Business angels –investment angels– generally invest between 25,000 and 500,000 dollars in new startups, often with the intention of getting them to a scenario where they can attract venture capital funds.
The rewards for the best investment angels can be significant, but the deals can also be very risky. So how can they maximize their chances of success and avoid feeling like they're throwing money down the drain?
Forbes points to the book entitled: “Best Practices of Angel Investing: Tactics and Strategies of Winners” by Heinrich Liechtenstein and Istvan M. Fulop in order to analyze the business angels phenomenon. According to these authors, there are four categories of angels:
The player.These are the "serial entrepreneurs" who have already started and sold one or more of their own companies. These are opportunistic investors who spend less time on portfolio enterprises than other angels.
The Silent Investor. While they are as opportunistic as players, they take less of an active role in the businesses in which they invest and tend to sit back and hope for profits.
The Hands-on Investor. As the name suggests, these investors take an active role and there is sometimes risk of friction between them and the entrepreneur if they have a significant stake.
The Professional Angel. These are both serial entrepreneurs and investors who tend to support portfolio enterprises by leveraging their networks to maximize the value of the venture.
Seven steps for success
Each of these four varieties of angel investors can become successful as long as they follow the seven fundamentals of early-stage investing:
- Sourcing.Winning angels have a very clear idea of what they are interested in and have investment criteria that help them filter out deals they don’t want to get involved in.
- Evaluating. Includes assessing whether there is a market for the service or products, the advantage, whether the time and the scale are right, the exit strategy and, above all, whether the entrepreneur and the team inspire confidence.
- Valuing. Some go on a 3 million-dollar ceiling as a rule of thumb; others give 1 million dollars each for sound idea, a prototype, a quality board and existing sale and then up to 2 million more for a good team. But none of these is a hard rule.
- Structuring.Although some argue that if you focus on having a positive relationship with the team, structure loses its importance. Yet there remain questions of the legal relationship (private investor or partner), the choice of investment instrument and the corporate structure of the firm and how that affects its flexibility.
- Negotiating.As with structure, not all angels agree on the fifth fundamental, negotiation. Many negotiate, or they leave it to someone else, while others do, principally over price, structure and the amount of capital invested.
- Supporting. Working with management is the supporting role most widely performed by angels. The supporting roles are:
- Silent: financial investment with no involvement.
- Reserve Force: ready to help if called upon.
- Team Leader: very active.
- Lead: the most active investor.
- Coach: investor who acts as a mentor to the entrepreneur.
- Controlling Investor: takes control of the deal.
- Harvesting. This is the financial score by which success will be measured. There are negative exits, of course, such as when a company runs out of fund (known as Chapter 11 bankruptcy in the United States) or when it is liquidated, in which case the investor may get little or nothing back. The positive harvests are:
- Strategic Sale: the most common form of exit, in which the company is sold to an industry player.
- Financial Sale: the company is sold to financial buyers, who purchase it for its future cash flows.
- IPO: the company sells a percentage of shares, which are listed on the public stock exchange, creating a market for the investors' shares.
- Partial Sales: the investor’s stake is sold to the management.
- Walking Harvest: the company distributes cash to investors on a regular basis.
Top angel investors understand that the extent to which they can follow these seven fundamental steps has a direct impact on their performance. They have learned to focus on the entrepreneur, knowing that when it comes to success, it's the people who really count. They plan their exit from day one and make sure that the entrepreneur is also exit focused, concludes Forbes.
The article in the NYT, Tips for the Aspiring Angel Investor , notes the skepticism of several the fad for investment angels. And they warn that not everybody has the right skills. “Smart people are doing it because they don’t know what they don’t know”, says Daniel L. Gottfried, a partner at the law firm Hinckley Allen, in the article. “When these doctors and lawyers are doing it, they’re investing with the hope that they’re going to make lots and lots of money. It’s roulette". But unlike roulette, there are things they can do to stack the deck in their own favor. Brin McCagg, an entrepreneur on his fourth company, recommends waiting to have enough money before becoming an investment angel.
“You should build a diversified portfolio of stocks and bonds and make money, and sooner or later someone is going to come along with a business opportunity in an industry you know”. Just because some entrepreneurs ask you to invest in their company doesn't mean you should. Flattery, after all, clouds judgment. And he says: “Who is managing the company is as important, if not more important, than the idea itself".