About Angel Investing

I was sent a survey recently by Vanessa Dunaway, a Babson MBA student, and I thought I’d answer her questions publicly. The answers are probably of some interest to more than a few entrepreneurs looking for funding.

1. Why are you an investor?

There are many reasons I got into this. Initially I was looking to connect with an early stage company needing a CEO or CTO. I quickly determined that this was going to involve way too much work, so I’ve been doing the investment thing exclusively since 2008.

My motivations include: learning something new every day, giving back to the community, meeting new people, and somewhere along the line maybe making some money. That’s in roughly descending order of importance to me.

I said at the outset and still feel that my best bet for making money is leaving it with my investment manager. But that’s not nearly as much fun.

2. What is your investment timeline/When are you looking to get your capital returned?

Since my primary motivation is not economic, I don’t have specific time constraints. That said, I favor investments that where an “early exit” looks possible. As a rough guideline, 3-5x my investment in 2-5 years. The hope is that positive exits will allow me to continue playing without risking my retirement funds.

3. How do you decide on follow-on investments?

I’m usually a “once and done” investor. I have done follow-on investments, but usually for the wrong reasons, and only with about a 25% success rate, so I’m trying to discipline myself to stick to my “no follow-on” rule.

4. How do you judge your success as an investor?

If my portfolio CEOs feel I have brought value with my advice and networking, then I’m very successful. If I make boatloads of money as well, that’s a huge bonus!

5. When do you prefer to invest, at what stage of business development? 

I’m a seed-stage investor. I’m not sure that’s the best stage at which to invest from a financial point of view, but it’s the stage at which I feel I add most value, and that at which I have most fun. About 1/3 of my investments are done before my angel groups get involved, largely because the companies are too early stage for the groups.

6. What is a typical round-size that you participate in?

I describe myself as a “small investor with a big mouth.” My own investments rarely move the needle on the round in which I participate. The rounds themselves range from first rounds from $100K to $500K, to early angel group rounds of $300K to $1.5M.

7. What are your specific criteria for investing in a company?

I need to be excited by the market opportunity and the product/solution, but these are conveyed to me by an entrepreneur and team, and they are the deciding factor. 

8. How involved do you wish to be in the business?

This is highly variable, though it’s somewhat correlated with the stage at which I invest in the business. I’m usually more involved with earlier stage businesses, often taking on an advisory role (sometimes with compensation in options), a board seat, or a board observer role.

9. What should an entrepreneur look for in an angel investor?

The tried and true aphorism is to look for “smart money.” This means that you want investors whose experience, expertise, or network can add value to the entrepreneur’s company. One of the advantages of working with angel groups is that the entrepreneur will garner some smart money from those members who bring the needed expertise, but these investors are backed up by “dumb money” that trusts the lead investor, so additional capital can be brought to bear.

10. How does a start-up know when it’s ready for angel funding?

This brings up the most important advice I give practically every entrepreneur I meet with: network, network, network. The best way to know when you’re ready for investment is to ask investors. They are not shy, and will tell you. 

That said, in software companies today it’s very hard to get investment before you’ve at least developed a prototype. In consumer products we’d like to see some proof of market interest (if not market demand) in the form of a successful crowdfunding campaign.

11. What are some questions you typically ask startups?

I consider myself very good at asking good “stupid questions” (this, as opposed to stupid stupid questions). These help me understand the company and the entrepreneur better. I’m looking for market knowledge, reasoning ability, and analytic skill. 

The questions themselves are necessarily different from company to company, but some are common: 

Who is your customer? How do your reach your customer? How much will it cost to acquire customers (CAC), and what is their lifetime value (LTV)? Is you solution scalable? How much capital will it take, all in, before the company will exit?

12. What criteria do angel groups use to select entrepreneurs?

We are looking for big ideas in big markets, led by an all-star team. But more fundamentally, we need to be sold on a great story, one that stands up to scrutiny at its core, but demonstrates resilience at the edges. What I mean by that is that we know there will be hundreds of things that will change during the course of company growth, from tweaks in the product to complete “pivots” in the business. These changes require resilience in the company, and we try to assess that up front though our dealings with the founders. We assess how they respond to our pushing on them. 

One of the surest ways of turning off the angel community is to be labeled “uncoachable,” which covers a multitude of entrepreneur sins.

13. How do I know my business is right for an angel group investment?

The time to look at groups is just a little later than with individual investors (many of whom are also group members). Groups and syndicates are able to raise more capital than most individual investors  but their investment is usually slower to close than earlier stages. Many entrepreneurs are dismayed by the length and clumsiness of angel group process, and this may lead to a reluctance to apply to the groups. The group process does have its benefits, however, and many companies are well suited to take this funding route.

Note that most groups in the Boston area operate more accurately as investment clubs, in that individual members invest in the company, not the group itself. There are several fund-based groups in the area, as well.

14. When should I approach an angel group?

Groups prefer getting warm introductions so you should network yourself into the group. Often seed-stage investors can make these introductions, as they may be group members themselves. Other seed investors are well known to the group community, again making the introductions easier. The timing will again depend on company stage, but angel group processes take a while to move, so you need to anticipate 3-6 months before funding is needed.

To be clear, most angel groups are looking for companies that have some indicators of success beyond a few people nodding at the concept on the back of a napkin. That can be a positive crowdsourcing campaign, early paying customers, or very positive lab tests of a new drug or chemical. Very rare is the group that will fund an idea, those days are gone, largely because there are so many companies that have demonstrated success that groups can fund instead.

15. What process can I expect if I apply to an angel group for funding?

Each group operates a little differently. First, screening.

Boston Harbor Angels has a formal screening process: we take applications in through our web site, then review the offerings on-line, giving a good deal of attention to the “referred by:” field, as this gives us a clue about the company as well as somebody to ask for more color. Eight companies each month are invited to present at our screening meeting, where usually about a dozen committee members will hear their pitch, ask many questions, then provide feedback to try to improve the company’s prospects, regardless of whether they are chosen to present the following week. Four companies present to the plenary meeting each month.

Walnut Ventures operates much more loosely, with one or two members responsible for assembling a slate of four companies to present each month. As this chair rotates, the criteria for presenting are many and varied.

Launchpad Venture Group has managers who select the slate of (usually) three companies each month, but they take input from “scouting groups” that are sent out and do some “pre-diligence” on prospective presenters.

Other groups in the area have their own processes, but the above examples are typical.

Diligence and deal structuring.

After presentation most groups poll their members to see how much interest there is in the company, and if enough is found, a diligence group is formed, usually with an identified deal lead. Entrepreneurs should be very cautious if nobody has stepped up to lead, as this usually indicates insufficient interest and diligence is likely to be a mutual waste of time, frustrating to all.

Diligence varies widely between groups and individual deal leads, and is often a function of the stage of the investment: obviously, earlier stage companies have less real facts to examine, so the diligence process is largely limited to sizing the market and evaluating the team itself.

If diligence comes to a positive outcome, the deal lead negotiates with the CEO about deal terms, with luck agreeing on an attractive deal for both sides. At this point group members will “soft circle” amounts they are planing to invest, and if there is sufficient capital around the table, the deal can close. Often deal size exceeds the capacity or interest in a particular group, in which case other groups or group members may be asked to join in the deal. This is called “syndication”, but is somewhat less formal than syndication at the VC level.

16. Will angel groups sign non-disclosure agreements? If they don't, how do entrepreneurs protect confidentiality?

Most angels prefer not to sign NDAs. The fact is that most active angels see hundreds of deals a year, and the likelihood that a particular entrepreneur’s idea is unique is actually fairly small. Mostly success or failure is base don execution, not the “secret sauce.” That said, the entrepreneur does have to be careful not to disclose inventions that are not yet protected through patent. 

Another piece of advice that goes along with not expecting to have angels under NDA is to make sure that you hire good lawyers for your company. Your counsel will advise you what you can disclose, and when.

17. Should I expect to pay fees to participate in the screening process or to present to an angel group?

Most angel groups in and aroundBoston do not charge fees. There are exceptions: Boston Harbor Angels charges a fee after screening if a company presents to the full group, Investor Circle has a presentation fee, and there may be others. Given that each group has its own personality and interests, the entrepreneur needs to decide whether fees are worth it and this will depend on many factors. In most cases it is unlikely that the fees involved will make or break a company. 

Copyright 1997-2018, Ben Littauer