Ten Reasons Why Not to Use Convertible Debt

It seems like a majority of pre-Series A deals are done with convertible debt these days and I’d like to point out a few reasons why this is a bad thing for entrepreneurs and investors alike.

Just to get definitions out of the way, we’re talking about the decision to raise funding for startups by either equity investment in stock of a company, or in a convertible debt instrument.  Equity is pretty straightforward – invest money, get stock.  Convertible notes, on the other hand are not widely known to those outside of startup investing.  Convertible debt works like regular debt in that there’s a promissory note and an interest rate.  The interest is rarely paid in cash for convertible notes though, and it’s usually rolled into equity when the note converts into equity.  There are usually a few “triggers” for h

RVC Convertible debt vs. equity

aving the note convert to equity, but the most prominent one is that there is a “qualified financing round” which is usually around $1 million.  The idea is that the professional investors at that stage know how to value the business and set the terms. The first early investors who invest will convert at the terms set by the VCs, but usually with a 20% discount in price to compensate for investing earlier.  Convertible notes today also have a “valuation cap” which is equal to what the equity valuation would have been if the deal had been a stock transaction in the first place.  So, when the qualified round causes the note to convert, it converts at the lower of the 20% discount or the valuation cap.

Ten Reasons to Avoid Convertible Debt

Reason 1:  Convertible Notes do not qualify for Section 1202 QSBS Tax Breaks<a href="http://www.freepik.com/free-photos-vectors/business">Business vector created by Dooder - Freepik.com</a>

Angel investors get a 100% capital gains tax break if they invest in equity in early stage companies that meet certain criteria such as being a C Corp., being under five years old, under five million in revenue and they hold the 

 

 

 

investment for five years.  Convertible notes don’t qualify for this tax break, so if all things were equal, the investor makes 20% LESS on convertible note deals since they have to pay capital gains tax on the investment, whereas investors who invest in equity do not have to pay any tax at all.

Reason 2: Equity is cheaper than convertible debt

You may have heard that it’s cheaper, faster and easier to do a convertible note, but the fact is that convertible notes are going to end up costing the company approximately 25% MORE than an equity deal.  The reason for this is that when the note converts, then it converts into EQUITY.  That means that the company pays twice for the legal: once to do the note and another time to do the equity.  So if a convertible note cost $2500 in legal fees and the equity deal cost $10,000, then the convertible note all-in is going to cost the company $12,500.  Why not just do it right in the first place and put all that money to work for the company?

Reason 3) 80% of Angel Investors Prefer Equity

If you’re selling something to a customer, wouldn’t you want to sell them what they want and not some more expensive and inferior product?  The American Angel Survey shows that investors prefer equity and I suspect that if the remaining 20% of angels read this blog, they’d prefer equity too.

Reason 4) You can lose your company if you default on a convertible note

When you take out the note you’re confident that you’ll have a qualifying follow-on round within 18 months, but many times it takes longer and the note comes due and payable and you’ve already spent the money and can’t raise any more.  You’re in default and investors can take your company from you.  Most investors don’t want to do that, but why go through the heartburn and stress of facing the potential loss?

Reason 5) Investors have to pay tax on interest they earned but never got

As interest accrues on convertible notes, interest is due.  Investors need to pay tax on those notes, even though they didn’t actually get the interest in cash.  So, if someone invests $100,000 in an 8% convertible note, they have to pay $2640 in cash to the IRS on that income.  Nobody likes paying taxes on money they never got and also, BTW, there is no tax due for equity investments.

Reason 6)  You have to come up with a valuation for convertible notes just like equity.

Many people think that using convertible notes lets them “kick the valuation can down the road.”  Nothing could be farther from the truth.  Every convertible note has a provision called the “valuation cap.”    The formula for calculating the valuation cap is as follows:

Valuation Cap = Equity Valuation

This means that when someone invests in a convertible note, they should never have to pay more than what the company is worth today.  If the valuation cap were higher than equity valuation, that would mean that note investors would have to pay more than the value of the company.  Just because it may convert at a higher valuation some time in the future does not mitigate the risks that the early stage investor has today.  In fact, the only way that the higher valuation comes about in the future is that the angel investor puts in the capital early, when risk is highest, so it doesn’t make sense that they should pay more than what the company is worth.

Many companies get confused about this.  One company told us that the valuation would be $5 million, but it would be $7 million valuation cap “because it’s going to convert at $12 million some day.”   It’s crazy to think that somehow using a convertible note makes a company worth $2 million more than one that uses equity. This kind of thinking makes no sense and hurts the startup community.

Putting valuations on early stage companies is something that is done every day and there’s no magic to it.  Seed Funds and Angel Groups have well established valuation methodologies that work well on pre-revenue companies.

Reason 8) Entrepreneurs get diluted with convertible notes

Entrepreneurs should be cautious about the cumulative dilution that paying interest which will be rolled into equity will create.  The longer the note goes on, the more startups will be diluted with the interest that they have to pay in the form of equity.  It would be better to preserve that equity for future growth.  Founders who chose equity over convertible debt don’t have to worry about interest accumulating and diluting their shares.

Reason 9) Equity creates better alignment between investors and founders

When convertible debt is used, there is a misalignment between investors and entrepreneurs.  Founders want to use high valuation caps or worse, no valuation caps, and prolong the amount of time before conversion, so that investors get the short end of the stick.  Some founders openly state that they want to use convertible debt to preserve their equity.  Those are founders that every investor should avoid – not because they want to build a strategy that preserves equity, but that they want to create unfair terms that preserve equity at the expense of investors.

Reason 10) Equity deals have all the terms defined

With a convertible debt deal, the conversion price is negotiated, but all the other terms which are extremely important to the relationship between the founders and investors are left open.  This represents a risk to investors and also leaves many matters unsettled.  One example is that there are usually terms about board representation which are not found in convertible notes.  Investors in early stage companies can offer much more to companies than just a check if they can serve on boards and help move the company along.  While there’s nothing to say that companies with convertible notes can’t have boards, in fact many don’t and that’s bad for both investors and entrepreneurs.

Last Words:

With all that being said against convertible notes, they can still be useful for the FFF rounds with friends and family who don’t know how to value a deal and who are investing primarily to support the entrepreneur.  Convertible notes can be better than some of the amateurish deals that get put together for early family investors who are often non-accredited that can make follow-on investments difficult or even impossible for the company, thus limiting its chances for success.

Visit www.rockiesventureclub.org to learn more.

 

Peter Adams

Managing Director, Rockies Venture Fund I, LP
Executive Director, Rockies Venture Club, Inc.
 Buy Venture Capital For Dummies on Amazon

 

Angel Investing is not as Risky as you Think.

It’s a common misconception that angel investing and venture capital is extremely risky.

But when best practices for investing are followed, tax breaks and portfolio returns can consistently outpace even the best mutual funds.  If you’re wondering how this can be true – read on!

Angel investing involves capital investments by accredited investors (people with a net worth of $1 million or more excluding the value of their primary residence, or with income of $200,000 or more per year/ $300,000 for a married couple).  These investments are in startups, usually with less than $1 million in revenue and less than five years old.  These startups have high growth potential and angel investors look to invest in companies that have a believable plan to be able to return 10X their investment or more within five years.  

Yes, some of these companies will fail, but let’s compare two investors.  The first one, Freddy Frugal, invests all of his money in mutual funds yielding a healthy 8% return. The second one, Andy Angel, invests his money in ten startups.  Both investors hold their investments for five years.  Let’s look at  their returns.

Freddy’s returns are 8%, but he must withdraw $2,640 in the first year, and more each year to pay taxes, so the compounding is based on his after tax returns each year.  After Freddy pays his taxes, his actual return is less than 5.93%.  Not bad, given the relative lower risk of a mutual fund and the liquidity it provides when funds are needed.

Freddy Frugal – $100,00 at 8% compounding
Year Investment Returns Failures Taxes Returns After Tax Portfolio Value After Tax
Initial Investment $100,000 -100000 -$100,000 $100,000
1 0 $8,000 0 $2,640 $5,360 $105,360
2 0 $8,429 0 $2,782 $5,647 $111,007
3 0 $8,881 0 $2,931 $5,950 $116,957
4 0 $9,357 0 $3,088 $6,269 $123,226
5 0 $9,858 0 $3,253 $6,605 $129,831
Total $44,524 $14,693 $29,831 $129,831
IRR Before Tax 8.83% $144,524
IRR After Tax 5.93% $129,831

 

Andy’s returns are a bit more complicated.  

First of all, because Andy is investing in a Colorado company he is eligible for state investment tax credits of 25%.  (many other states have similar credit programs)  This means that he gets $25,000 back immediately from the state government, so he actually has only $75,000 of his capital at risk.   We’ve shown this below by adding the $25,000 cash returned by the state to the value of his portfolio.

Also, Andy’s returns for his portfolio match the HALO report of thousands of Angel investing deals reported, so in the second, third and fourth years one company totally fails each year, resulting in a complete loss of investment and another is liquidated and returns $.50 on the dollar.  This results in a tax loss of $15,000 each year which he can take accelerated write offs against ordinary income thanks to IRS Code Section 1244.  This results in a cash benefit to Andy each of these years in the form of reduced taxes which we’ve calculated at $4,500 per year.

In the fifth year, the remaining four companies have exits ranging between four and ten times the initial investment amount, resulting in a $295,000 positive cash flow.  Because Andy made equity investments in early stage C-Corporate startups and held the investment for five years, he is entitled to a 100% long term capital gains tax exemption thanks to IRS Code Section 1202, so his tax bill for that year is zero.

 

Andy Angel – $100,000 in ten startups at $10,000 each
Year Investment Returns Failures Taxes Returns After Tax Portfolio Value After Tax
Initial Investment $100,000 $25,000 $25,000 $125,000
1 $0 $0 0 $0 $0 $125,000
2 $0 $0 1.5 -$4,500 $4,500 $114,500
3 $0 $0 1.5 -$4,500 $4,500 $104,000
4 $0 $0 1.5 -$4,500 $4,500 $93,500
5 $0 $295,000 0 $0 $295,000 $333,500
Total $320,000 -$13,500 $333,500 $333,500
IRR Before Tax 31.5% $333,500
IRR After Tax 31.5% $333,500

 

There is a lot of mythology about how many startups fail on average.

So, how risky was Andy’s Investment?

The statistics about how many startups fail on average can be deceiving.  Many of those statistics come from the SBA or local Secretaries of State who report failures of hair salons, restaurants and lawn mowing services along with other companies.  But, companies that receive venture capital investment have to reach a higher bar than just registering with the state.  They need to have gained significant traction and have gone through a lot of due diligence and had to jump the hurdle of convincing dozens of angel investors to write a check.  These companies are far less likely to fail than the general population of company formations.  In fact, HALO report data shows that about 52% of these companies will return less than $1.00 for each dollar invested.  Of that 52%, about 18% will be complete failures.  So, we’ve been a little hard on Andy Angel and had him with three total losses and three returns of less than a dollar.  On the upside, we’ve also been a bit conservative.  About 5% of venture backed startups will return 30X or greater, and there’s a good distribution of returns between 10X and 4X.   These winners more than pay for the losers.

Andy’s key to success was that he diversified his portfolio into ten investments.  Smart angel investors know the value of spreading out the risk so that the winners can more than offset the losers.

Another point to observe is that we’ve valued Andy’s portfolio at the value of the investment only until the returns came in.  Despite that conservative accounting, he barely dipped below his $100,000 investment amount in year four with a portfolio value of $93,500.  This means that if the four remaining companies had returned only 1X, his loss would have been limited to $6,500.  

But, his returns were a more typical 3X over the portfolio, resulting in a return of $295,000.  We can add in the $25,000 state tax credit and his $13,500 in accelerated write-offs  from the $45,000 loss, and his net cash return AFTER TAX is $333,500.

Andy was hardly more at risk than Freddy, and yet the internal rate of return on his investment was more than FIVE TIMES GREATER.

So, who is the smarter investor?  Freddy Frugal with a 5.93% after tax return or Andy Angel with his 31.8% return and $333,500 in cash after five years?  Angel investors have figured out how the system works and have been profiting handsomely from it for some time.  Accredited Investors should consider contacting their local angel group, preferably groups that are members of the Angel Capital Association, like Rockies Venture Club, and consider membership so that they can benefit from great deal flow, a community of smart investors, group negotiation and high quality due diligence.  

Visit www.rockiesventureclub.org to learn more.

 

Peter Adams

Managing Director, Rockies Venture Fund I, LP
Executive Director, Rockies Venture Club, Inc.
 Buy Venture Capital For Dummies on Amazon

What you need to know about Angel Investor Syndication

There’s a lot to know about angel investing, but the one thing most people miss is how to syndicate a deal.  Almost every angel investment deal in an entrepreneur’s company is a syndication and there’s a lot more to it than just getting a bunch of investors together.   Read more

Attendee Notes from the “Strategic Planning for Venture Backed Business” RVC Academy Workshop

RVC hosted it’s first workshop on Strategic Planning for Venture Backed Business earlier this week and Kathleen McFadden, Senior Account Supervisor at McGregor Graham Advertising Agency attended and shared her notes with us. Read more

Due Diligence Beta Program Launched

Rockies Venture Club recently launched a beta program for due diligence analytics, assembling a team of highly capable industry and academic individuals in order to streamline the time consuming process and assist angel investors with making the most informed decisions possible. This is an extremely exciting prospect because research shows that extensively researching a company at the onset of a deal pays off for angel investors. Read more

Ten Reasons why your Venture Capital Pitch Didn’t Work

Presenting a great Venture Capital pitch is critical to getting the follow-up appointment and beginning due diligence.  Most teams never make it past this critical step.  Why? Read more

How Investors See the Best Companies at Angel Capital Summit

The crop of companies presenting to investors at this years’ Angel Capital Summit are truly outstanding.  Some people may believe that these awesome companies just fall into our lap, ready to pitch and raise capital, but nothing could be farther from the truth.  The selection process for the Angel Capital Summit is rigorous and the preparation companies go through is even tougher. Read more

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

________________________________________________________________________________________________

 

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.

Click to Share!

Why Venture Capital Investors Should Want to See Your Five Year Financial Proforma

Many entrepreneurs and VCs alike are hesitant to produce a proforma for more than two years out into the future.  They claim that it’s impossible to know what will happen and that the third year and beyond are “just numbers.”   While I would agree that nobody expects a startup to perform according to its projections, I am heartily in disagreement with the claim that a five year proforma doesn’t tell us anything.

venture capital proforma

First of all, let me say that it’s totally ridiculous to think that even a two year proforma has some degree of accuracy.  The earliest launch dates are typically missed and the first two years are highly variable – perhaps even more variable than years three and beyond.  So, if you’re going to say that you can’t predict years three through five, I will counter that you might as well abandon the effort all together since nobody has a crystal ball that extends to two years, much less five.

Why do I want a proforma out to five years (or more)?

1)      I am focused on the EXIT.  I want to know clearly how you plan to get from Point A (where you are today) to Point B (your exit strategy).  I want to see how you think and how big you expect to grow.  If you’re only planning on growing to five million in sales, and that’s your best case scenario, then maybe I’m not interested in investing.  I want to know what you’re shooting for.

2)      I want to know if you can SCALE.  I see a lot of entrepreneurs who are good at running companies with up to twelve employees.  But there are relatively few who know how to grow a big company, develop partnerships, put systems and metrics into place and scale up BIG.  Your numbers will show me that you know what it takes to scale and the resources required to do it.  I recently reviewed a proforma for a company that projected $35 million in sales with three employees.  Even with outsourcing their manufacturing, it didn’t make sense.

3)      I want to know how you THINK.  Are you detail oriented and able to develop your numbers from the bottom up, or are you just taking a percent of your total projected sales?  Do you understand the factors that will impact your growth and the costs that will accelerate or decelerate growth?  Do you show a straight line growth curve or does it vary wildly from year to year?  Do you understand the common ratios for support staff, sales and management at each level of growth?  Even if you’ve got a disruptive strategy that operates more efficiently, I want to see that you know what the norms are and how your new methods will be more efficient.

4)      I want to know how you came up with your VALUATION.  I use five different valuation models when assessing investment in companies and three of them are based on your exit strategy and the exit value is typically going to be some multiple of sales or EBITDA.  I will adjust your sales figures to what I believe are realistic, but I also want to see how your valuation relates to your projected sales.  Are you picking a valuation out of the air or are you doing the work to research and find ratios that make sense?

5)      I want to know how long it will be before I get my MONEY BACK.  Are you planning on an early exit within two or three years, or does your strategy take five to seven, or is it eight or longer?  These numbers will be critical to my investment decision since I don’t want to be in deals that take longer than seven years to liquidity.  If you think it will take eight years, then it will probably take ten and I’m not going to be hitting my investment objectives.  I calculate my returns based on Internal Rate of Return which is a ratio of total return of capital over time, so the longer my capital is out, the lower my IRR.

So, if you’re pitching to a VC, it can be in your best interest to show all years projections between now and your exit – and most VCs are realistic in knowing that if you actually hit your numbers that it will be a miracle.

 

____________________________________________________________________________

Peter Adams is Executive Director of Rockies Venture Club and Co-Author of Venture Capital for Dummies (John Wiley and Sons, 2013)   Available at Amazon, Barnes and Noble and your local book store.

Venture Capital For Dummies

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

Register for Investing In Tech Companies event