Be an Angel

What is Capital Risk for Angel Investors?

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Few Investors (or founders) look beyond the immediate funding round in any detail (if at all). Yet Assessing Capital Risk is critically important when assessing if this is a deal you should do – even if every other indicator is screaming “Yes”.

Every deal I have ever seen has needed more than one round of funding to reach a successful exit. Most need multiple rounds of funding – perhaps 5 to 8 is typical, over 5 to 10 years.

If that follow on funding is not going to be available, or you don’t build something the next round funder will invest in, you are not building a bridge to a profitable exit, you are building a pier to nowhere.

So, asses what is the Capital Model for this deal going forward, and get answers to the fooling questions:

  • How much additional cash will company need?
  • Where will that cash come from?
  • On what terms can we get it?
  • What will Funding environment be like in 18 months?
  • Will we need a VC partner?
  • What terms will the VC offer?
  • What does this company have to have / look like (users, customers, data etc.) to be of interest to those VC’s? Can we achieve any of that on the funds we are about to invest? Is the target of the business plan to achieve those key requirements?
  • Will they need so much capital that follow-on VCs will wipe us out? (Dilution + Preferential Returns).
  • How big an exit will we need to hit Our Target Return – if this company is successful, can it get close to that number?

Strategic Angel Investing – Rarely Understood

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As an Investor your financial returns will be driven by the following factors:

  1. Initial Valuation (% of company you own)
  2. Subsequent dilution (factor of both future funding amounts and the structure of future deals – do new investors have a preference return ranking ahead of yours?)
  3. Time to Exit
  4. Exit Value

Most founders / investors spend lots of time on item 1 – and almost no time considering 2, 3 or 4.

In determining your financial return the % you have of the company at EXIT is much more important than the % you have at round one. Yet so many investors spend enormous amounts of time focused of getting that initial valuation ‘right’, and no time considering the company’s future funding needs, their ability to contribute to those needs and their resulting dilution.

There is no point in having what looks like a large % at exit, if the other investors have a preference over you. I have seen an exit at $475 million – with the angels getting zero as a result of the preferences.

Don’t let those unicorn valuations fool you. The reality is in the detail of the last finding round terms (which will not be disclosed). Frankly you can claim whatever stupidly high valuation you want – if I have a 3x preference that I will take off the exit table before anyone else gets a penny.

Angel – Sense of Humour Required

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In the book “The Archangels’ Share” the remarkable inside story of Archangels, the oldest and one of the biggest business Angel syndicates in the world (Available from Amazon – http://amzn.eu/dSd8NJC) there is a story about one of the groups founders complaining bitterly to another when his first investment, which had been described at the start as a “slam-dunk”, failed in a rather spectacular fashion within weeks. Having listened to the “incandescent” rage his fellow investor responded with “For heaven’s sake, where’s your sense of humour”!

They both must have had one, as 20 years later they are still investing.

Angel investing is significantly about money, and money is a serious thing. But Angel investing is about more than just a financial transaction, and few people who stick at Angel investing over the long term are only, or indeed primarily, focussed on financial return. Putting something back, meeting interesting people, and critically “having some fun” are usually to be found at the top of the list of motivations to be involved in this often crazy activity. Those most suited to Angel investing tend to be individuals who don’t take themselves too seriously, and who do maintain their sense of humour, while at the same time being entirely professional in their Angel activities.

These characteristics are epitomised by John Huston, who founded Ohio TechAngels in Columbus in 2004 and grew it to be one of the world’s largest Angel investor groups with more than 340 members. Internationally, John is well known as the past Chairman of both the ACA and the Angel Resource Institute (ARI) and as the recipient of the Hans Severiens Award for angel leadership. A hugely entertaining speaker, John has produced seminal works on effective Angel investing, notably in relation to post investment mentoring and the exit process. A serious investor, what comes through John’s writings is his sense of humour. Something he somehow managed to maintain despite his 30-year commercial banking career. John’s sense of humour, and a determination to tackle Angel investing professionally, but not to take it so seriously that it’s not fun anymore, has found expression in his recently published “100 Hustonisms”.  Some short sharp comments on Angel investing for those, like John and the Archangel founders, who have maintained both their sense of humour and their appetite for Angel investing.

LINC is very grateful to John for allowing us to share his humour and publish the Hustonisms, for, as John writes “In the theme park of finance, angel investing is the fun house”.

Read the Hustonisms here:

http://lincscot.co.uk/wp-content/uploads/2017/12/100-Hustonisms-12-9

 

 

 

 

 

 

 

Do we know what a Business Angel is anymore?

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The conventional definition of a Business Angel has been:

“an individual investing their own capital in an unquoted business with which they have no prior (especially family) connection and to which they make a value-added contribution through active involvement in the business”.

The Global Entrepreneurship Monitor (GEM) survey has blurred the distinction between the ‘classic’ disinterested business Angel investment and kinship and affinity-based ‘family and friends’ money to the extent that no more than 10% of informal investment reported in GEM may meet the definition of classic Business Angel investment.

Local culture also plays a part, with Angels in some countries much more likely to form syndicates with family members, and to invest in business they have a family connection to.

The growth of Angel syndicates and equity crowdfunding has also thrown doubt on the continuing relevance of this definition.  Within European Angel networks, groups and syndicates (and those of other countries outwith the USA) a large proportion of members seem in practice to be relatively passive in terms of both the investment process and post investment support of investee companies. Most of the “work” is done by a small number of “Lead Angel” investors. This, at least in part, reflects the nature of many of the European Angels, who are often still in some form of full time employment and do not have the time to take on the lead investor role. It also reflects the growing number of individual Angels that are now likely to syndicate in any one deal. Too many for all of them to be particularly active in the process[1].

Angel investing is very much a personal activity. An individual voluntarily choses to invest their own money in companies they select.  It is extremely rare to find an individual who is a full time Angel investor (some individuals are full time Angel group / network managers), so the activity is typical practiced on a (very) part time basis, and could be likened to a “hobby”. Angel investing is often also referred to as “informal” investing, and this combination of self-motivation and determination within an informal framework is often a key attraction to individuals to become involved.

Angel investors also have varying motivations. Many Angels do not have profit maximisation as their principal motivation. They may simply like being involved in the process, or being part of the Angel club. As a result, it would be inappropriate to suggest that there is one “correct way” to be an Angel investor, and attempt to enforce a rigid training structure on all. Just because an investor does not adopt a particular technique or strategy does not mean that they are a “bad investor”.  For example, while many would recommend Angel investors mitigate their high risk by having a large portfolio of investments (and this advice is likely to form part of an Angel training program), if the investor is investing for largely non-pecuniary reasons they likely, and to them rationally, don’t care about optimal portfolio sizing. If investors are not trying to maximize their financial returns, then there is no reason for them to have large portfolios. Some may specifically want smaller, concentrated portfolios because they enjoy working closely with the entrepreneurs or just want to invest locally so that they can give back to their community.

The traditional, “western” definition of an Angel is increasingly being diluted – and this is a good thing. It allows more individuals to be comfortable bringing increased amounts of capital to fund new and expanding ventures.

[1] Bridget Unsworth who manages the New Zealand Angel Co-investment Fund estimates that as few as 5-7% of Angels in groups are truly active Angels.

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.