FiBAN - Angels in groups - By Bill Payne


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making syndicated angel investments is proven to lower the risk especially when making the first angel investment.

Bill Payne will share his wide experience on this fiels and give his best practices to find a balanced solution.

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FiBAN - Angels in groups - By Bill Payne

  1. 1. Angel in Groups Helsinki, May 7, 2012 BILL PAYNE
  2. 2. Bill Payne is an active angel investor, board member, and advisor to entrepreneurs.He assisted in founding four angel groups: the Frontier Angel Fund (2005), TechCoast Angels (San Diego – 2000), Vegas Valley Angels (2003) and Aztec VentureNetwork (1999).For three decades, Bill Payne has successfully founded or invested in over 50 start-up companies. He served as an Entrepreneur-in-Residence to the KauffmanFoundation for twelve years. While there, he directed the development of thePower of Angel Investing education series for entrepreneurs and angel investors.He has served as lead instructor for over 100 seminars in seven countries.In 2009, Bill was named the Hans Severiens Award winner as the “outstanding angelinvestor in America.”
  3. 3. AGENDAAngels: Importance to US EconomyPortfolio Strategy for Angels Study: Returns for Angels in Groups Implications of Study to Investing StrategyInvesting with Groups versus Solo InvestingAngel Group Investing ProcessAngel Group ModelsSyndication Among Angel Groups Copyright © 2012
  4. 4. The Capital Lifecycle Investigation Feasibility Development Introduction Growth Maturity Proof of Pre-Seed Seed & Early First, Second, etc... concept Start-up Government Sources SelfPROFIT Friends & Family Venture Capital Angel Investors IPO, Banks First Revenues VALUE OF DEATH TIME
  5. 5. Who Are These Angels?Wealthy individuals – sophisticated investors“Been there, done that” entrepreneurs Invest time and money in portfolio companies“Mad money”Generally $25K-$250K per deal per angelMany angel investmentsRange of involvements Lead investor – Chairman of the Board Investor/advisor Passive investor
  6. 6. Professor Josh Lerner(Harvard University – 2010)Regarding angel investors:• Angels make a large and significant impact on the success and survival of their portfolio companies• Mentoring and business contacts are even more important than angels’ money
  7. 7. MotivationVENTURE CAPITALISTS: make moneyANGELSReturn on Investment is the metricStaying involved (sense of usefulness) altruisticGive back to community motivationsAffection for entrepreneurs
  8. 8. US Job Creation (1977-2005) Kauffman Foundation 2009
  9. 9. Quotes:Dr. Bob Litan, VP Kauffman• Companies less than five years old have created 40 million jobs in the US in the past 30 years• Companies five years and older have, in the sum, lost jobs in the past 30 years
  10. 10. American angels fund 20,000 newcompanies per year that are in thesweet spot of job creation in the US
  11. 11. Portfolio Strategy for Angels
  12. 12. Classic Assumptions• High risk asset class• A high fraction failed• Shooting for home runs = >10X• Seed/startup VC yields >20% IRR• Paucity of data
  13. 13. Two Studies by Prof. Rob Wiltbank (Willamette University, Portland, Oregon)
  14. 14. 3 yrs 3.3 yrs 35% 0X Overall Multiple: 2.6X Avg. Holding Period: 3.5 years 4.6 yrs 4.9 yrs 6 yrs
  15. 15. Time to Exit 16Years from Investment to Exit 14 12 Pessimistic 10 8 Wiltbank Data 6 4 Optimistic 2 0 0 10 20 30 40 50 Return on Investment (ROI – cash on cash)
  16. 16. Conclusions from Wiltbank Studies Returns are skewed    Therefore:   
  17. 17. Adjusted Portfolio Strategy Invest in at least 10 -25 deals (lifetime)  90% of deals return all capital invested in portfolio  10% provides all upside and must be a 20X Investing in more than ten deals is good  Conversely, a small number of large angel investments increases risk All deals must have potential for 20X Angel investing is a 10+ year commitment  Similar to VC investing, perhaps longer!
  18. 18. Gambling Analogy: Angel Investing
  19. 19. Portfolio Strategy: Gambling AnalogyPay $1 and pick number from 1-10 Win $25 if you pick correctly (25X)This is a skewed distribution (like angel investing) Win 10% of time lose 90%Expected Value is 2.5x ($1 for 10 plays, win $25) Play once, likely lose; but could win $25 If you play many times, should win 2.5x what you bet But also reduces chance big win (25x in one play)
  20. 20. Example: Gambling AnalogyPlay 1 time likely lose money (90% of time) could make 25XPlay 3 times probably lose your money could make 8X, 17X or 25XPlay 10 times probably make money most likely about 2.5XPlay 100 times expected return is 2.5XPlay 5000 times assured return is about 2.5X
  21. 21. Lessons Learned1. The distribution of returns from the Wilbank study strongly suggests that invests pursue a portfolio strategy of at least 10 investments and perhaps as many as 25 investments to optimize returns.2. Based on the Wiltbank studies, anticipated returns for angel investing is an IRR of 20-25% (~2.5X ROI)3. Investor patience is required (10+ years)
  22. 22. Patience is requiredLemons Rot Faster than Plums Ripen• -1X typically takes 2.5 to 3 years• 10X is expected to take 4-5 years• 30X could take 6-8 years or moreHint: Angels should not expect high portfolioyields (IRR) after only three years of investing!
  23. 23. Invest in at least 10 companiesBut: How much should angelsinvest in each deal?
  24. 24. Determining Size of Angel Investments • Invest in at least 10 deals (lifetime) • • • • Determine total personal assets set aside for angel investing (3-10% of total assets) • Divide total commitment by 20 investments •
  25. 25. Strategy: A Personal Choice• Invest in each round of perceived winners o Invest along side subsequent investors o Invest a lot in some company, little in others o OR…limit follow-on investing• Invest in new companies o Be very selective in follow-on investments o Chose to diversify over betting on winners
  26. 26. Other Triggers for Investment• Scalability and diversity are not only issues• Vary by investor and within angel groups• Some additional critical triggers may be: • • • • • •
  27. 27. Groups versus Solo Angel Investing
  28. 28. Solo Angel Investing• Process is time-consuming • Deal sourcing • Reading plans • Due diligence• Due diligence is difficult • Finding vertical experience • May require using outside experts• Legal support is expensive
  29. 29. Advantages of Solo Angel Investing• Control over the round of investment • Take a little – take a lot • Include only your friends • Negotiate control ownership• Grab hot deals • Move quickly • Dominate an emerging business sector• Negotiate your own term sheet
  30. 30. Disadvantages of Solo Angel Investing• Much more difficult • To manage deal flow • Doing sufficient due diligence • Mentoring/supporting growth in funded companies• Leads to larger investments • Fewer to share any round • Larger personal investments • Pressure to invest in follow-on• Less diversification • See fewer deals • Lose deals to others/no incentive to share deals
  31. 31. Solo versus Group Angel InvestingGroup investing facilitates best practices• Easier to see more deals• More resources to evaluation deals• More experts to mentor companies • Business sector experts as Directors/Advisors • M&A experts to facilitate exit• Best practice for optimum returns (Wiltbank) • Many, smaller investments • Easy to make many, smaller investments
  32. 32. Sharing Deals is Best Practice
  33. 33. Larger Portfolio Improves Returns1. Wiltbank Study – Investing in 10 -25 deals is abest practice for optimum returns. Invest in moredeals – with smaller investments per dealInvesting with groups• Increases deal flow• More investors – less investment per deal per investor• More investors for follow-on investing
  34. 34. Due Diligence: In Group Investing2. Extensive Due Diligence Improves Returns • Group offers substantial business expertise • Group members have time to do diligence • Team due diligence is faster and more comprehensive
  35. 35. Median: 20 hrsMultiple: <20 hrs - 1.1XMultiple: >20 hrs - 5.9XMultiple: <40 hrs - 7.1X
  36. 36. 50% of deals were not related When related, theytypically had 14 years of experience
  37. 37. Mentoring Funded Companies3. More experts to mentor companies • Business sector experts as Directors/Advisors • M&A experts to facilitate exit • Angels groups provide Director training and establish Director/Board best practices
  38. 38. High = 1-2 times per month Low = 1-2 times per yr High: 3.7X (4 yrs) Low: 1.3X (3.6 yrs)
  39. 39. Investing through Angel Orgs• Increased deal flow – more deal choices • Pick and choose the deals you like• Variety of vertical experience available • Expertise in due diligence • Mentors for growing portfolio companies• Standardized processes and term sheets• Great camaraderie among the like-minded
  40. 40. Growth in US Angel Groups350300250200150100 50 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Center for Venture Research (pre 03 data) and Kauffman Foundation/ARI (04- data)
  41. 41. Profiles of US Angels (Wiltbank – US)Years investing 9Number of investments 10Total exits/ closures 2Years as entrepreneur 14.5Number ventures founded 2.7Age 57Percent of net worth 10%Education University
  42. 42. Engagement from Each Angel  Ten portfolio companies  Engaged with 2-4 o Chairman o Director o Mentor/coach  Passive with six or more  Available, if needed
  43. 43. Typical US Angel Group Deal - 2011• $150,000 to $2 million in a single round o Median round size $700,000 o Median from local angel group: $250,000• 20-40% ownership in company• Board position(s)• Special voting rights• Liquidation preference
  44. 44. Engagement of Angels5 to 20 angels invest in a company  Which angels engage with the company  Available Time  Vertical Experience, familiar with M&A exits  Good rapport with entrepreneur  How many will be involved  One or two – depending on need  Others on call for special assistanceNote: Most angels are part-time investors
  45. 45. Angel Roles in Portfolio Companies Board of Directors Advisor, mentor, coach o Of CEO, of management team Step in during crisis (temporary) Assist in raising additional money o Another angel round o VC or strategic money Tee up the company for exit Angels are active in a few deals and passive in most
  46. 46. Fundable Companies
  47. 47. Nondisclosure Agreements (NDAs)• Most angels and VCs will not sign o See too many deals o Integrity is key to continuing business o Not motivated to steal technology• May sign NDA… o During due diligence, not earlier o Covering a very narrow set of issues• Business Plan - no proprietary information
  48. 48. High Growth vs Lifestyle CompaniesLifestyle companies • Organic growth • Great income source for entrepreneurs • Flexible exits o Sell o Stay engaged into retirement o Give business to children • Not fundable by investors (no anticipated exit)
  49. 49. High Growth vs Lifestyle CompaniesFundable Companies (high growth)• High growth potential• Need investor’s capital to grow• Exit strategy defined at outset o IPO (very unlikely) o Sell to public or private company• Entrepreneur builds wealth but perhaps not high income
  50. 50. Evaluating DealsWhat investors look for?
  51. 51. Angel Rating System Management team 0-30% Size of opportunity 0-25% Product & technology 0-15% Sales channels 0-10% Competitive advantage 0-10% Size of this round 0 - 5% Need for more funding 0 - 5%
  52. 52. Don’t Like These Ratios? Management team 25-40% Size of opportunity 20-30% Product & technology 10-30% Sales channels 5-20% Competitive advantage 5-20% Size of this round 0-5% Need for more funding 0-5% BUT: Don’t Make Product/Technology 95%
  53. 53. Fundable Management Teams CEO o Coachable (very important) o Integrity o CEO experience, Leadership o Vertical experience o Team members identified Team o Balance and complete o Experience working together
  54. 54. Size of the Opportunity Scalable o $20 million (min.) in revenues in 5 years o (VCs look for >$100 million) Large niche market o Achieve high revenues with minimum competition High gross margins o Growth with internally generated cash o Requires less investment capital
  55. 55. Product and Technology Product available for customer validation o Prototype o Beta test• Unique technology o Patents, trademarks o Trade secrets o IP protection underway• Manufacturability in quantity validated
  56. 56. Intellectual Property Patents, trademarks, trade secrets Competitive advantage is a “must have” o Competition with resources cannot just reverse engineer and compete o But, IP does not bring great value to startups because they do not have resources to defend Intellectual Property primary value at exit o Acquiring companies insist on IP o Great IP adds substantial value at exit
  57. 57. Marketing and Sales Customer validation is available o Investors need to verify with customers o Essential to investment• Marketing/branding issues addressed• Reasonable sales channels defined• Some partnerships established• Competitive advantage identified o Small competitors, fractured marketplace
  58. 58. Other Issues International o Sales and marketing off-shore  Direct or landed presence Capital o Size of this round o Subsequent funding required  Small (angels) or Large (VCs)  Raising money off-shore  Substantially increases risk
  59. 59. Typical Angel Deals
  60. 60. Typical Angel Group Deals (p1)• Management team has: o Integrity o Experience (management, business vertical) o Identified key advisors/directors o Key players in the wings• And…CEO is coachable• Willing to build a functional board o Entrepreneur will not have control
  61. 61. Typical Angel Group Deals (p2)• The business will scale o Build revenues to >$20 million in five years• The business serves a large niche market o No major players as direct competitors• Large gross margins can be expected• M&A exit are feasible within 5+ years o Multiple acquiring targets can be identified o Technology key to target’s tech roadmap
  62. 62. Typical Angel Group Deals (p3)• Company has prototype ready for customers.• Customers have been identified and have been shown the product or prototype.• Customers can validate that the product is a pain killer, not a vitamin pill• Company has unfair competitive advantage
  63. 63. Typical Angel Group Deals (p4)• The business model can be validated• Reasonable sales channels are available• Customer acquisition costs are low• Competition is fractured (Microsoft is not lurking around the corner)
  64. 64. Typical Angel Group Deals (p5)• Entrepreneurs is flexible on terms• 20+X ROI is possible (not all angels agree..)• Valuation is reasonable• Structure of deal allows input/control by investors.• Board makeup is flexible by entrepreneur• CEO is willing in advance to step aside when opportunity justifies this Board decision
  66. 66. 1. Taking dumb money from many investors!
  67. 67. 2. Pitching product and technology.Entrepreneurs must present theirbusiness plan and the investmentopportunity
  68. 68. 3. Overestimating the market size
  69. 69. 4. Don’t allow entrepreneurs to “ballpark” revenues as a percentage of thetotal market.
  70. 70. 5. Don’t be impressed with “first mover advantage”
  71. 71. Summary• Betting on the Jockey, not the horse• Looking for companies with large opportunities in niche markets• Seeking a competitive advantage• Skeptical about companies that have huge capital requirements.
  72. 72. Angel Group Investing Process
  73. 73. Angel Group Investing Process PROCESS SOURCE COMMENTS %Deal Flow Referenced or Groups seek 100% New unreferenced dealsPre-screening Staff review Criteria for Investment 50%Screening Members Due Diligence or Reject 20%Due Diligence Team of 4-6 Invest or Reject 5-10%Investor Varies by Deal Collect money ~2%Commitment Seek additional investorsClosing Varies by Deal Include outside investors? ~2%
  74. 74. Deal Flow• Many deals come from members, incubators and local lawyers (etc.)• Groups encourage unreferenced deals from local community• Refer outside deals to groups local to the deal
  75. 75. Pre-screening Deal Flow• Pre-screening done by o Staff o Interns (students from local schools, trained by angels) o Small groups of members• Based primarily Criteria for Investment o Published on website (next slide)
  76. 76. Criteria for Investment• Geography (local deals)• Business sectors of interest• Range of acceptable round sizes o Typically $150,000 to $1 million• Upper valuation limit• Preferred stage of development• Other criteria
  77. 77. Screening• Presentation to some or all members• Structured meeting • Using PowerPoint template • Timed presentation, Q&A, private discussion and feedback to entrepreneur• Objective o Move on to Due Diligence phase, or o Optional recommendations to entrepreneurs
  78. 78. Due Diligence• Team of angel members (4-6)• Negotiate term sheet (not part of DD)• Use due diligence checklist• Validate investment opportunity o Management team, Size of opportunity o Technology/IP, Capital required, financials• 2-3 months, decision to write checks• Document in DD book, share with others
  79. 79. Investment• DD team recruits investment from group• Collect investment funds• Make decision about investment from other groups (70% of US deals are shared)• Provide DD documentation to others• Select lead investor (board directors)• Close deal
  80. 80. Syndication with Other Groups• Move quickly• Provide with Due Diligence book• Make entrepreneur and lead investor available to syndication partners• Emphasize importance of timing• Close deal
  81. 81. Models for Angel Organizations
  82. 82. Models in the US• Organizational models o Angel networks o Angel funds• Management models o Member managed o Manager managed o Administrative support
  83. 83. Funds or Networks Angel Funds Angel NetworksManager-managed X XMember-managed XTime commitment X X XDues X X XCarry (preferential return) X XIndividual investments XGroup investments X X
  84. 84. Angel Funds• Pool money in advance• Screen and Due Diligence as group• Vote of members determines investments• Member managed or• Hired manager o Leads the process o Provides administrative support o Is paid thru dues and/or “carry”
  85. 85. Angel Networks• Members do the heavy lifting o Screen and Due Diligence as group o Negotiate common term sheet o Select a deal lead• Members make personal investment decisions o Some pass – no investment o Other invest a little…or a lot• Usually some administrative support
  86. 86. Strengths and Weaknesses Group Organization Model Strengths WeaknessesNetwork Individual decisions Less diversification Less investment in recessions Diversification for all members Group decisionsFund Pooled funds- recession proof More startup work Accounting issues
  87. 87. Manager-led Networks and Funds• The manager o Leads the process o Provides administrative support o Is paid thru dues and/or “carried interest” o Or, provided by public agencies• Sometimes do “heavy lifting in o Due diligence o Coaching, pre-investment• Member must engage post investment
  88. 88. Strengths and Weaknesses Member versus Manager Leadership Strengths WeaknessesMember Member engagement Administrative load Leadership succession Consistent leadership Member engagementManager Single point of contact Operational costs Carried interest cost
  89. 89. Side-by-side Group Investing• Individual member investing along side angel funds, or• A fund established to invest along side individual angel network members• Add leverage for angel group• Let’s members fund their favorite companies• Allows network members to diversify portfolio
  90. 90. Side-by-Side Investing
  91. 91. Automatic Side-by-Side Fund No manager, no carry  Leverage to angel group No fiduciary responsibility  Angels can diversify Typical investment:  Other accredited investors o 30-50% match, if can invest o 5 angels in network  Fees could offset costs of invest at least $250K angel organization Diversified portfolio  Possible to engage 10 to 20 investments governments as investors
  92. 92. Co-Investment and Syndication
  93. 93. Trend towards Angel-only Deals• World-wide VCs are troubled • Returns are low • Raising new funds very difficult• Follow-on funding by VCs problematic• Many angels look for angel-only deals • Require few million US dollars to succeed • Syndicated angels in multiple rounds can fund • Seek earlier exits via M&A, not IPOs
  94. 94. Definitions• Syndication and Co-investment have similar definitions, depending on the region• In some jurisdictions, investing as part of a single, local angel groups is syndication• In US group investing is the standard (and not considered syndication or co-investment)• In other locals, syndication (or co-investment) means different investment groups (angel groups, VCs, family investors and others) investing in the same round.
  95. 95. Syndication (or co-investment)within US Angel Groups• Standard practice for US angel groups • Average round size 2011: $700,000 • Local group invested about 1/3 = $250,000• Cooperate on due diligence• Negotiate a single term sheet• Coordinate with a single deal lead• Leverage group investment for best terms• Invest a little, invest a lot…or pass
  96. 96. Syndication (or co-investment)among several US Angel Groups• Trend growing rapidly• Local group leads the deal• All groups agree to single term sheet• Coordinate with a single deal lead• Local group shares due diligence results• Principal advantage: • Raise more money • Engage more investors (and expertise) • More investors available for follow-on rounds • Not so dependent on VCs for follow-on
  97. 97. US Angel GroupsCo-Invested Deals in 2011 Halo Report - 2012
  98. 98. Growth in US Angel Groups350300250200150100 50 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Center for Venture Research (pre 03 data) and Kauffman Foundation/ARI (04- data)
  99. 99. New Zealand Angel Groups• New Zealand Demographics • Land mass of UK, population of 4 million • 14 angel groups, spread over the country • About as active as Boston in the US• Invest together as a group, similar to the US• Syndicate deals • All groups participate • Small VCs engage • About 50% of deals involve more than one group
  100. 100. Trend for Multi-group Syndication Among Kiwi Angel Groups NZ Young Company Finance 2012
  101. 101. Multi-group Syndication in New Zealand• Exports are key to NZ economic success• Raising money in multiple rounds is critical • Raise money for startup • Raise money to demonstrate traction locally • Raise money for exports • Raise money to create landed presence off-shore• Successful fundraising offshore only possible after offshore product validation
  102. 102. Keys to Success (With a Group or Between Groups)• Build trust with other investors • Join due joint due diligence teams • Sharing deals goes both ways• Single investor contact point • One term sheet • Share due diligence • Cooperate finding best angel experts • Single lead investor• Cooperating angels can fund larger deals
  103. 103. MORE