As the news cycle spins with tales of start-ups and their founders’ good fortune, most of us find ourselves stunned by the speed with which these companies accelerate from zero to sixty-million-dollar valuations.
However, what frequently goes unmentioned in these stories of bedeviling success is the role that angels play — angel investors, that is — in enabling many young companies to grow from idea, to capitalized venture, to viable — and sellable — commercial enterprise.
The Angel Capital Association estimates that there have been roughly 225,000 angel investments made in the US during the past two years, and that the number of angel investors has to potential to grow to four million in the coming years.
Sounds like reason to rejoice, doesn’t it? Well, if you count yourself an entrepreneur, a potential investor, or just someone interested in finance and industry, you probably agree.
We certainly do, which is why creative.reconstruction sat down with Linda Holliday, a serial entrepreneur and member of the New York Angels — the nation’s most active group of its kind — to learn more about the spirit of angel investing.
CREATIVE.RECONSTRUCTION: For starters, how would you define “angel” investing? What are its distinguishing features, and how might it differ from venture-capital investing?
LINDA HOLLIDAY: Angels are amateurs and VCs are professionals — meaning that they have raised funds from outside partners and are running an organization that vets and manages investments. Angels are often individuals; VCs are essentially committees.
In my experience, it’s also the case that angels are more emotional, and 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 just 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.
In truth, both groups of investors can be very trend driven — always looking for the next Pinterest or Uber, etc. That makes it much easier to get an iterative idea funded than an original one.
At what stage of a company’s life cycle is it most advisable to approach an angel investor? Can it ever be too soon or too late for an angel?
Unfortunately, as the options for early financing increase with platforms such as Kickstarter, and the competition for seed money gets more and more intense, most angels now want quite a bit of “de-risking” before investing. So that often means that the product has been built and or tested with some users. It’s usually only too late to approach an angel if you’ve already pushed the valuation for the company beyond seed level ($3M–$8M pre-money), but even that is flexible and changing. You should definitely have a good team together, and enough assets in place so that you can convince strangers that you can pull something off. When I teach my class on entrepreneurship, the first day I come in I ask the students to give me $1,000. That kind of underscores the importance of persuasion.
Is angel investment more advantageous than borrowing as a means for companies to finance growth? Why or why not?
It’s extremely difficult to obtain debt financing for seed companies, but if you can get it, it would prevent significant dilution. I learned business the old-fashioned way: that selling equity was very expensive; that you should do everything you can to hold equity. Alternatively, given the high failure rate for startups, many entrepreneurs might be nervous to finance significantly with debt.
Many entrepreneurs are relatively inexperienced, and if they have the commitment of some experienced angels it can make a big difference as to whether they succeed or fail. In an ideal world with lots of choices, angels would be selected for that experience.
What have you found to be some of the more common misconceptions held — or mistakes made — among entrepreneurs who seek angel-investor support?
Most entrepreneurs are shocked to find out just how much equity they have to sacrifice to raise angel funds. If you look at the investment class and do the math: If one-third to one-half of funded companies fail, and one-half of the remainder are essentially flat, it means that last portion has to generate a huge multiple for an investor to break even. It’s not uncommon for an angel to seek a multiple of 10x or greater on their investment — of course that doesn’t mean they get it.
It really is a buyer’s market for investors. Entrepreneurs will only have one shot at an investor. You really have to have everything buttoned up — everything. And unfortunately, that often means having a serial entrepreneur with a successful exit on the core team; it’s the greatest predictor of success.
For me, I look for domain expertise, or at least that a lot of research has been done. We’re in a moment now where having no experience is somehow seen as a disruptive advantage. Wake me when it’s over!
What tools or metrics have you found to be the most reliable means of evaluating a company’s investment-worthiness? What would you consider to be the three most critical characteristics of an investment-worthy venture?
It’s hard to trust metrics too much, since really all you’re buying is a story that happens in the future. That being said, some metrics, like referrals or time spent with the product, can have strong predictive value.
When I evaluate an entrepreneur, I ask myself the question, Would I hire this person to run, say, a $10M department? For five years? Unsupervised? That’s the level of confidence you need to have in somebody. For me, that clears things up pretty fast.
Three important invest-ability characteristics would be: An idea that’s riding one more important tech trend; an entrepreneur that is plausible with a well-considered game plan; and a concept based in a sector that I would consider myself qualified to evaluate.
Are there any particular business sectors, scenarios or needs for which you feel angel investment is best-suited? Why or why not?
There are many ways to be an angel investor: The tech sector is obviously very hot; so is e-commerce. Being an angel in those areas could lead to a vibrant professional life. You may also want to stay close to the industries you understand most, or that most interest you. Many angel investments will require follow-on rounds. It’s a good idea to think about what the life-cycle for the company is and whether not you have the patience, or as we say, the “powder,” for it. Many angels are looking for investments that will exit relatively quickly. (A $2M valuation now for a $20M exit in two years is one desirable formula.) Other angels are looking for a “Hollywood hit,” and want to make many bets. If the sector you’re looking at doesn’t have a history of raising follow-on rounds of investments, it’s probably too risky as an angel unless you think that company can get to break-even on seed money.
Do you feel that there’s value in angel investors having a clear and guiding investment philosophy? Or is it best to evaluate each opportunity on its own merits?
It all depends on one’s motives: If you don’t start from a financial point of view, you’ll probably end up losing money. But even if you do start with a purely financially driven evaluation process, there are plenty of interesting companies to choose from in every sector. All young companies are risky and it’s always advisable to diversify your portfolio. If you want to make money it’s probably a good idea to think about investing in 10 to 20 companies at a minimum. It’s easy to fall in love with ideas, but 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 super-important, too. Doing enough due diligence as an individual is pretty onerous. The group can perform that role en masse, or as an individual investor you can follow behind groups of more seasoned angels who have done most of that activity.
In what ways — be it through marketing, efficient, debt profile or product/service focus — can an entrepreneur make her 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 towards future value creation not paying down past value creation. Maybe that’s not logical, but it’s true.
Entrepreneurs really need to be out there, stirring the water, making a splash, trying to crescendo a bunch of attention at the closing of a round. Of course, this is very hard to do — especially without the benefit of expensive communications professionals. Thus, most entrepreneurs are on the hunt for product demonstrations and promotional ideas that create a lot of buzz for very little money.
Watch what other entrepreneurs do. Goldie Blox [the company that makes engineering-themed toys for girls] was particularly brilliant this year: They capitalized on negative stereotypes about girls as engineers and provoked a lot attention with their aggressive use of copyright-protected music in promotional videos. The controversy actually landed them a sponsored spot in the Super Bowl. That’s a 10!
In your years as an angel investor, which would you count as your most memorable and your most forgettable experiences — and why?
Most memorable? Giving a young CEO high-end 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. The entrepreneur just took the advice, executed perfectly and saved the day. He’s a natural. You make lots of little saves and lots of introductions and all of them are satisfying and memorable. In that way it’s kind of like being a parent, I guess.
Most forgettable? The “repetitive-stress injuries” one suffers with inexperienced executives who don’t take coaching very well; they almost always fail. It’s a really tough balancing act. Stubbornness isn’t confidence, but they can look very similar.
Are they any parting words of advice or wisdom that you would offer to current or prospective entrepreneurs? What about prospective angel investors?
To the entrepreneurs: I would say that every day is a struggle to separate the important from the urgent. 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 would say read my friend David Rose’s new book “Angel Investing: The Gust Guide to Making Money and Having Fun Investing in Start-ups.” If I’d read it five years ago, I might not have had more fun, but I definitely would have made more money.
For more information on becoming or finding an angel investor, visit the Angel Capital Association or the New York Angels.
A edited version of this article was originally published on Learnvest.com and Forbes.com in November 2015.
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