Raising Money from Business Angels

1. Raising Money from Business Angels

2. What’s an Angel? • A person who provides capital from his own funds to a private business owned and operated by someone who is neither a friend nor family member.

3. Many Different Types of Angels • Accredited and unaccredited • Active and passive • Knowledgeable and naïve • Interested in early and late stage ventures • Providers of large and small amounts of money • High- and low-risk investors • Providers of debt and equity • Investors as individuals and as part of groups

4. Angel Market is Small • Angel capital market is about $23 billion year • About equal to VC market • All informal investors provide $162 billion • Only 8 percent of informal investments are made by angels; 92 percent by “friends and family” • Angels invest in only about 0.2 percent of U.S. companies But angels are important for certain types of startups

5. Typical Angel • Isn’t an accredited investor • Makes investment of $10,000 • Prefers cash flow positive businesses • Is no better than friends and family • Has no more entrepreneurial experience • Makes no more informal investments • Doesn’t attract VC follow-on investment Not right investor for true high potential businesses, but useful for others

6. Angel Groups • Accredited investors • Active investors • Knowledgeable investors • Interested in early stage ventures • Provide of more money than typical angels • Primarily equity investors Valuable for high potential companies

7. In 2006, angel groups invested in only 512 of the 25.4 million businesses in the U.S. In 2006, angel groups invested $250 million of capital But They are Very Rare

8. Is three years old Has 37 members Is structured as a network (3/4) Is member led (59 percent) NEO’s groups are Arch Angels and North Coast Angel Fund Typical Angel Group

9. Investors in Angel Groups • 5,600 people across the country • All accredited investors • Many with experience in high growth startups • Many have made multiple angel investments • Invest around $30,000 per investment round

10. What Members of Angel Groups Are Looking For • Early stage businesses • “High tech” businesses • Very high potential for growth - $50 million in sales in 5 years • Clear exit strategy – acquisition or IPO • Investment around $250,000

11. Source deals – through members and unsolicited Initial screen, weed 60-90 percent with “no chance” of funding Select companies for presentation, ¼ to ½ of remainder Typical presentation is 20 minutes with 20 minutes of Q&A Group decides whether or not to do due diligence Subgroup does due diligence and reports back to members with recommendation Members decide whether or not to invest Group monitors investment with a board seat Investment Process

12. Highly Selective • 400 companies apply to the typical angel group annually • 24 companies present to the typical angel group every year • 4 companies per year receive an investment from the typical group

13. What Angel Deals Look Like • Few angels have VC-like term sheets • Convertible debt is used in less than 7 % of investments • Money is staged in only 21% of investments • Investor veto of management decisions in only 5 percent of cases • 40 percent of investments are straight common stock • 40 percent of investments involve debt • But, angel group terms are getting more like VC terms • Often preferred stock, rarely debt • Adding VC-like terms and covenants

14. Performance of Angel Group Investors • ROI is 19.2 percent per year after investor’s opportunity cost is factored in (probably biased up by willingness to talk) • But lots of variance • 7 percent of investments account for ¾ of all returns • 52 percent of the investments return less than the capital put in • Only about 40 companies founded annually reach $50 million in sales in 6 years in industries that investors target

15. Are very selective Only about 500 U.S. startups hit the $50 million sales target so they don’t believe projections Have high return expectations 30 X +, Put in $100,000 get out $3 million Only 45% of angels have 10X + return expectations Invest in the same industries as VCs Typical angels favor retail and personal services IPOs and acquisitions are concentrated in industries VCs invest in Conduct substantial due diligence 25% of angels will invest without seeing a business plan Only 15% of angels report doing “extensive” research More than half of angels get no independent references What the Best Investors Do Differently

16. What the Best Investors Do Differently • Are accredited investors • Fewer SEC limitations • Can invest as part of a group • Can invest more money • Become involved with their portfolio companies • Bottom third of angels only spend 7 minutes per week per venture • Use appropriate financial instruments • 40 percent of angel only rounds are common stock, • 40 percent of funding is debt) • Avoid overvaluation • Initial valuation of a business has a curvilinear effect on ROI • Diversify across 10+ investments • Return across investments is worse than return to investors with multiple investments • New investments in place of following on

17. Implications for Entrepreneurs • Be aware of how difficult it is to raise angel money • Understand what angels are looking for • Understand the angels’ investment process • Angel groups are important type of investor between individual angels and VCs • Choose the right type of angel – don’t choose angels who provide nothing more than money • Recognize that the best angel investors have a unique approach to investing

18. Questions and Comments ???????? Scott Shane Case Western Reserve University Scott.shane@case.edu (216) 368-5538