- January 27, 2011
If you are willing to give up some ownership and voting rights in exchange for quick cash, equity financing could be for you. Keep in mind, however, that most venture capitalists and angel investors are looking for a high rate of return. This type of funding is most likely suitable for high-tech and biomedical businesses.
Appealing to these investors will be different than appealing to a bank. Both a bank and an angel investor will want copies of basic legal and organizational documents, financial statements and tax returns. The loan officer at a bank will mostly be interested in the cash flow of your business model to ensure it generates enough revenue to pay back the loan.
But angel investors and venture capitalists will be more interested in the growth potential of your business. Equity investors will spend more time reviewing your projections and strategic options than your historical financial information. Angel investors also are more willing to wait — often five to 10 years — for a return on their investment.
There are two types of private-equity investors:
- Individual angels.
- Private-equity investors — a group of private investors who pool their money together so their investment is larger and their risk less.
Typically institutional or fund “rounds” of equity are preceded by one or more angel investments. Individual angels, angel clubs and pledge funds are typically looking at six-figure investments in companies with $2 million to $10 million in revenue that can grow to $20 million before another round of equity financing is needed or the company anticipates being sold.
Larger private-equity funds are usually looking for seven-figure investments in companies that can grow to more than $50 million in revenue. There are also mezzanine funds that provide investment capital in small deals, being reflected between the bank debt and pure private equity on the company’s balance sheet.
Is your company right for funding from an angel investor group? Virginia Business asked for some advice from Letitia Green, managing director of the Virginia Active Angel Network, a group of investors that provides funding for startup and early-stage companies in the mid-Atlantic area.
- What types of companies are best suited for funding from angel groups? The companies must be scalable, are almost never “bricks and mortar” companies, must be issuing equity or convertible debt to interested investors, and cannot be using investor money to pay off old debts, reimburse another investor, or pay legal fees. Angel groups also are unlikely to be willing to sign an NDA (non-disclosure agreement) to see your idea. If it needs an NDA, angel groups can’t promise that their members won’t talk, and we won’t accept that liability. If we can’t show it to our full membership, there is no point. Also, an NDA can suggest a lack of confidence about the idea being unique.Caveat: angel groups can have different rules so be sure to ask if they sign NDAs.
- How should businesses prepare to pitch their ideas to angel groups? First, always have a 30-second “elevator pitch” memorized in order to explain your idea in a restaurant, an elevator or a chance meeting. Next, always have an up-to-date PowerPoint (detailed) on a labeled thumbnail drive in your purse or pocket to give to an interested investor. Also, have a separate, up-to-date simplified PowerPoint presentation if you should get the opportunity to actually give the “pitch” to the investor with your laptop. The simplified PowerPoint should have no more than five words on each slide in large font and can even be just a picture to make your point. Be prepared to give the details of your pitch from this simplified presentation. The investors should focus on you and not your PowerPoint. Finally, always have a one-page executive summary prepared with your contact information.
- Are there any pitfalls entrepreneurs should avoid when seeking angel funding?
- The most important thing is to remember that angels invest locally, whether that is in our city, in our state, or like VAAN, the Mid-Atlantic Region. Don’t waste your time OR your money to contact angel groups that are too far away to be outside of a reasonable car trip to see you, or vice versa. Make sure you approach angel investing groups as “teachable” and not arrogant or that you know it all. That will kill your chances in the first few minutes of questions and will be obvious. Angels invest because they want to give back to the entrepreneurial community, want to help someone, and most importantly, want to invest in something that will make them a handsome return on their investment both financially and mentally: but first and foremost, they must feel comfortable with the founder… period.
- Do not complicate your capital stack by having hundreds of little investors if you can avoid it. This indicates that your financial raises have been unfocused and angel investors know that it always costs more for your little company to pay the legal and accounting costs of all those K-1s and/or legal documents and signing. It also indicates that when decisions are going to be made that may require voting by investors, it could be slow, painful and preclude the next opportunity for the company.
- Always make sure your investors are “accredited” by federal law standards (ask your lawyer for language for each investor to sign upon investment) and have available for new investors these signed forms for verification. An accredited investor indicates his net worth allows him to lose this money and he/she knows what he is doing and thus signs to this effect. The neighbor on the other hand, who didn’t sign one, can sue you for having convinced them to invest in a “sham” if they so choose. We’d rather not have to watch our investment go down the drain because of an unnecessary disgruntled, non-accredited investor, so we’re unwilling to invest in any company that can’t produce those signed accreditation statements.