White Paper: Successfully Raising Angel Funding

Successfully Raising Angel Funding by @adrianreeve Hamilton Bradshaw Venture Partners 60 Grosvenor Street, London W1K 3HZ E:adrian.reeve@hbvp.co.uk M:+44 (0)7887 756106 www.hbvp.co.uk € 2012 Adrian Reeve

OverviewThis paper endeavours to unravel the seemingly complicated and occasionallyobscure process that entrepreneurs face when trying to persuade angelinvestors to part with their money for a stake in the entrepreneur’s businessventure.It focuses on the UK environment although many of the principles and issuesraised will be relevant in other jurisdictions.Definitions:Friends and FamilySo-called ‘love money’, which is generally obtained from the family circle orvery close friends of the entrepreneur and which may not be invested forcommercial gain.Angel InvestorAn individual not connected with the entrepreneur or the venture, who investspersonal funds in an unquoted commercial enterprise, alone or alongside otherinvestors, with the intention of receiving a significant financial return at afuture date.While not an authorised person within the meaning of the Financial Servicesand Market Act 2000, such an investor will be a high net worth individual or aself-certified, sophisticated investor, as defined by the Financial Services andMarkets Act (Financial Promotion) Order 2005.Venture CapitalistA finance professional, usually part of an established investment firm, typicallyauthorised and regulated by the financial services authority, who invests otherpeople’s money in commercial enterprises with the expectation of making asignificant financial return for both parties at a future date. Funds are providedto the investment firm by pension funds, institutions, family offices and otherindividuals.EntrepreneurAn individual who creates and develops a new commercial enterprise with theexpectation of making financial gain. This is distinct from a social entrepreneurwho develops a new enterprise to achieve social change or benefit.PhilanthropistAn individual with significant personal net worth who invests in or donates tocommercial, non-commercial or charitable enterprises, often for no personal orfinancial benefit. € 2012 Adrian Reeve

Angel investment in contextAngel investors will have usually had successful business careers. Theirmotivations will differ but are likely to include a desire for:a. Financial return: This is the primary motivation of the business angel. Tocompensate for the risk involved a business angel seeks to make at least 10times their investment over, say, a 5 year period, ideally in a tax efficientmanner. This equates to an internal rate of return (IRR) of almost 60%.b. Personal return: The satisfaction of being involved in a new venture,keeping up to date with technology or trends, and the potential excitement ofbeing part of a real success story.Business angels have been recognised as an important source of finance forentrepreneurial businesses for nearly 20 years in the UK and for even longer inthe USA. Business angel investment activity is difficult to identify and track. Inthe 2011 report on the UK business angel market1, the British Business AngelsAssociation (BBAA) reported that the 1,800 active angels within its networkhad invested ƒ32.2m of the ƒ98.3m raised by 245 companies. This analysisformed part of the authors’ estimate for total UK angel investment of ƒ318m.Angel investing is inherently risky. The 2009 NESTA/BBAA research report2“Siding with the Angels” analysed returns suggesting that 56% of angelinvestments exited at a loss, with most losing the entire investment, and 44%at a gain.The average exit multiple was 2.2x the original investment in 3.6 years,although 9% of exits were made at a multiple of 5x or more. Overall the resultwas a gross IRR of 22%. Distribution of Angel Investment Returns Percentage of Source:BBAA/NESTA Research report: Exits “Siding with the Angels" 60% 50% 40% 30% 20% 10% 0% <1x 1x to 5x 5x to 10x 10x to 30x >30x Exit multiple of original investment € 2012 Adrian Reeve

Back to basicsBefore considering the issues involved in attempting to approach businessangels the entrepreneur should reflect on some fundamental questions:a. Do I have the tenacity, determination and enthusiasm to raise funds? The process may take 3-6 months and is likely to become all-consuming. You will be rejected more than accepted and are more likely to fail than to succeed. Angel groups across the BBAA network received almost 10,000 business plans during 2009/10 of which only 8% were deemed of sufficient quality or interest to pitch to members and only 1/3rd of these, or 2.5% of the original submissions, secured funding.1b. Do I need angel finance at all, given that many startups do not receive investor funding?3 Is it possible to bootstrap my new venture? Could I finance my embryonic business with the support of some co-operative clients, a helpful supplier or maybe a modest, friendly loan from the “bank of mum and dad”?c. Is my startup something in which I would invest, if the roles were reversed? Is it just another mousetrap or something truly innovative that changes the way people buy or use mousetraps or approach the mice-catching problem?The entrepreneur has 3 fund-raising objectives: Create multiple opportunities to present the venture to business angels Sell the opportunity so that they become potential investors in the venture Guide them through the legal process to a successful conclusionFinding angelsA useful starting point is the British Business Angels Association4 which has amembership of over 100 organisations and angel networks. Individual angelscan be more difficult to identify and may be found at investor network orpitching events, or online through personal blogs or social media platformssuch as LinkedIn, Twitter or Google+.Exposure to angels is achieved through the increasing number of acceleratorprogrammes, incubators or competitions, such as Tech Entrepreneurs Week,that have developed over the past years. Table 5 of the NESTA report, “TheStart Up Factories”, provides a list of 12 UK-based accelerator programmes.5Motivating angelsRegrettably the sentiment expressed in the 1966 pop classic, “Reach out andI’ll be there”, does not apply to the entrepreneur and the business angelcommunity unless a number of conditions are fulfilled. The risk of failure forstartups is high6 and so it is in the interest of the startup team to reduce asmany of these risks at fund-raising stage as possible. € 2012 Adrian Reeve

Angels assess investment propositions across a number of dimensions.Hygiene factors will relate to things like location, industry sector, the amountbeing raised, stage of development, and timing. Motivating factors include:a. An inspiring teamViews differ on what constitutes the optimum team and useful insight may beprovided in online discussions on the subject.7 Investors value sector ordomain experience, technology skills and execution capability. In the absenceof any prior success, interest is also increased if the entrepreneur comes with arecommendation or referral from known investors. It’s called “social proof” andshould work both ways in the startup/investor relationship.b. A problem solved, or a new product/market createdGiven that truly new product/market innovations are thin on the ground, theventure must solve a real problem. This can be achieved by being “disruptive”,bringing a new approach to an existing business model, or being considerablycheaper/more efficient/better quality at delivering an existing product orservice.Propositions such as bottled water for pets (thirstycat), online currencyalternative to cash and credit cards (flooz) and the infamous attempt by theworld’s largest beverage company to introduce “New Coke” in 1985 areexamples of products looking for a problem. c. An awesome solutionThe problem may be clearly articulated but the solution has to be realistic,affordable, and capable of generating enough revenue and profit, anddeliverable within a timescale acceptable to investors.Proposing yet another online hotel reservation business may not captureinvestor imagination, but suppose you could create a business that connectspeople who have space to spare with those who are looking for a place to stay?That’s the proposition of airbnb, started in 2007, in response to the problem ofa lack of hotel space, now offering private accommodation in 186 countries,and valued at $1.2bn.d. Some form of competitive advantage.Occasionally referred to as a “moat”, to reflect the difficulty for a competitor togain entry to the market. This may be evidenced to investors through thecompany’s intellectual property (IP) which may be in the form of patentsapplied for or granted or other forms of technical advantage.e. TractionA great team presenting a wonderful solution to a clear problem will look evenmore attractive to investors if customers are already on board or have madecommitments to use/buy the product or service. It’s called traction andinvestors love it because it is the best demonstrator of the inherent potentialvalue of the business. € 2012 Adrian Reeve

f. The size of the prizeThe target market needs to be capable of delivering a customer base ofsufficient size to enable enough value creation to reward investors for the risktaken. At one extreme is the world’s most successful startup,8 Facebook,incorporated in 2004, which has 800m active users and a valuation of $80bn.Your startup is unlikely to be a global play, but if you can steer clear of “verysmall market niche” that will work in your favour.g. ValuationThe best advice that can be offered to the entrepreneur on the thorny issue ofvaluation is: “be realistic”. If you are bringing all the above criteria to thetable, are revenue generating, have patents granted in all key markets, arelikely to be profitable in year 1 and have a large target market, then theargument for a higher valuation is more easily justified.Valuation rules of thumb are many and varied and are typically lower in UK &Europe than North America. Generally, the angel investor community operatesin the ƒ100k to ƒ1m pre-money valuation range and wishes to secure ameaningful equity stake, which means between 25%-35% of the business.9Pitching angelsPitching to angel investors should be regarded as a sales process, the objectivebeing to create an appetite to invest in the business opportunity.1. Capture attentionTell them about you, your killer team, the problem and your awesome product,the traction gained and the (significant) potential. In more detail explain yourbusiness model, how you add value to customers, how you plan to obtaincustomers, distribution and revenues and where, how and why you are better,different or protected from competitors.2. Create interestThe best way to create interest is to demonstrate traction; that customers arebuying the product/service in increasing numbers. If it helps investorsunderstand the product or technology then a demo, mock up or screen shotsmay be helpful.3. Build desireShow how revenues and cash can be developed in the near term, and whatsort of value could be built over a 3-5 year period.4. Confirm actionSummarise the funding that is required and how it will be used, showing anyrelevant milestones. After positively responding to questions, connect withthose who are interested, agree a next step and follow up promptly.Don’t forget to qualify their level of interest and their ability to participate in afunding round in the timescales proposed. € 2012 Adrian Reeve

Do not: Provide technical detail about the product Provide financial detail Overuse jargon or catchphrases Misrepresent the facts Use phrases like “if we can just get 1% of the market….” Use phrases like “likely trade buyers are Google or Facebook” Tell your life story Talk to the slides or read from a scriptDo: Provide a summary of sales revenues, costs and profit per year Indicate when you plan to break even and achieve significant milestones Explain how much money you are raising and commitments made to date Clarify how these funds will be used Draft, re-draft and practice the pitch Keep it to 10 slides max, some say 6! Be focused, passionate, engaging and clear Make it memorable…..for all the right reasons!Closing the angel roundPitching is one thing, being able to celebrate the long-anticipated fundsarriving in the company bank account is another thing entirely. Those whohave been through the process will know that successfully completing aninvestment round with multiple angels can be the equivalent of……. "Herding Cats" illustration copyright € Rich Faber www.richfaber.com, 2011. Used with permission. € 2012 Adrian Reeve

12 steps to success1. Establish a group of angels who have indicated an interest in investing inthe opportunity to form the syndicate for the round.2. Ensure that you are in direct contact with all the syndicate members, havevalidated their ability to invest and know the amount they are prepared toinvest.3. Identify and gain the support of a lead investor for the syndicate. Thisindividual is ideally the angel with most investment experience, who hasspecific and relevant domain or sector experience, who is sufficiently known toother members of the syndicate such that they gain additional confidence fromhis/her involvement. The individual is likely to be a significant investor in theventure and may become the investor representative on the board.4. The entrepreneur will need to be ready and able to respond to due diligenceinformation requests. This process may include the provision of variousscenarios on revenues and costs as the syndicate validates forecasts initiallypresented. Establishing an online data room beforehand will streamline thisprocess.5. In the absence of a term sheet being presented to the entrepreneur by thesyndicate, agree a term sheet with the lead investor and present it to thesyndicate.6. The term sheet is a legally binding document, once signed, and shouldinclude the following elements:a. Offer terms, such as: 1. Company, founder and investor details 2. Amount to be invested 3. Pre-money valuation 4. Type of security and structureb. Conditions, such as: 1. Satisfactory completion of due diligence and references 2. Enterprise Investment Scheme (EIS) qualification10 3. Service contractsc. Terms of the agreement, such as: 1. Board composition & decision making criteria 2. Rights and restrictions for shareholders 3. Representations, undertakings and warranties of the founders 4. Professional fees and costs 5. Exclusivity period and timescales € 2012 Adrian Reeve

d. A capitalisation table showing the post-investment ownership structure ofthe business to include founders, option pool and investors in the currentround.Term sheet templates are readily available online from various sources and canalso be provided by the legal adviser of the entrepreneur or angel syndicate.117. Once the term sheet items are agreed, secure the signatures of thesyndicate and the founders to create a binding document.8. Instruct legal advisers to begin the documentation process, having earlierestablished and agreed the fees involved. Both parties will need legalrepresentation, but the angel syndicate should now operate as one with asingle legal adviser. The documentation process will include a shareholdersagreement, articles of association, disclosures and various board minutes andfilings for Companies House.9. Maintain communication with the syndicate, through the lead investor,throughout the documentation process. Confirm the expected date for fundstransfer and completion to ensure that angels will have transferred funds tothe legal adviser beforehand and are available for document signature.10. Respond to documentation queries and change requests raised by theinvestor side promptly. Don’t fight unimportant issues.11. Ensure the business continues to make progress and, especially, meetsany expected milestones. If at all possible provide the syndicate with somegood news to reflect progress, increased traction and momentum.12. Do not under-estimate the difficulty of gaining signatures on documents ifmultiple investors are involved. Many angels travel regularly and can often bedifficult to contact.Completion itself is likely to be something of an anti-climax, with the exceptionof the knowledge that the funds are now in the company bank account.ConclusionRaising funds from business angels may be difficult, time consuming and evenfrustrating but for the right founder with the right project it may be thepreferred option. Your chances of success are likely to reduce the more youdeviate from the approach and guidelines discussed above.If you manage to successfully conclude your angel fund raising process you willhave started the really hard work…..of delivery.You might like to take a moment for some additional inspiration.12 € 2012 Adrian Reeve

REFERENCES1. Annual report on the business angel market in the United Kingdom: 2009/10Colin M Mason & Richard T Harrison. May 2011.2. BBAA/NESTA Research report: “Siding with the Angels. Business angel investing, promisingoutcomes and effective strategies”. Robert E. Wiltbank. May 2009.3. Martin Zwilling, CEO Startup Professionals Inc. “Most startups get no professional investorcash” March 2011.http://blog.startupprofessionals.com/2011/03/most-startups-get-no-professional.html4. British Business Angels Association. www.bbaa.org.uk.BBAA member directory angel networks: http://www.bbaa.org.uk/member/directory?type=15. The Startup Factories. The rise of accelerator programmes to support new technologyventures. NESTA Discussion Paper. Miller & Bound. June 2011http://www.nesta.org.uk/home1/assets/features/the_startup_factories_report_feature6. 20 Top Reasons Startups Fail. Chandni Shah. January 2011.http://www.chubbybrain.com/blog/top-reasons-startups-fail-analyzing-startup-failure-post-mortem/7. Question-answer thread on the ideal web-technology start up team:http://www.quora.com/Startups/What-would-the-ideal-web-technology-start-up-team-be-composed-of8. The Digital 100: The Worlds Most Valuable Internet Startups! Zach Lichaa. October 2011.http://www.businessinsider.com/2011-digital-1009. Rule of thumb on percentage of equity to give an angel investor. Mark Suster. August 2010.http://www.quora.com/Mark-Suster/Equity/answers10. Enterprise Investment Scheme (EIS)An Introduction to the Enterprise Investment Scheme (EIS)http://www.hmrc.gov.uk/eis/guidance.pdfHM Revenue & Customs (HMRC) EIS web site: http://www.hmrc.gov.uk/eis/HMRC EIS advance assurance application form:http://www.hmrc.gov.uk/forms/eis-aa-bw.pdf11. Term sheet examplesStandard angel investment term sheet which includes all major commonly used terms:http://seedsummit.org/legal-docs/Term sheet and legal documentation developed by BBAA advisers for angel investors:http://www.bbaa.org.uk/node/10412. Inspirational quotes from start-up entrepreneurshttp://inspirationfeed.com/inspiration/50-inspiring-entrepreneur-startup-quotes/ € 2012 Adrian Reeve

White Paper: Successfully Raising Angel Funding

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