How do Angel Investors differ from Venture Capitalists?

angel investors vs. Venture capital

In many ways Angel Investors are looking for the same things as Venture Capitalists, but there are some big differences that companies should be aware of that will play a part in shaping their financing strategy.

Here are a few obvious contrasts that you should be aware of.

Let’s start with Definitions:  An angel investor is a high net worth individual with a net worth excluding their home of $1 million or more, or who has an income of $200,000 per year (or $300,000 for a married couple) with the expectation that this income will continue into the future.  Angels differ from Friends and Family who will typically invest very early on when all you’ve got is an idea and who will invest in YOU rather than in your company.   Venture Capitalists are typically formed as Limited Partnerships in which the Limited Partners invest in the Venture Capital fund.  The fund manager is sometimes called the General Partner and the job of the General Partner is to source good deals and to invest in the ones that they think will return the most money to the Limited Partners.

Size of Investment:  Angels investing as individuals typically invest between $25,000 and $100,000 of their own money.  While there are deals that are more than $100K and less than $25K, this is the area most angels fall into.  Angel Groups work to syndicate many angels together into a single investment that may average $750,000 or more.   Angel groups are becoming more prevalent and are a great way to get investment more quickly and all at the same terms.  Venture capitalists invest an average of $7 million in a company.

Stage of Investment:  Angel investors are typically investing in deals earlier than Venture Capitalists.  They don’t like to invest in anything that’s just an idea, so the entrepreneur starts with Friends and Family to finance the early stage of the company up to where there is perhaps a prototype or Beta versions of the product.  Angel investors most commonly fund the last stage of technical development and early market entry.    Venture Capitalists will then come in with a “Series A” investment to take the company through rapid growth and rapidly develop market share.  VCs will help a company to grow until they are ready to go public or be acquired, so the dollars they invest will be increasingly larger and larger as the rounds progress.

Due Diligence:  Angels range from due diligence that might include having coffee or lunch with an entrepreneur to doing more thorough background checks and research with experts.  When angels invest in groups they tend to do more due diligence than they do as individuals.  Venture Capitalists have to do a lot more due diligence because they have a fiduciary duty to their Limited Partners.  Venture Capitalists may spend as much as $50,000 or even more to conduct thorough research on their investment prospects.

Decision Making: Angels make decisions typically on their own and are not beholden to anyone except perhaps their spouses.  VCs will have an investment committee who will work together to make decisions so that they are as objective as possible and won’t be swayed by just one member’s excitement over a deal.

Returns: Angels are investing earlier than VCs and so they have a higher risk to take into account.  Despite this, they tend to look for about the same kind of returns that VCs look for – something like 10X the investment over five years.  The reason they look for such a high return is that half of their investments are likely to go belly up and not return anything to the investor.  VCs and Angels want to see a return across their entire portfolio of investments that is 20-30% per year.

Time Frame: Most Angels and VCs look for an Exit, or Liquidity Event in which they get their money back, within three to five years.  Some investments take longer, of course, but Angels need to get their money back and VCs are even more under the gun since a typical Venture Capital Fund has a lifespan of ten years, after which the fund must return all capital and profits to the Limited Partners.

Board Involvement: When angels invest as a group, there will typically be an angel from the group who will sit on the board and represent the investors’ interests.  If the angel is a significant contributor, then they may stay on the board even after venture capitalists invest.  In other cases, the VC will take the seat representing the investors and the angel may stay on as a non-voting observer, or may retire from the board entirely.

Angel vs. Venture Capital Strategy:  Raising capital from Angels is hard work.  The capital raise always distracts entrepreneurs from doing the actual work of building product and getting in contact with customers.  Entrepreneurs should try to put off their capital raise as long as possible, so that they can build value and get a higher valuation for their company before raising capital and diluting their equity.  Sometimes angel investment is a great way to get enough traction to capture the eye of a good Venture capitalist.  Other times angels will continue investing and you might never need to go to a VC.  Your strategy for angels vs. VC investment will include factors such as 1) your ability to work for extended periods with little or no income, 2) the availability of Angel Investing Groups in your area, 3) the number and types of VCs in your area.  (e.g. do they invest in early stage companies, etc.) and finally, because money is an accelerator for business, you will need to determine the need for rapid development of product and market.  If your project is highly capital intensive and there are others who are nipping at your heels, then you probably have no choice but to raise capital as early as possible.  If your strategy involves starting with Angels and then going to VCs for Series A investment, keep in mind the following: 1) angels will usually want 20-30% of your equity for their investment so be sure to keep enough equity available for follow-on investments, 2) make sure your documentation is VC Friendly.  Use standard term sheets (check out nvca.org for a good template).  Your deal should look as much like other deals in terms of incorporation, term sheets, board structure, etc. in order to be attractive.  3) Try to eliminate or minimize participation of non-accredited investors in your deal.  Even though you can legally have a certain amount of non-accredited investors in certain types of deals, it’s best to leave them out if you’re going the VC route.

Good Luck!

 

Register for Angel Investors UnpluggedFor more information on Angel Investing (either as an Angel or an Entrepreneur) consider attending the Colorado Capital Conference Tuesday and Wednesday November 15th-16th. We will have an audience of experienced Angel Investors examining 8 companies that are currently raising early stage capital in addition to two panels and two keynote speakers.

Angel Investors or those who want to learn about Angel Investing in Denver, may consider our Angel Investing Accelerator on Thursday, November 10th

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Peter Adams is the Executive Director of Rockies Venture Club and Co-Author of Venture Capital for Dummies, John Wiley & Sons, August 2013.  Available at Amazon.com, Barnes and Noble and your local bookstore.

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Why does RVC pitch so many companies?

Why do we pitch so many companies?baseball-vc-pitch

I like to tell the story of the first time I filled out a questionnaire about Rockies Venture Club’s activities for the Angel Capital Association.  When I got the the question about how many companies we present each year, the choices were something like 1-3, 4-7, 8-10, 11-15, 16-20, 21-25, 25+ pitches per year.   With over 100 companies pitched in 2012 and 80 in 2013, we are off the charts!

I have a huge respect for the people I’ve met at the ACA, so I began to wonder whether we were doing something wrong.  I started looking at how the different angel groups functioned and why we were different.  Here is a summary of what I found:

1)      RVC is unique in that it serves the whole community and not just investors.   We have pitch events with 100+ people watching four pitches every month and conferences with hundreds of people watching 12 or 24 pitches.  We reach out to the community through partner groups.  If you just have a few dozen angels to depend on for your deal flow, then you won’t see a lot, but if you involve the whole community, then the deal-flow suddenly becomes significant.

2)      RVC is also unique in its focus on education.  By educating both the angel investors and the entrepreneurs, we make a smarter environment full of smart investors and savvy entrepreneurs.  This means that there are more high quality deals available than if no quality educational resources were available.  Without Pitch Academy we’ve noticed that most  (but not all) of the pitches we see are pretty flat.  They’re not only poor pitches, but the thinking behind them is often thin and poorly researched.  RVC workshops help entrepreneurs to build a solid logic to their plans, backed up by good research and hard work.  This alone is not enough to succeed, but it definitely raises the bar and puts higher quality deals in front of investors who now have the tools to really evaluate the deals that they’re looking at.

3)      You could challenge our plan to pitch roughly one in ten applicants.   “Why not just pick a few really good companies and go with them?”   There are a few problems with this challenge.  The first is that in many cases you don’t know which companies are good until you pitch them and get into due diligence.  If you just goody-pick the companies with great executive summaries all you get is companies that are good at executive summary writing.

4)      What about the 75% of RVC pitch companies who don’t get funded?  I’m often surprised about what does and what doesn’t get funded.  What I have seen is that something like two thirds of the companies that don’t get funded didn’t make it because they weren’t ready to pitch yet.  They still had homework to do in order to back up their plan and to refine their message and build a sharp strategy.  Some times these companies give up and other times they go back to the drawing board and come back six or twelve months later with a new CEO on board and the funding falls immediately into place.  Giving these companies the opportunity to pitch provides them with the perspective that they need to grow and get funded – or better yet, it teaches them how to bootstrap so that they never have to be beholden to angel or VC investors!

5)      Seeing lots of companies is the best way to build your 10,000 Malcolm Gladwell hours as an investor.  Some angel groups pitch only one company per month.  It would take one of those angels ten years to see as many deals as an RVC investor sees in a year.  Which investor do you think is going to have the ability to spot the winners from the losers?  Pattern recognition plays a big part in investing and the only way to build that is to see lots of deals.

6)      Enterpreneurs benefit by seeing lots of pitches too.  If entrepreneurs can see lots of great pitches, they get an idea for how high the bar has been set in our community.  They see what investors like and don’t like and they get to see which companies get funded and go on to do great things.  In many angel groups, the first pitch the entrepreneur sees is their own.  This is a bad way to learn how not just to pitch your company, but to build a winning strategy and team.

After thinking about it, my conclusion is that, like so many things, the best solution is to reach a balance.   It’s great to pitch a lot of companies for perspective, exposure and deal flow, but you also have to be prepared to limit the companies pitching to the ability of your entrepreneurial community to produce quality deal flow.    Right now we’re seeing 80 quality deals a year, but if things slow down, 60 might be the  right number, or if they heat up, then maybe 120!

To see a dozen great pitches – and I mean it – twelve highly investable companies – attend the 25th Rockies Venture Club Colorado Capital Conference.  #2013CCC   This even will have twelve great companies PLUS presentations from four Colorado companies that have gone big-time and had huge exits this year.  Hear from their founders and CEOs to learn how they did it and what to watch out for as either an investor or entrepreneur.

November 6-7 in Denver and Golden.  The 25th Colorado Capital Conference

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The Debate: When Should a Company Start Planning its Exit

success-next-exitI’ve been talking to a lot of people about exit strategies this year, including VCs, Investment Bankers, two and three time exit participants, entrepreneurs and investors.  I’ve heard a lot of great exit stories and yet there doesn’t seem to be a consensus about when a company should begin planning for its exit.

One school of thought is that you should just start a company and grow it as fast as possible and you’ll know when it’s time to exit.  This has been described kind of like lightning striking and then it’s time.

The problem with this school of thought it that it is all wrong.

Companies should be thinking about their exit plan before they even form the company.

Why?

Here are a few reasons:

1)      It’s an agreed upon principle that a company should really know its customer.  If you’re selling widgets  through your company, you need to know the widget buyers, but if you’re eventually going to be selling the company, pursuing an IPO or other exit, you need to know your customer – and it’s not the guy who buys your widgets – it’s the company that acquires you.   You need to know why your company would be a strategic advantage for them – would you provide a geographic benefit?  A new set of clients? Intellectual Property? Or would they buy you just to get rid of a meddlesome competitor?  You need to know who will acquire you and why they want to acquire you.  Once you know that, then you build the company to provide the most value to the people who will buy it.

2)      Exits aren’t executed in a day.  By the time that you realize it’s time to exit, it’s probably too late to put a plan together and get it done.  Smart companies plan for their exits and understand acquisitions in their field and structure their company so that multiple companies will be likely to be bidding for it when the time comes.  If you spend your time building a company that has only one potential acquirer do you think you’ll get top dollar?  A great exit is built on relationships.  These can take months and years to cultivate, especially among multiple acquirers.  Why not begin those relationships at the start and shorten the time to exit?

3)      Understanding exits is the key to understanding company value.  Many valuation methodologies for early stage companies are based on the exit value.  The Venture Capital Method begins with potential exit scenarios and then discounts the value of those exits to present value.  If the company can’t develop a strong case for a big exit, they will either fail to raise venture capital, or they may raise capital at valuations far lower than their potential.  Early stage companies should research who is acquiring whom in their market and for how much.  This research will make them much more attractive to investors who know that without an exit, they will never get their money back.

4)      I recently worked with a company that set up several subsidiary companies with different ownership structures and potential conflicts of interest among them.  This could make sense in terms of building an international distribution business, but it makes no sense to potential acquirers.  Ultimately this strategy would lead to much lower acquisition price in the end.  If you think about the exit when you’re setting up your company, your decisions will be easier since you can just ask yourself “what will add the most value to an acquirer?”

5)      Finally, there’s Steven Covey’s second Habit of Highly Successful People “Begin with the end in mind.”   Do you think he meant this for everything except something as important as the destiny for your company?   No, you need to found your company with the idea that there will be an exit and a clear idea of who will acquire it.  Without this clarity, the company will be spinning its wheels on initiatives that may not ultimately be adding value to the acquirer.  Some people say that you can’t know for sure who will acquire you when you’re just starting out.  Sure – that’s true.  But the fact is that you can’t know ANYTHING for sure, so if you can only plan for things you know for sure, the only sure thing is that you shouldn’t be planning on being an entrepreneur.   I’ve heard the same arguments from people that entrepreneurs shouldn’t even bother with a business plan – just do it, they say.  This is a pendulum-swing response to those who are stuck with analysis-paralysis which is also a company killer.  Neither extreme is good.  These people are sometimes lucky, but more often not, they’re forming part of the 90% of businesses that fail.  All investors and entrepreneurs should know that their plans are not likely to be executed as stated, but this doesn’t mean that there shouldn’t be a plan.  Without a plan, there is no alignment among team members, no goal, no smart thinking about options and alternatives, and all you’ve got going for you is luck.  Good luck with that.

 

To learn more about exits and learn from some of the biggest exits in Colorado, attend the Colorado Capital Conference November 6-7 and hear about seven big exits and how they happened.  You’ll also get to see twelve great startup pitches, all of which have a clear exit strategy articulated!  Join us and follow the debate!

Register now at www.coloradocapitalconference.org

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Four Tips to Know if You Have Practiced Your Pitch Enough

Practicing your pitch is one of the most important parts of presenting to a group of investors.  While some people can do a pitch with relatively little practice, no one can just wing it.  So how do you know when you’re ready to pitch and you’ve practiced enough?   Here are a few quick tips:

1)       Practice at least ten times before you pitch in front of someone else.  You should get to the point where you’re not having to think about what you’re saying – you have key phrases that you use every time.

2)      Time your pitches.  If you have more than ten seconds of variation between the pitches,  that means you’re making up new stuff each time.  Practice enough times that you can hit the same amount of time within ten seconds each time you present.

3)      Memorize your slide order.  If you have fifteen slides, you should be able to recite the titles of each of the slides in order.  This way when you’re on your “problem” slide, you’ll know that the next slide is your “solution” slide and you can transition smoothly and powerfully from one thought to the next.  Have someone quiz you for the complete order and starting at random slides so that you always know what is coming next.

4)      Be smooth even if you have distractions.  Use the TechStars method and have people throw wadded up balls of paper at you while you’re pitching.  Have someone unplug the projector and then practice dealing with that smoothly and without dropping a beat in your presentation.  Things often go wrong in a pitch, so be ready to roll with the punches.

If you do these things, your pitches will be more professional and confident and you will be better prepared to communicate your ideas most effectively to investors.

Colorado Needs More Exits

At the Esprit Entrepreneur Conference in Boulder this week a question was asked about how we can make Colorado more than a flyover state and attract more out of state investment.

Given that Boulder and Denver are in the top three cities for startups on a per-capital basis, it’s clear that we don’t have a problem with developing an entrepreneurial community  and the great high quality deal flow that comes from that.  I’m continually impressed with the ability of the Front Range ecosystem to turn out high quality companies.

But, if we want to attract more out of state investors, we need to have more Colorado exits that we can celebrate and make public.  This year has been a great year for Colorado exits with the IPOs from Noodles & Company and Rally Software.  Both companies have more than doubled since their IPOs and are doing great.  We’ve also had a number of great $100 million plus acquisitions including LineRate and NexGen Storage.

Colorado needs to get the word out more about these great exits.  We’re well known for startups, but investors know that without exits, there is no way to get their money back.  In short, exits are what investors care about.  When investors see that our community is sophisticated and is thinking about how to best position ourselves for exit, even if it is an acquisition by an out-of-state firm,  that there is a greater chance of attracting those coastal dollars to Colorado.

Rockies Venture Club is celebrating Colorado Exits with its 25th Colorado Capital Conference November 6th and 7th, 2013.  www.coloradocapitalconference.org  We will be hosting twelve great startups whose pitches will ALL include a description of their exit strategy so that investors know how they will get their investment back.  The theme of the conference is Steven Covey’s Second Habit of Highly Successful People – “Begin with the End in Mind.”

We will also have speakers from the top companies who have had exits this year who will tell us how they positioned themselves, how they decided on IPO vs. acquisition, and when they actively started the exit process.  The fact that the founders are still with the companies shows that an “exit” is really a liquidity event where money is returned to investors, not an actual exit where the founders leave a company.  This year’s CCC is a must-attend event for investors and entrepreneurs alike.

Get Ready for the 25th annual Colorado Capital Conference!

On November 6th and 7th, the Rockies Venture Club will host the 25th annual Colorado Capital Conference in Denver and Golden, CO. 12 companies will be selected to pitch to investors, and the 2-day event will focus on recent Untitledsuccessful exits from other Colorado businesses.

2013 CCC speakers include Jim Lejeal, CFO of Rally Software that went public this April, and John Spiers, CEO of NexGen Storage, who sold to Fusion-io just a couple weeks later. Congressman (and Techstars founder) Jared Polis will also keynote the conference. A rare breed in politics, the Boulder native earned substantial entrepreneurial success, including multiple exits and an E&Y Entrepreneur of the Year Award, before running for office.

Applications to pitch are competitive, and open until October 15th. Conference attendees and investors can find early-bird discount registration until October 10th. The Colorado Capital Conference is one of the most important events of the year in Colorado both for investors, and companies looking to raise $100k to $2 million. In 2012, companies that pitched through Rockies Venture Club received over $22 million in financing, and this year’s CCC is sure to kick off the last big funding push of the year!