Cash, Connections and ChemistryTop Entrepreneur and Angel Investor To-Dos when Joining Together for a WinningRelationship ...
negotiating postures. Most of all, the right counsellors have a reputation for business savvy in addition tolegal savvy in...
Angel InvestorTime, Guidance, Sounding Board and Networking. The advice and counsel that an angel provides to theentrepren...
other. At the same time, more robust strategies and execution come from enough relevant diversity toexpand the range of th...
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Cash, Connections and Chemistry - Angel investment in early stage technology ventures feb 2011 - dave litwiller - final

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Cash, Connections and Chemistry - Angel investment in early stage technology ventures feb 2011 - dave litwiller - final

  1. 1. Cash, Connections and ChemistryTop Entrepreneur and Angel Investor To-Dos when Joining Together for a WinningRelationship in Early Stage Technology VenturesDave LitwillerThis article details high leverage activities at the time of angel investment. It considers the entrepreneur,value-adding angel investor and jointly, addressing undertakings before and after investment that increasethe likelihood of forming a mutually beneficial long-term partnership in early stage technology ventures.Emphasis is placed on actions beyond common rule-based checklists for investors and entrepreneurs at thisstage, to highlight preferred practices pre- and post-investment which help qualify and most contribute tosuccess of the relationship and investment.EntrepreneurFirst Impression, Near Term Roadmap, and Responsiveness. Much of the impression and visceralcomfort about the entrepreneur that the angel will base his investment decision on is established in the firstminutes of the first meeting. Come out of the gate strong. Deliver a practiced, concise pitch that has beenwell reviewed and tested.During the first meeting with the angel, lay out the roadmap for the business for the next two to fourmonths.1 This is the time window when investment discussions and negotiations typically take place.Meet those operational, technical and market development milestones. Moreover, hit a few more that youhadn’t promised over that time frame. Near-term predictability, tangible execution progress, and up-sideall form the proof points to help build investor confidence to bring an early stage investment across thefinish line.During the second meeting with the angel, show that you are prepared, and have answers to everything thatwas identified for follow-up detail or explanation at the first meeting. You’re exhibiting to the angel thatyou’re a good listener, you are fast and responsive, and that you have a compatible communication style.Undivided Attention at Term Sheet Time. Turn off all sources of interruption and distraction whennegotiating and evaluating a term sheet. Take time during the process to reflect and get advice.There are many terms that are necessary to protect investors in a term sheet and subsequent shareholderagreement. Many of the elements of traditional venture capital term sheets and shareholder agreements arecoming into those of angel investors. These mechanisms are necessarily complex and have significantramifications for founder and early employees’ entitlements to the ultimate proceeds from the business.Model the distribution of proceeds under a range of liquidity scenarios. Pay attention especially to whatwould happen in an early or modest valuation exit. With later round financiers typically expecting at leastas good terms as earlier round investors, the terms of an early angel round often have significant influenceover flexibility accessing downstream financing, and ongoing operating agility with the business.Shareholder and debt holder agreements have much more inertia than many other corporate matters. Careand calm consideration are essential at term sheet time for a good entrepreneur outcome.In addition to undivided attention, this is not the time for inexperienced legal advice, if cheap or the mostreadily accessible. Investment negotiations, term sheets and shareholder agreement drafting and review areinstances to pay up for seasoned legal counsel. The best lawyers for these purposes have typically advisedon dozens of past such agreements, and seen the life cycle ramifications of a multitude of terms and1 “Mastering the VC Game”, Jeff Bussgang, Portfolio, 2010 © David J. Litwiller, 2011 1
  2. 2. negotiating postures. Most of all, the right counsellors have a reputation for business savvy in addition tolegal savvy in term sheets, shareholder agreements, new venture governance, and venture finance.Explicit Liquidity Scenario Planning. Discussing and reaching a clear and shared sense with anincoming investor of the likely time frame to exit, and a plausible range of liquidity scenarios for thebusiness, helps make sure that people are able to reach alignment with a pervasive force that will influencethe ongoing governance and management of the business.Over time, liquidity ideas will nearly always evolve. Even so, the best way to assess if a group of peopleare likely to be able to stay in sync about exit objectives is to unambiguously reach agreement about anacceptable range of plausible outcomes prior to the onset of the relationship based on initial conditions.Competition for the Deal, with Valuation Pragmatism. The valuation should signal confidence andopportunity tempered for stage of development. Best from a valuation perspective is to show a functioningprototype and customer traction prior to seeking angel investment, extraordinary people working in thebusiness, and a large target market with a sustainable edge and a scalable model. Doing so brings the bestchances for competitive angel interest to drive not only valuation but also flexibility with investment terms.At the same time, there is a caution. A high valuation may be pleasing to the entrepreneur for thevalidation it provides, and minimized dilution at the time of early stage outside investment. An ideal butrare scenario even exists in which the angel who best knows the space, has the most vibrant network to addvalue, and has a particularly favourable bias toward the entrepreneur, is willing to invest based on thehighest valuation. But, such conditions are exceptional with competing time demands for the entrepreneurwhen fundraising. Usually, excessively high valuation carries outsized risk for increased dilution and lossof control for the founder and early investors if there is turbulence down the line. Reduced future access tocapital can result.A more moderate valuation typically provides access to a wider range of investors and investorrepresentatives to participate in the build-out and governance of the company, and less need for draconianinvestment terms. A more modest valuation increases the odds of finding the right investor chemistry andcomplementary skills. Often, when it comes to early stage business valuation, a little less at the start endsup yielding more for the entrepreneur at the exit.Willing to Share, and Even to Step Aside. The entrepreneur needs to be willing to share decisionauthority with an incoming investor, especially on transformative issues. The entrepreneur also mustdemonstrate self awareness of strengths and weaknesses, be willing to bring on help in his weaker areas,and if conditions call for it in the future, to step aside. The obligations to shareholders and stakeholdersbeyond the founder may come to demand it with outside investment, even if such a future inflection seemsa remote possibility at present.Reverse Due Diligence. Do as much due diligence on a prospective angel as he does on you. Get to knowthe investor to understand and test out how involved he intends to be, the value he can add beyond cash, thebuzz that surrounds him based on his track record, and, his rate of investment in other firms at the moment.Check references. With the right investor, cash is only part of the contribution. The larger value comesfrom: guidance at major transition points; personal network to originate deals and ecosystem relationships;testimonial impact of his investment; and, leadership in syndication and follow-on financing.Explore particularly to understand the double or even triple bottom line he may have for his investment interms of learning, networking, giving back to the community, and capturing more entrepreneurialism in hisbusiness life. Especially if an angel invests or intends to invest with a view toward taking an executive rolewith the business, rather than holding the line at being solely an investor, an even greater level of care thanother major hiring decision needs to be taken because of the complexity of extrication should theemployment arrangement not work out. © David J. Litwiller, 2011 2
  3. 3. Angel InvestorTime, Guidance, Sounding Board and Networking. The advice and counsel that an angel provides to theentrepreneur can be as much about the person as it is the business, given the multi-faceted challenges ofleading a high growth technology business. It takes time to do this well and regular candid contact throughups and downs.An angel typically adds the most value when he helps de-risk or accelerate the development of the market,technology, and operational execution in areas where the entrepreneur and senior management team maynot be as strong. An experienced sense to pick up on the likely soft spots in the entrepreneur’s strategic andfinancial model, in order to tighten them up, activates the value of an investment greatly compared withlearning things the slow, hard way. Angel time availability to help out most at turning points or momentsof turmoil for the business is paramount to add value. Angel value add is also high when syndicating aninvestment round, by the lead angel bringing the right group of other angels together for the deal rather thanthe operating management having to take time out to do so. Furthermore, helping management to scenarioplan for some of the more likely pivots the business may encounter enhances the confidence and agility totake new headings when conditions call for doing so. As companies mature, angel ability to source interestand competition for M&A exits also generates significant returns compared to most other effortinvestments during the company’s development.Over time, the quality of an angel investor’s deal flow will be determined by how well he helps buildcompanies through personal networking to facilitate partnerships, key hires, and follow-on financing. Thereputation for doing so well brings better entrepreneurs and ideas to the angel in the future.Capital Reserve. The ability to keep up ownership percentages in winning portfolio companies duringsubsequent financing rounds enables the angel to realize the full value of his investment. As well, theadvantages in speed, control and conservation of management time from being able to provide additionalfinancing through an inside round frequently have a strong bearing on success to get the business throughnear-term turbulence, rather than having to access outside financing to power through minor setbacks.IP Management and Protection. Survival and later stage funding success statistics both correlatesignificantly with early IP protection measures. The risk of IP ownership and infringement claims risedisproportionately for those early stage companies that go on to much greater scale. At the same time, it isoften difficult to retroactively apply effective IP protection measures covering earlier groundbreaking work.With a strong disproportion of angel investor returns concentrated in a minority of hyper-successfulinvestments, sufficient funding and attention needs to be paid to IP protection from an early stage in orderto maximize outcomes. A strong IP portfolio also provides greater monetization flexibility for investeebusinesses, enhancing liquidity options.Particularly at the present time with the popularity of lean start-up models, a blending often occurs ofemployees’ personal resources with those of the company absent a clear mandate for company ownershipand control of IP. Angel investors are usually well served to encourage management to have distinctcompany ownership and repository of important IP, including items such as source code and design files,configuration management, invention notebooks and disclosures, invention assignment agreements,confidentiality agreements, and employment agreements, as well as supplier, customer, and partnerrelationship information.Both Entrepreneur and AngelRapport and Mentorship. The mentor-mentee role at the start between investor and investee gives wayquickly to mutual mentorship as a good relationship develops. The capacity to evolve to peerage needs tobe evident during the investment qualification process based on mutual respect, communicating clearly,listening, sufficient similarity in personality traits, and a track record on each side to be persuasive to the © David J. Litwiller, 2011 3
  4. 4. other. At the same time, more robust strategies and execution come from enough relevant diversity toexpand the range of thinking from the combination of minds beyond what either would have come up withalone. The idea for the business will morph. To thrive throughout, a great interpersonal dynamic needs tobe the bedrock for the entrepreneur and an involved angel.The big six dimensions of personality variation between people can be a helpful framework for investorand entrepreneur to assess fit, rapport and likelihood to achieve mutual mentorship. This can be donethrough a gauged degree of similarity and diversity in:2 • Openness to experience, including curiosity, novelty seeking, interest in cultures and aesthetics, individualism and liberalism • Conscientiousness, as evidenced by self-control, willpower, reliability, consistency, trustworthiness, and focus on long-term goals • Extraversion, being friendly, gregarious, talkative, funny, expressive, assertive, active, excitement seeking, and socially self-confident, or even more pronounced forms of power displays and dominance • Agreeableness, such as warmth, kindness, empathy, compliance, and modesty • Emotional stability in the form of adaptability, equanimity, maturity, stress resistance, optimism, calmness, and speed rebounding from setbacks • IntelligenceThese trait profiles will tend to come out over the course of a sufficiently wide ranging discussion about theprospects for the business. Throughout the dialog, both should be on the lookout for compatibility andcatalysis of thinking styles, ways of working, enthusiasm for the business, and a shared view of the future.A quick test to make sure that joint enthusiasm isn’t overlooking major latent disparities is to scenario planfor how the business, entrepreneur and investor would respond under the conditions of a threateningsetback. Consideration of prospective events and reactions are illuminating for this purpose such as slowerramping revenue than planned, weaker margins, development milestone push-outs, departure of a keymanager, or need for significant additional downstream financing that is well beyond current plans.Such internal investigations about personality and style should be augmented with external discovery fromcolleagues each has worked with in the past. More extreme behaviours can go undetected during initialinteractions which are evident to those who have logged more time and under a greater range of demandingcircumstances with the entrepreneur and angel.All said, exploring interpersonal chemistry beyond cursory impressions, and under both challenging andfulfilling scenarios, will help to assess the compatibility of people and opportunity.About the AuthorDavid J. Litwiller is a senior executive in high technology, based in Waterloo, Ontario. His background is inwireless devices, precision electro-mechanics, semiconductors, electro-optics, MEMS, biotech instrumentation,and enterprise software. He serves as an advisor for various private corporations in matters of strategy,technology, operations, and business development. Mr. Litwiller is the author of “Rapid Advance - Mergers &Acquisitions, Partnerships, Restructurings, Turnarounds and Divestitures in High Technology”.http://www.amazon.com/Rapid-Advance-Acquisitions-Partnerships-Restructurings/dp/1439200874/ref=sr_1_1?ie=UTF8&s=books&qid=1287516364&sr=1-1.2 “Spent” Geoffrey Miller, Viking, USA, 2009 © David J. Litwiller, 2011 4

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