White Paper: Successfully Raising Angel Funding


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This paper unravels the seemingly complicated and occasionally obscure process that entrepreneurs face when trying to persuade angel investors to part with their money for a stake in the entrepreneur’s business venture. It focuses on the UK environment although many of the principles and issues raised will be relevant in other jurisdictions.

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White Paper: Successfully Raising Angel Funding

  1. 1. Successfully Raising Angel Funding by @adrianreeve www.YesGrowth.com Short term loans for growing SMEs © 2012 Adrian Reeve
  2. 2. Overview This paper endeavours to unravel the seemingly complicated and occasionally obscure process that entrepreneurs face when trying to persuade angel investors to part with their money for a stake in the entrepreneur’s business venture. It focuses on the UK environment although many of the principles and issues raised will be relevant in other jurisdictions. Definitions: Friends and Family So-called ‘love money’, which is generally obtained from the family circle or very close friends of the entrepreneur and which may not be invested for commercial gain. Angel Investor An individual not connected with the entrepreneur or the venture, who invests personal funds in an unquoted commercial enterprise, alone or alongside other investors, with the intention of receiving a significant financial return at a future date. While not an authorised person within the meaning of the Financial Services and Market Act 2000, such an investor will be a high net worth individual or a self-certified, sophisticated investor, as defined by the Financial Services and Markets Act (Financial Promotion) Order 2005. Venture Capitalist A finance professional, usually part of an established investment firm, typically authorised and regulated by the financial services authority, who invests other people’s money in commercial enterprises with the expectation of making a significant financial return for both parties at a future date. Funds are provided to the investment firm by pension funds, institutions, family offices and other individuals. Entrepreneur An individual who creates and develops a new commercial enterprise with the expectation of making financial gain. This is distinct from a social entrepreneur who develops a new enterprise to achieve social change or benefit. Philanthropist An individual with significant personal net worth who invests in or donates to commercial, non-commercial or charitable enterprises, often for no personal or financial benefit. © 2012 Adrian Reeve
  3. 3. Angel investment in context Angel investors will have usually had successful business careers. Their motivations will differ but are likely to include a desire for: a. Financial return: This is the primary motivation of the business angel. To compensate for the risk involved a business angel seeks to make at least 10 times their investment over, say, a 5 year period, ideally in a tax efficient manner. 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 of being part of a real success story. Business angels have been recognised as an important source of finance for entrepreneurial businesses for nearly 20 years in the UK and for even longer in the USA. Business angel investment activity is difficult to identify and track. In the 2011 report on the UK business angel market1, the British Business Angels Association (BBAA) reported that the 1,800 active angels within its network had invested £32.2m of the £98.3m raised by 245 companies. This analysis formed part of the authors’ estimate for total UK angel investment of £318m. Angel investing is inherently risky. The 2009 NESTA/BBAA research report2 “Siding with the Angels” analysed returns suggesting that 56% of angel investments 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 result was a gross IRR of 22%. Distribution of Angel Investment Returns Percentage of Exits Source:BBAA/NESTA Research report: “Siding with the Angels" 60% 50% 40% 30% 20% 10% 0% <1x 1x to 5x 5x to 10x 10x to 30x Exit multiple of original investment © 2012 Adrian Reeve >30x
  4. 4. Back to basics Before considering the issues involved in attempting to approach business angels 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.1 b. 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 conclusion Finding angels A useful starting point is the British Business Angels Association4 which has a membership of over 100 organisations and angel networks. Individual angels can be more difficult to identify and may be found at investor network or pitching events, or online through personal blogs or social media platforms such as LinkedIn, Twitter or Google+. Exposure to angels is achieved through the increasing number of accelerator programmes, incubators or competitions, such as Tech Entrepreneurs Week, that have developed over the past years. Table 5 of the NESTA report, “The Start Up Factories”, provides a list of 12 UK-based accelerator programmes.5 Motivating angels Regrettably the sentiment expressed in the 1966 pop classic, “Reach out and I’ll be there”, does not apply to the entrepreneur and the business angel community unless a number of conditions are fulfilled. The risk of failure for startups is high6 and so it is in the interest of the startup team to reduce as many of these risks at fund-raising stage as possible. © 2012 Adrian Reeve
  5. 5. Angels assess investment propositions across a number of dimensions. Hygiene factors will relate to things like location, industry sector, the amount being raised, stage of development, and timing. Motivating factors include: a. An inspiring team Views differ on what constitutes the optimum team and useful insight may be provided in online discussions on the subject.7 Investors value sector or domain experience, technology skills and execution capability. In the absence of any prior success, interest is also increased if the entrepreneur comes with a recommendation or referral from known investors. It’s called “social proof” and should work both ways in the startup/investor relationship. b. A problem solved, or a new product/market created Given that truly new product/market innovations are thin on the ground, the venture must solve a real problem. This can be achieved by being “disruptive”, bringing a new approach to an existing business model, or being considerably cheaper/more efficient/better quality at delivering an existing product or service. Propositions such as bottled water for pets (thirstycat), online currency alternative to cash and credit cards (flooz) and the infamous attempt by the world’s largest beverage company to introduce “New Coke” in 1985 are examples of products looking for a problem. c. An awesome solution The problem may be clearly articulated but the solution has to be realistic, affordable, and capable of generating enough revenue and profit, and deliverable within a timescale acceptable to investors. Proposing yet another online hotel reservation business may not capture investor imagination, but suppose you could create a business that connects people 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 of a 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 to gain entry to the market. This may be evidenced to investors through the company’s intellectual property (IP) which may be in the form of patents applied for or granted or other forms of technical advantage. e. Traction A great team presenting a wonderful solution to a clear problem will look even more attractive to investors if customers are already on board or have made commitments to use/buy the product or service. It’s called traction and investors love it because it is the best demonstrator of the inherent potential value of the business. © 2012 Adrian Reeve
  6. 6. f. The size of the prize The target market needs to be capable of delivering a customer base of sufficient size to enable enough value creation to reward investors for the risk taken. 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 “very small market niche” that will work in your favour. g. Valuation The best advice that can be offered to the entrepreneur on the thorny issue of valuation is: “be realistic”. If you are bringing all the above criteria to the table, are revenue generating, have patents granted in all key markets, are likely to be profitable in year 1 and have a large target market, then the argument 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 operates in the £100k to £1m pre-money valuation range and wishes to secure a meaningful equity stake, which means between 25%-35% of the business.9 Pitching angels Pitching to angel investors should be regarded as a sales process, the objective being to create an appetite to invest in the business opportunity. 1. Capture attention Tell them about you, your killer team, the problem and your awesome product, the traction gained and the (significant) potential. In more detail explain your business model, how you add value to customers, how you plan to obtain customers, distribution and revenues and where, how and why you are better, different or protected from competitors. 2. Create interest The best way to create interest is to demonstrate traction; that customers are buying the product/service in increasing numbers. If it helps investors understand the product or technology then a demo, mock up or screen shots may be helpful. 3. Build desire Show how revenues and cash can be developed in the near term, and what sort of value could be built over a 3-5 year period. 4. Confirm action Summarise the funding that is required and how it will be used, showing any relevant milestones. After positively responding to questions, connect with those 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 a funding round in the timescales proposed. © 2012 Adrian Reeve
  7. 7. 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 script Do: • 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 round Pitching is one thing, being able to celebrate the long-anticipated funds arriving in the company bank account is another thing entirely. Those who have been through the process will know that successfully completing an investment 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
  8. 8. 12 steps to success 1. Establish a group of angels who have indicated an interest in investing in the opportunity to form the syndicate for the round. 2. Ensure that you are in direct contact with all the syndicate members, have validated their ability to invest and know the amount they are prepared to invest. 3. Identify and gain the support of a lead investor for the syndicate. This individual is ideally the angel with most investment experience, who has specific and relevant domain or sector experience, who is sufficiently known to other members of the syndicate such that they gain additional confidence from his/her involvement. The individual is likely to be a significant investor in the venture and may become the investor representative on the board. 4. The entrepreneur will need to be ready and able to respond to due diligence information requests. This process may include the provision of various scenarios on revenues and costs as the syndicate validates forecasts initially presented. Establishing an online data room beforehand will streamline this process. 5. In the absence of a term sheet being presented to the entrepreneur by the syndicate, agree a term sheet with the lead investor and present it to the syndicate. 6. The term sheet is a legally binding document, once signed, and should include 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 structure b. Conditions, such as: 1. Satisfactory completion of due diligence and references 2. Enterprise Investment Scheme (EIS) qualification10 3. Service contracts c. 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
  9. 9. d. A capitalisation table showing the post-investment ownership structure of the business to include founders, option pool and investors in the current round. Term sheet templates are readily available online from various sources and can also be provided by the legal adviser of the entrepreneur or angel syndicate.11 7. Once the term sheet items are agreed, secure the signatures of the syndicate and the founders to create a binding document. 8. Instruct legal advisers to begin the documentation process, having earlier established and agreed the fees involved. Both parties will need legal representation, but the angel syndicate should now operate as one with a single legal adviser. The documentation process will include a shareholders agreement, articles of association, disclosures and various board minutes and filings for Companies House. 9. Maintain communication with the syndicate, through the lead investor, throughout the documentation process. Confirm the expected date for funds transfer and completion to ensure that angels will have transferred funds to the legal adviser beforehand and are available for document signature. 10. Respond to documentation queries and change requests raised by the investor side promptly. Don’t fight unimportant issues. 11. Ensure the business continues to make progress and, especially, meets any expected milestones. If at all possible provide the syndicate with some good news to reflect progress, increased traction and momentum. 12. Do not under-estimate the difficulty of gaining signatures on documents if multiple investors are involved. Many angels travel regularly and can often be difficult to contact. Completion itself is likely to be something of an anti-climax, with the exception of the knowledge that the funds are now in the company bank account. Conclusion Raising funds from business angels may be difficult, time consuming and even frustrating but for the right founder with the right project it may be the preferred option. Your chances of success are likely to reduce the more you deviate from the approach and guidelines discussed above. If you manage to successfully conclude your angel fund raising process you will have started the really hard work…..of delivery. You might like to take a moment for some additional inspiration.12 © 2012 Adrian Reeve
  10. 10. REFERENCES 1. Annual report on the business angel market in the United Kingdom: 2009/10 Colin M Mason & Richard T Harrison. May 2011. 2. BBAA/NESTA Research report: “Siding with the Angels. Business angel investing, promising outcomes and effective strategies”. Robert E. Wiltbank. May 2009. 3. Martin Zwilling, CEO Startup Professionals Inc. “Most startups get no professional investor cash” March 2011. http://blog.startupprofessionals.com/2011/03/most-startups-get-no-professional.html 4. British Business Angels Association. www.bbaa.org.uk. BBAA member directory angel networks: http://www.bbaa.org.uk/member/directory?type=1 5. The Startup Factories. The rise of accelerator programmes to support new technology ventures. NESTA Discussion Paper. Miller & Bound. June 2011 http://www.nesta.org.uk/home1/assets/features/the_startup_factories_report_feature 6. 20 Top Reasons Startups Fail. Chandni Shah. January 2011. http://www.chubbybrain.com/blog/top-reasons-startups-fail-analyzing-startup-failure-postmortem/ 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-becomposed-of 8. The Digital 100: The World's Most Valuable Internet Startups! Zach Lichaa. October 2011. http://www.businessinsider.com/2011-digital-100 9. Rule of thumb on percentage of equity to give an angel investor. Mark Suster. August 2010. http://www.quora.com/Mark-Suster/Equity/answers 10. Enterprise Investment Scheme (EIS) An Introduction to the Enterprise Investment Scheme (EIS) http://www.hmrc.gov.uk/eis/guidance.pdf HM 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.pdf 11. Term sheet examples Standard 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/104 12. Inspirational quotes from start-up entrepreneurs http://inspirationfeed.com/inspiration/50-inspiring-entrepreneur-startup-quotes/ © 2012 Adrian Reeve