Angel Investing Seminar Notes


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Notes from an angel investing seminar conducted with a panel of experienced angel investors in June, 2000.

I've added some notes from experience over the past 13 years but for the most part, the information is as applicable today, as back then. This information should be helpful to not only angel investors but also entrepreneurs seeking their investment.

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Angel Investing Seminar Notes

  1. 1. Notes from UCSD and “San Diego Band of Angels” angel investing seminar held on June 9, 2000. I’ve added some “Notes from the future (2013)” for some additional empirical data learned over the past 13 years but otherwise the notes are as valid today as they were in 2000. [Before the Deal] 1. Starting out, work within area you know ideally so you understand business and potential requirements to make a success of the business. 2. Groups of investors good because different people are better at different things - one might be good at technology, financing, people-person etc. Sometimes one person in group sees things others may not. Groups of investors bad because it is sometimes (often times?) hard to get consensus. 3. Questions to ask: What is idea? Do I “get it” (business idea/model)? Who are the people (principals) and their qualifications? 4. Non-disclosure agreements: early-on - NO - the value is not the idea, the value is in the execution of the team. Later on when you do due-diligence, see specs/code or other intellectual property, an NDA becomes more appropriate (to protect trade secrets of company). NOTE: NDAs might expose you to legal issues/risks, be careful when they are used - seek legal advice. 5. Patents: talk to company's patent lawyer about patents, their due-diligence during patent search, why they think it is patentable etc. 6. READ EXISTING LEGAL PAPER TRAIL: see references/warrants in any existing stock purchase agreements and schedule of exceptions that describe any leases, employment agreements etc. don't want to make a $1M investment and have 50% of it go to a company to pay executive loans etc. Ask for "cap table" or table of company's capitalization (investments to date). 7. CHECK REFERENCES - former employers, bosses, co-workers. Is their personal life in order? Divorces, lingering deaths in family, debts, etc. all might interfere with person's concentration, when it is extremely important at this stage. 8. LOOK FOR PASSION - want someone focused and self-motivated. For young entrepreneurs - can they attract "the right" people later on (senior management etc.). 9. VALUATIONS/FINANCING: principals must have realistic plan for next 6 months+ to reach next financing goal: must have tangible milestones such as prototype for proof of concept, hiring goals, press etc. The idea is to have these goals lead up to next round of financing, show accomplishments, meeting goals etc. 10. $500K -> $1M should cover this first "seed" investment to get to a point of a more substantial first round. NOTE: these days this angel round is sometimes in the $1.5M -> $2.5M range which panelists feel is extreme over-valuations for early stage companies (depends on where they are with products/in product life cycle).
  2. 2. Note from the future (2013): most angel deals are failures; you will lose some or all of your investment. Negotiating a lower valuation takes failure into the equation: a lower valuation on your successes will yield a higher return to compensate for the failures of other investments. Does that mean you should avoid all high valuation deals? No, but always remember failure is more likely than success. 11. "THE HERD" - like Wall Street, angel investors typically follow the herd mentality - get a few investors interested and others follow. Need champion (lead angel) that acts almost like a leadVC would to work getting other investors interested. Note from the future (2013): this point can’t be emphasized enough – especially when doing investments with angel groups, there are influential members. If you can get “influencers” involved in deals early on as “deal leads” or “lead helpers”, it helps the process. But ultimately this doesn’t negate having a great team, idea and market to invest in. 12. THE RETURN - VCs typically look for 10X over 5 years or 58% annual return. The range is more like 10X to 20X over 3-5 years. Might have 1 or 2 successes during span of 20 investments. Angel or early stage investing is not rational as just an investment vehicle - if you just want money, invest elsewhere, if you enjoy "the game" and aren't in it just for the money, this might be the place. Note from the future (2013): you might be looking 6-7 years out to exit – maybe more. In an ideal world, if you seek an earlier exit, you would invest in companies that are building something as an early-exit (3 years or so) acquisition target via M&A. 13. Probability of company following plan exactly and succeeding is low. Have 3 buckets: success, walking-wounded and the failures. Majority are walking-wounded or failures. 14. Can't value company too high early on because it sets the stage for later investors where you are looking for future bumps in valuation (after meeting goals). 15. If initial investment valued too high, can make smaller investment tied to some goals to get ball rolling. 16. Fallback: for every $1 invested, put 50 cents aside for future investment - usually company is late and over-budget and "mini-round" or some type of bridge to next financing round may be needed. The premise is that you have to "really believe" in the company and see it demonstrate execution to plan. 17. Do you really do "bridge-loan"? Ideally "NO" – if you invest, you want equity behind investment. There are some investors who don't mind fronting money with conversion debentures/ability to later convert investment to stock.
  3. 3. ["Doing the deal"] 1. Term sheet: see examples, flesh out any issues: board seats, employment contracts, intellectual property ownership, anti-dilution agreements etc. Note that term sheet sets basis for later rounds but term sheet is always up for negotiation. Note from the future (2013): with more than ten years of empirical data, I’ve seen that any prior round term sheet can be negated by any future round of investment. You can have “recapitalizations” which change the valuation of your invested money diluting you, you can lose “anti-dilution” protections as requirements of future rounds, you can lose “board seats”. It’s important to remember that any future round required to keep a company running has the ability to wash out any terms you negotiated earlier. A term sheet is written on paper, not stone. 2. Board: ask founders if they know what a board is, what its role is and what it is responsible for along with what management is responsible for... board exists to help CEO to succeed along with raising capital. 3. Seek good legal counsel for the company and they should have equal footing with board at board meetings (ability to chime in). 4. Angels can be on board but be aware that company, if successful will most likely out-grow angels area of expertise and may need to leave board seat for more experienced member. 5. Angels should have rights to sit in on board meetings any time they ask. Communications should remain open and senior management should be available to investors to meet as appropriate for both parties. As an example, one panelist has $2M invested in 18 companies and is on 7 boards but some of his investments are passive - may only talk to CEO once a year. 6. While company is private, should have regular status reports to investors - quarterly financial/product milestones in "notice to shareholders". If IPO really is a goal - company should be run that way to have financial/product paper trail for later IPO. 7. Once first financing done, need to think of next round (always thinking financing/future milestones with goal in mind: IPO, buyout or whatever parties agreed to). 8. Note that anti-dilution provisions not always workable, but might be able to set up provision to do things like have equal-participation available in later rounds. 9. Intellectual property rights have to belong to company (not employees or other entities). 10. Ensure no outstanding issues with previous employers of company - don't want to have ongoing legal issues that become a money & time sink for company. 11. Stock registration: can ask for registration rights to have stock more "liquid" or "piggy-back" rights along with other shares. Basically want ability to sell when stock becomes available for public consumption. Not that you will sell, but need to have flexibility.
  4. 4. ["After the deal"] 1. Angels/startups should meet at least once a month after deal to check financial/product goals against milestones, have a narrative of status and list of variances. Note that goals may be organizational (hiring), financial (licenses etc.), product (status towards schedule) etc. 2. Have "open environment" and stamp out politics immediately when it rears its ugly head. Again, seek visitation rights on board of directors meetings - don't necessarily want to visit but should have opportunity when important (commonly granted/rarely used right). If large group of investors, choose representative to meet with board and inform other investors - large groups may be too cumbersome... 3. RISKS: market is risk - not technology – concentrate on customers and what it takes to reach them. NOTE: most panelists have experience more marketing than technology issues with companies failing. Note from the future (2013): this also can’t be emphasized enough – most companies fail because they never first discover the customer. Sounds crazy, right? Time is better spent early on testing whether product will really fix customer pain it purports to solve and whether (and what “$”) the customer will pay for the company’s solution. Raising money and building a product to meet a customer pain are much easier when you have the data describing in detail the problem you are trying to resolve. 4. Milestones are usually 2X late, more than 2X over budget. If you have great people with large market, usually not a problem but an opportunity. Note from the future (2013): almost ALWAYS happens – twice as long and twice as much! 5. Angels need to get company to practice company pitch to 15 minutes - should have polished presentation ready at all times along with anticipated Q&A, post pitch for future financing rounds. 6. When asking questions, want direct answers from principals and if they don't know answer, have them say they don't know -- no BS: look for competence and honesty. 7. More competent management is, more it meets goals and has track record, better later financing will be. 8. Exit strategies: IPO *NOT* an exit strategy, it is a financing event - one panelist's viewpoint. He thought S3 or secondary offering was exit strategy, not enough volume/float in IPO or early stage of public company for exiting. Exit strategies are buy-out of company, secondary offering where majority of equity might be sold etc. My cut: you *can* begin a slow exit at IPO, but obviously volume/float of company might be mitigating factor. However, if you really believe in the future of the company, why not keep invested in some large degree? Answer: probably most VCs don't want long term exposure, want quick hit and to get out for other future investments. 9. See SEC Rule 144 - read all…