Cover Story

 

Calling on Angels

The Ins and Outs of Getting Your Company Funded By Angel Investors

 

By Lisa Ann Thomson

 

Martin Frey, a customer relations consultant and member of Olympus Angels and Utah Angels, sums it up in a nutshell: "We haven't run out of money to invest."

With more angels in Utah than ever before, there is more capital available to young companies than ever before. And angel investors want to put it to work. But for entrepreneurs to tap into this funding, they need to know what angels are looking for, how best to work with them, and where to find them.

And they need a business that merits investment.

So we got inside the heads of angel investors around Utah, as well as some experts on angel investing, to figure out what makes angels tick and learn what you can do to be the right investment for the right angel. From their responses comes a primer for every entrepreneur who might be looking for help from above.

 

The Angel Opportunity

Angel capital is a rapidly growing segment of the equity capital markets. According to numbers compiled by the Ewing Marion Kauffman Foundation, about 500,000 new businesses are started every year in the United States. Of those half million companies, between 30,000 and 50,000 receive some type of angel capital. In 2005 (the most recent numbers available), angel investors in the United States invested about $23 billion compared to the $22 billion invested by venture capitalists. Those numbers translate into a huge percentage. Kauffman estimates that as much as 90 percent of companies who get outside equity capital, get it from angels.

"There is a growing importance of angel investors in funding start up and early stage companies," says Marianne Hudson, executive director of Kauffman's Angel Capital Education Foundation.

That was part of the motivation for Alan Hall and his associates in rallying the troops in Utah. Hall sees an ongoing need for capital for early stage companies, and he firmly believes that entrepreneurism is an important aspect of economic development. "But I'm just one guy," says Hall, who himself is a long-time angel investor based in Ogden. "We need hundreds of people like myself who are in a position to invest. So my philosophy has been to also act as a facilitator and encourage others to become investors."

A few groups, like Utah Angels, have been successful stalwarts in the Utah investment community for years. But in the past few years, angel groups have been surfacing all over the state — from the Cache Valley Angels to the Dixie Angels — mostly at the behest of Hall. Today, he estimates there are about 70 active angel investors in Utah's organized groups, and Brock Blake, CEO of FundingUniverse.com, estimates there are a few hundred more who invest individually or could be considered semi-active.

 

What Types of Companies Do They Invest In?

In reality, the type of company an angel will invest in depends on the angel. But there are truisms that can help you research potential investors so you target those most likely to take interest in your venture.

First, research shows that angels tend to look for deals within a geographical area. For instance, Lon E. Henderson, president and CEO of Soltis Investment Advisors and founding member of Dixie Angels, says his group will entertain deals throughout the region, but they will look hard at companies in the St. George area.

"We're open to the state and the region, but we do have a priority of trying to be an economic stimulus for Southern Utah," he says.

Next, angels tend to focus on companies that match their expertise. Hall prefers companies with a technology focus or a sales and marketing emphasis because his background as the founder and chairman of MarketStar allows him to bring deep industry knowledge and a strong network to the table. Ronald W. White, a long-time investor and member of Olympus Angels, does strictly information technology deals because of his experience and background in that industry sector. With his degree in computer science and his long history with technology companies, local investor Greg Warnock also tends to be most attracted to technology-oriented businesses.

"It's because of a comfort level they have," Hall says. "They understand the market, they understand the industry, they understand the products and competitors."

But Hudson points out that organized angel groups — which are an increasing trend across the country, not just in Utah — are helping individual investors expand their industry knowledge and investment opportunities.

"Over time, these groups are going to become more sophisticated and better investors because the investors themselves are learning from each other, certainly learning more about technologies and industries that one angel may not know about but their colleague in that group does," she says.

 

When Should You Look for Angel Investment?

One misstep entrepreneurs make when seeking angel investment is looking for it too soon. The first money in your company should come from your own checkbook, says FundingUniverse's Blake.

"I call it the capital food chain. The first place you are going to go to is yourself — whether that be through savings, personal credit cards, second mortgage, etc.," Blake says. After bootstrapping with your own funds, you can move on to friends, family and fools — anyone in your personal circle who believes in you and is willing to invest.

If you are going to seek outside investment after that, angels may be a good next step. As with industry sectors, individual angels have their own comfort levels at which stage to invest, but most angels tend to look for early stage companies who have moved beyond an idea on paper and are positioned for growth.

"I look for firms with validation in the form of revenue and customers," says Tony Howells, a member of Olympus Angels. "Volumes of analysis can't authenticate a business plan like paying customers who are representative of a larger market."

"If you have somebody who's out on the market with a product and a few sales, the proximity to a meaningful business is a little bit closer," echoes Warnock.

"I think that's where we can best apply our money," Hall says. "It's going into a stage of the business which is probably the most critical, and that is to generate and accelerate the revenue growth."

So if you have a great idea and a slick presentation, your company may not be ready for angel investment. But if you have a great product and a few clients, you may be primed.

 

How Much Do They Invest and What Kind of Equity Stake Do They Expect?

The Kauffman Foundation studies indicate that from individual angels you can anticipate as little as $20,000 and an average of about $100,000 to $500,000. Its research has also found that in 2005, the average round of investment from angel groups was $266,000 with the range tending between $100,000 and $1 million. But Hudson also points to several examples of angel groups co-investing up to $2 million or more.

Some angels do provide loans, but for the most part, angel investors expect equity. That's what they trade you for — a chunk of your company for a chunk of their money. The typical stake can range from 5 to 40 percent, according to Kauffman numbers, but the average range is 15 to 30 percent. That may seem like a lot to an entrepreneur who hasn't done this before, but to the angel investor, it's a way to secure a reasonable return on his or her investment, and perhaps more important, a way to secure involvement in the company.

"If they are not going to own 15, 20, 25 percent of a company, at some point they feel like, ‘I'm not really a partner in this business,'" Warnock points out. And since angel investors are often motivated by more than just financial return, a small equity stake that means small participation isn't as attractive.

Giving up ownership may also be the best way to take your own remaining equity stake to a much higher level, says Frey. "When there is a real opportunity in the market that additional capital would allow you to capture and would increase the overall value of your venture by more than the equity you would have to give up, it's advantageous for you to raise capital," he says.

 

What Do They Look for In a Potential Deal?

"The bedrock considerations are favorable valuation and deal terms, a scalable business with high margins and accessible market, a defensible position with respect to intellectual property and competition, a well-balanced management team with a track record in the designated space, a clear exit path, and of course projected return on investment," Howells says.

But he adds that angels look for intangibles too, like philosophy, chemistry and intuition. "Too often during the pitching process entrepreneurs are focused on a product or concept demonstration and overlook the fact that they are selling an investment with many elements that extend beyond the scope of the business activity," says Howells.

A big one is the management team. For White, "The key is the management team. Everything else is secondary."

Investors are keenly interested in the management team for one reason: risk. "When you put together a business plan and a forecast for your project, the only thing you know for sure is what's on the business plan and forecast, will not happen," Warnock says. "You don't know if it will under-perform or over-perform, or in what ways it will change. But the business world is so dynamic that there's just no chance you'll execute exactly to strategy. Knowing that, we're looking for a team that can be adaptive and reactive and make good decisions in responding to changing circumstances."

Other factors that attract an angel to a deal include return on investment, involvement, legacy and community building, and mentorship, Howells adds.

 

How Do You Keep Your Foot Out of Your Mouth?

Knowing what angel investors look for in a potential deal will help you target specific angels who are compatible with what you have to offer and then help you prepare for the meeting.

"The entrepreneur will only get one chance to make a first impression," White notes, "so he or she should learn everything possible about the prospective target before contact is made. Most entrepreneurs are surprised at how much can be learned, first from public information such as the Web and printed sources, and then from person contacts."

When given the chance to pitch to angels, send no more than two people to the presentation and deliver a well-rounded overview in 15 minutes or less, says Howells. "The objective is to create interest and generate further discussions," he says. "By definition, angel investors do not expect a fully actualized and executed business plan."

But they do expect candor and an accurate analysis. "Shortcomings, inaccuracies and exaggerations are usually exposed during due diligence anyway, so why risk your credibility?" Howells points out.

"Entrepreneurs need to be forthright," Hall adds. "People want to hear the good and the bad."

Something else to consider as you approach angels: be realistic. Blake points out that statistics show a mere 1 to 2 percent of everyone who is looking for equity money actually gets it. "You have to be a very, very, very good deal to raise money," he says.

But you'll help your chances if you are prepared — something angel investors see entrepreneurs consistently fail to do. From practicing your presentation before you get in front of investors to having your company correctly positioned for investment, entrepreneurs need to have their ducks in a row.

"They haven't created a good legal team or engaged a good tax player. They have a good product but don't understand yet who their real client is. They probably have underestimated their time to market," says Henderson as he lists common mistakes he sees.

Finally, have a long-range plan for your company. Angels get the return on their investment at the end of the life cycle, so you have to be prepared to explain what the exit strategy is. And be realistic about that too, says Hudson. "Angels who are sophisticated very rarely expect you to say IPO as your exit option. Mergers and acquisitions are really the exit option they are anticipating," she says.

So know how you are going to grow to the point of merging or being acquired. "Entrepreneurs have to be able to describe how they would end up selling their business," says Hall.

 

A Few Reasons To Consider Calling On Angels.

Finally, it's important to realize that angels bring more to the table than just cash. They bring experience, objectivity and a network. And those intangibles may be worth more than their money.

"The right angels, the sophisticated ones, really help an entrepreneur build their company," Hudson points out. "I've seen amazing stories about how their background and credibility have ultimately been more important than their money."

Because angel investors are often motivated by more than a return on investment, they usually want to engage in the growth of the business, mentor the entrepreneur and utilize their networks. "A lot of them are former entrepreneurs themselves and just love to stay involved and use their skills and experiences," Hudson says. "And many of them are all about helping to build great companies in their communities as a way of economic development and a way of giving back."

So if you are at the right stage, in the right location, and willing to trade ownership for funding, then angel investment may be the perfect way to grow your company and tap into Utah's brightest minds and deepest experience.

 

Launch - Mar/Apr 2007