Dilution: the reduction of the value of a company’s stock when new investor money comes into that company.
FAMILY AND FRIENDS ($100,000–$250,000)
This certainly is an investment option many would like to avoid! Entrepreneurs often don’t have any choice. When you take the money from family and friends, you are on the clock 24/7. You will be dragging yourself home, and there are your in-laws or your sister sitting on the couch, wound up with fresh ideas while you are ready to do a face plant in exhaustion. Their money once in the hopper is most often immediately spent on operations, as it was needed desperately in the first place. Now that they are on board, they own a piece of you.
Although family and friends will be omnipresent, the great point of family and friends is they will not hold you to strict operational procedures or oversee you day to day. They will let their money ride, as they know they are invested early and have other motives besides just seeking a cash-on-cash return. They supposedly are looking for the big return, and thus their money should be considered “patient money.” As they are in early and constantly are getting diluted and ignored through the business’s life cycle, they are a painful pay-off to be addressed at the end when the business is sold. Most times, they have been overly diluted (at least in their minds), and the founder is having to keep harmony at the home front or with friends and has to compensate them more from his equity than is required on the balance sheet. If the business is not sold and is running break even just paying the bills, some novice investors may eventually get impatient and ask to be cashed out. This is usually an issue unless you can give them a pay-off and financial haircut that benefits the company. This pay-off is often done through cash from the company’s line of credit.
The sums taken in from family and friends are usually in increments no lower than twenty-five thousand dollars and preferable in blocks of fifty thousand dollars. Some operators like to say the units are of one hundred thousand dollars, but they will “split” a unit if they can get two individuals ready to take fifty thousand dollars each. It is a bit of a sales tool to split a unit.
ANGEL FUNDING ($250,000–$1,000,000)
For the first time, you will be stepping into the world of professional investors. These are usually experienced players working in teams that will expect you to have a professional approach and know your business backwards and forwards. Typically the angels are far more interested in tech and software-related enterprises that need expertise in scaling. They are not interested in meat-and-potato operations growing at 10 percent per annum. They want the juggernaut, the land grab, the scaling machine that will give them a tenfold return. Their preference is not for a start-up but, rather, a company that has “proof in concept” and has a blue-chip client that has bought into the company’s services or products. This “beta” client of the company hopefully has bought repeatedly of its own volition and because it is locked into a first-time contract.
Virtually all research references state that Angels should get 5X to 20X return. Most seem to say that 10X is realistic and so that should probably be considered a reasonable “best practice” number.
On the one hand, everyone would like a 10-bagger (10X return on the investment (ROI)) plus, realized in three-to-five years. Many Angels have also argued for a 30 percent ROI, presumably over a shorter period.
A 30 percent per annum ROI over three years is only a 2.2X return, while 30 percent ROI over five years is a bit less than 4X. Conversely, if the Angels demand a 10X return over only three years that is a staggering 115 percent annualized ROI. Over five years that’s almost 60 percent.2
Angel groups abound, and they are usually retired (not by age), well-heeled, former operators trying to stay in the game and invest in sectors where they can bring their industry expertise to the firm to enhance operations. They usually pride themselves on being mentors and usually seek an active over-sight affiliation with the firm. Oftentimes, they bring in strategic thinking and have deep networks that, if harnessed correctly, could rapidly propel the company forward. They are seeking an organization that they understand how to grow rapidly.
Angels are all about rapid growth and time to market. They have virtually no interest in long technology gestation periods. They will ride the company for as long as the company is increasing in value. If the company plateaus out and sees no large expansion upside, they will seek an exit for their investment or, if locked in, try to manoeuver the company into a sale. The angels need to have their chips back in their hands for another investment opportunity that will give them the big 10X return.
The company shopping for angel money should be wary of the kindly big brother that, once on board, becomes more involved and dictatorial. The angels usually seek a board seat and will review financials and strategies to great extents. A good angel or angel group can be the key to success for a promising firm. Their wisdom, money, connections to bigger money, and group think-tank mentality are great tools for the entrepreneur.
Before you introduce yourself to these groups, undertake a rigorous dress rehearsal with your current team of advisors. Also do your homework on them. Many of these angels or angel groups can be notorious tire kickers who are just keeping themselves busy and not investing very often. They often throw out term sheets that, if carefully analyzed, can be seen as the actions of a pirate! Ask them what deals they have done in the sector and ask for references as well. Do not take their credentials at face value but really drill down to understand their accomplishments. Oftentimes, this due diligence can lead to new relationships with industry players that will continually expand your network.
TEN TIPS FOR FINDING AND WORKING WITH ANGEL INVESTORS
By David Gass
1 Network, network, network. Build your network and you’ll build your net worth. You don’t have to know an angel investor to get a meeting with one; you just need someone in your network that can connect you to an angel investor.
2 Have a Business Plan. Once an angel investor says they are interested in learning more they will want a business plan. The business plan should have all key areas mapped out such as a clear explanation of the product/service, the size of the market, the target demographic, return on investment for the investor, exit strategy, financials, pro forma, and organizational structure of the company.
3 Investors invest in people not the idea. Don’t pretend to be someone you’re not in order to solicit an investor. Investors want to work with people they like, they trust, and they believe can grow the business. If you pretend to be someone you’re not, the investor will find out over time and the deal will likely blow up.
4 Have your elevator pitch down. You never know when you will have the opportunity to get an investor interested in your deal. You could run into an investor who wants to hear about your deal at a cocktail party, walking down the street, by email, over the phone, in a meeting or just about any way you didn’t think would have been the traditional introduction. So be prepared to present a killer elevator pitch that clearly states your offer, your business, and what makes you and your company unique.
5 Put together a one–two page summary. In addition to the elevator pitch you need to have a one to two page executive summary on your business, similar to the elevator pitch, but on paper. This is something you can hand to an investor if they want to learn more without boring them with a 30-page business plan.
6 Know your numbers. Angel investors don’t want to invest in a business when the owner can’t articulate what the numbers in the business plan mean. The fastest way to lose confidence in an investor is when you can’t explain the numbers.
7 Learn basic presentation skills. Investors want to have confidence in their investment. You are their investment. If you have trouble