not a formalistic driven process. There is no proven formula for success, and no hard data to put into a formula should one exist.

Rather, decision making is based on a mix of technical analysis and intuitive assessment (what Angels frequently refer to as their “gut feeling”), with recent research suggesting that intuitive assessment is favoured over technical analysis[1].

The typical Angel decision making process begins with a subjective assessment as to whether the investment is likely to ‘fit’ with their personal investment criteria rather than a technical analysis. This may include location, amount sought, knowledge of and interest in the sector, and their own ability to add value.

Experienced investors rely heavily on their prior experience and previous investments to inform their present decision making and typically prioritize their intuitions about the entrepreneur over process and “hard fact” (e.g. business viability data).  Finance, in terms of the financial structure of and projections for the venture, is the most important criterion for both nascent and novice Angels but ranks only fourth for experienced investors[2].

The Learning Process

Investors who may now be classified as experienced consistently said that initially investing with other, and then more experienced, Angels had been their most valuable source of learning.  A number added that they had learnt more from failed investments than successful ones!

This suggests that the most effective way to improve the skills of new Angels is through engaging with experienced Angels in actual real investments. How do they get that engagement? Join an existing, active local Angel group, attend their meetings, help with the due diligence and join in a few syndicated deals.

 

[1] Managing the Unknowable: The Effectiveness of Early- stage Investor Gut Feel in Entrepreneurial Investment Decisions, Laura Huang and Jone L. Pearce, Johnson Cornell University, 2017.

[2] Heuristics, learning and the business Angel investment  decision-making process, Richard T. Harrison, Colin Mason & Donald Smith, 2015.

What Is It Worth? Valuation of Investments

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Valuation is probably the most emotive issue to be addressed in any investment negotiation.

Both entrepreneurs and investors seek reassurance that they are not agreeing to an inappropriate (unfair) valuation that will result in them receiving an inadequate share of the anticipated future exit proceeds. Both seek to find definitive valuation techniques that will give them the “correct” valuation. Both are often attracted to the more mathematical, formula based valuation methods involving discounting future values of potential exit values to present day money values.

While many of these methodologies have some merit, it is appropriate that whatever valuation they suggest, that this is sense checked against what is happening in the local market at the time of the deal. Always compare proposed valuations with other comparators in the local market. If you and the company are not based in Silicon Valley then Silicon Valley valuations are largely irrelevant.

Bill Payne carried out a valuation survey of US angel groups collecting pre-money valuation data for pre-revenue company investments from 35 angel groups in 22 states. He found that valuations ranged from $0.8 million (Boise Ohio) to $3.4 million (Silicon Valley), with an average valuation of $2.1 million. The survey showed wide geographic variance, with, perhaps not unsurprisingly, Silicon Valley, New York City and Boston showing the highest valuations, and Idaho, New Mexico and perhaps surprisingly, San Diego at the lower end.

There are a number of factors that likely result in these regional variations. The nature of the business will have an influence, with Biotech, life science and medical devices typically funded at higher pre-money valuations than, say, software and Internet companies. Increased competition among investors for “good” deals will tend to drive up valuations. Valuations in Silicon Valley are driven by the need to have much larger investment sizes because of the significantly higher cost of operating a business there.

However the size of the investment round seems to be one of the most influential factors.  Some investment rounds can be for £2 million or more, while others may be for £100,000 or less. Since angels typically prefer purchasing less than a majority ownership, a higher pre-money valuation is more likely for a larger round size. 2016 valuations may have been up at $3.6m (notably down from a high in 2015 of £4.5m), but the Angels still took 22% of the equity

The Angel Resource Institute’s annual report (The HALO report) on Angel activity in the USA constantly shows that while valuations vary both by geography and by year, the amount of equity taken by the Angels remains remarkably consistent at between 20% and 30%.  So a higher valuation does not result in less equity dilution of the founders.

Having empirical data on local valuations will provide extremely valuable in the negotiation process, providing a “reality check” to both aspirational values put forward by entrepreneurs and “scientific” valuations produced from mathematical formula. Angel groups should seek to cooperate in collecting and sharing local valuation data to ensure their own investments start out on a solid foundation.

The Myth of the VC Series A for Angel Funded Companies (or any others)

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Very few Angel investments receive follow on funding from venture capital firms.

According to the University of New Hampshire, Centre for Venture Research there were around 75,000 Angel investments in the USA last year. Yet the PWC Moneytree report recorded just 5,004 VC deals (of which 33% were in the San Francisco area). So even if every VC deal had previously had Angel funding, that would still be a tiny fraction of Angel backed companies going on to secure any form of VC funding.

CB insights reported that 68% of USA and European successful technology company exits had received no VC funding before the exit.

These numbers are supported by the research in Scott A. Shane book “Fools Gold? The Truth Behind Angel Investing In America”, (Oxford University Press, 2009). “Fools Gold? is possibly the first book to bring together hard data on angel investing within the USA from multiple governmental and academic sources, including the Internal Revenue Service, the US Census Bureau, the Federal Reserve, the Kauffman foundation and many others. The book so encourages Angels to invest as part of an Angel group, and encourages policy makers to invest in supporting the creating of angel groups. This to facilitate a portfolio style of investing and the pooling of investment funds to provide larger amounts of funding over a longer period than would be possible as a solo investor.

Fundamentally Angel investors need to plan for the Whole Life funding of their companies. They cannot just assume that future funding will be provided by some as yet unidentified VC. They must therefore crowd in as many investors as they can into the first and other early rounds, even where this means each individual investor investing less into each deal than they could, or would like to. Only in that way will there be sufficient future reserves of capital to fund the likely 4 or 5 rounds typically necessary to get to a successful exit.

Angel Investing – Not Just for the Supper Wealthy (who are usually not very good at it anyway).

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The Best way to be an Angel Investor? Become a member of an established Angel Group of Network and join in lots of deals with other members, investing just a little initially in each one. Let’s say a company was looking to secure £250,000. That should be provided not by one of two really rich individuals, but by 10 or more individuals each investing between £10,000 and £40,000. Why? Because Angel investing is very risky – as many as 70% of the Angel backed companies in the USA fail to provide a return to the investor – so the reality is, however good that pitch looked, no one, however experienced they are, can pick the winners.

Angel investing can be highly profitable, with organised angels with a portfolio investing strategy achieving IRR returns of 25% (and one Angel friend showing a 101% IRR!). But you must do a lot of deals. Less than 6, and the probability is you will not get any return. You need to be planning to do 15 to 20 new investments over say a 5 year period, recognising that many will not manage to develop as planned. Then be prepared to provide follow on funding only to those that do show real development and in particular customer traction. Don’t keep funding the ones that don’t perform (and they will likely be the majority!). It’s only after the company has been actually operating for a few years that you will have any chance of starting to see which ones are likely to be the real winners.

And the only practical way to be able to invest the necessary cash, and time, across such a large number of investments is to do it as a “team sport”, investing with as many other Angels as you can, providing small amounts of initial funding each, and then building on the successes with more capital. A good rule of thumb is that for every £1 you provide as an initial investment, you need to plan on providing another £3 for follow on into the “good” ones.

Being part of a group has many other advantages.  Usually better access to deal flow as the Group will be better known than individuals, certainly more people and brain power to do screening and due diligence and access to much more post investment support.

And why are the Supper Wealthy usually not very good at it? They don’t share the deals, and put too much money into too few companies, and don’t have the time to provide adequate post investment support into a properly sized portfolio. Better to be a team player.