Archive for the ‘Angel Investing’ Category

How Do Venture Capitalist Justify Doing Angel Deals To Their Investors?

Q: It seems that many VCs do angel deals on the side. For early stage (or even mid stage) VCs, how is this justified to their LPs? Wouldn’t VCs have the ability to select the best deals for their own cash and leave the LPs to invest later (through the fund) on at a higher price?

A: (Jason) This isn’t a problem with reputable VCs. Here is why:

First, most fund agreements say that VCs can’t engage in this type of behavior. This can be achieved in a number of ways from the LP advisory board having to sign off on all angel deals of the partners to a provision in the LP agreement that says VCs can only do angel deals that the fund would not consider for investment.

Second, assuming that the VCs do invest in angel deals, most don’t have enough money, personally, to fund a company through its life cycle. In fact, many only fund the angel round and don’t continue funding future financings. Bottom line, they are going to need outside capital – probably from their own fund. In this case, the only legitimate way to deal with the fund investing in this company is to buyout the VCs personal stake at his / her cost – no markup or cost of capital. In this case, the fund is actually getting the advantage of buying shares at a lower price with less risk because the company is later staged.

Third, remember what VCs are in business for: to raise additional funds to provide above market returns for their investors. If VCs were to hoard all the good deals in the personal portfolios, their main funds would perform poorly and they would not be able to raise future funds.

Communicating with Your Angel Investors

Question: Hey Guys, I’m new to the CEO gig and want to keep my angel investors informed with some sort of regular communication…Maybe a quarterly or even monthly letter.  What kind of things should I put into it?  What are they going to want to hear about?  How do I keep from saying something stupid, but still give them quality information they’ll find useful?  How do I position less than great information so it won’t freak them out but still get’s the info across?

(Brad) Before we get into the discussion of content, let’s start with frequency.  Every CEO in any angel deal I’ve been involved in starts off strong – planning (or even promising) monthly communication with his angel investors.  The half life of this promise is usually two or three months – very quickly the communication becomes every other month, then quarterly, then semi-annually.

This stinks.  Many angel investors are low maintenance, but they love to hear about what is going on with their investments.  A consistent rhythm of communication – I prefer monthly – helps the angel investors understand what is going on with their investment and gives them clear points of engagement with the CEO and the company.  Someone wise once told me “if you are going to communicate something, do it consistently.” 

Since most angel deals are early stage investments, the focus is often on the products, markets, early customers, people, financial, and financing.  I recommend a short (no more than two page) monthly email that covers the same set of topics, formatted in a way that is easy to put together (there is no value in a “fancy” document.)  Email is better than an attachment as it can be read quickly and responded to if appropriate.

Blunt, direct, and clear is always best. Don’t spin – just talk about what’s working, what’s not working, and where you need help.  Most angel investors understand that the business they are investing will have plenty of ups and downs – hiding this isn’t helpful.  However, be careful not to err on the other side and be too pessimistic either (e.g. don’t write you update letter after a long weekend that you spent at the office trying to get your crashed server back up and running.)

Finally, keep your angel investors informed about your financial status.  Many of them are the likely source of at least part of your next round of financing. 

What is the Minimum Amount of Investment Should I Take From an Angel Investor?

Question: We are in the process of raising angel money ($500,000) to be followed by 1 or 2 rounds of institutional money. We’ve heard many times that the less number of angels that you have the better it will be when it’s time to sort the details of the following rounds. We are not sure what would be considered an acceptable minimum investment per investor. At first we thought that $50,000 could be an acceptable minimum but we were advised to lower it to $25,000 considering the area where we are located. Is it ok to accept a smaller amount as long as we request power of attorneys from the angels to mitigate any risk for the following rounds?

(Jason)  You are thinking about all the right issues.  To reiterate your point, the potential negative of having too many investors is trying to “herd the cats” when you later take on institutional money.  Normally $25,000 is a good minimum, but it’s not unheard of to see $10,000 or $15,000 chunks as well.  If you are able to get a proxy on their shares to vote, then having more investors than less becomes much less an issue.  In short, if you can truly control the shareholder group, it’s not a major issue to have a few more angel investors. 

Whatever you do, make sure that your investors are qualified investors and that you aren’t running afoul of any federal or state securities laws.  If you sell private company securities to non-qualified buyers (read:  not high enough net worth), then you will have real issues closing on an institutional round later because of potential rescission rights issues.   

Should An Angel Investor Invest in Friends?

Question: I’ve done angel investing for the past 8 years.  I most often invest with people I don’t know or am referred to.  I have invested a few times with friends and it has always been hard to be tough on them as a shareholder, so I’ve stopped which is too bad since I have some smart friends.  Any advice for investing in a friend’s company?

This reminds me of the cliche “some of my best friends are angel investors.”  While I understand that it can be difficult to be an angel investor in a friend’s company, it surprises me that you’d actively seek out “non-friends” to make angel investments in.

I’ve made over 50 angel investments since I started investing in high tech companies in 1994.  Some of them have been in companies run by friends; many of them have been in companies run by people I didn’t know at the time I invested.  When I look historically at my economic outcomes, some of my biggest successes were in companies where I didn’t know the people involved prior to becoming an investor while others were with close friends.  My failures correlate similarly.

Over time, one thing has remained constant: almost all of the people that I’ve invested in – including those that failed – have become friends.  And – in many cases, I’ve backed them again (and again.) 

If you asked an entrepreneur I’ve invested in about my behavior – in both success and failure – I think he’d tell you that I was supportive, helped whenever and wherever I could, but was always direct with my feedback, even if it meant tough love.  I try to just spoke my mind, be as clear as I can be, and do my best.

Ultimately, I think it’s a mistake to shy away from investing in friends (especially if you have smart ones.)  The key is to be confident in your ability to communicate clearly and – when delivering tough, difficult, or critical feedback – to do it in a constructive and thoughtful way.  And – some of my best investments have been in people I’ve become close friends with through my earlier investments with them, regardless of the outcome.

Investing In An Angel Deal Without A PPM?

Question: What are the risks associated with funding an Angel round without a PPM? Assume the round is under $250k. Any resources you’d recommend looking at or people to talk this through?

Our Take: Few deals these days (at any size) have PPMs written for them. The costs (legal, accounting and management time) just don’t justify creating this document most times. We still see PPMs for large rounds (above $50M), but even then, it’s not guaranteed.

The risks are pretty straightforward. Without a PPM, the investor has less information and less recourse should something go wrong. That being said, companies raising angel money don’t have enough money to pay out investors if something does go wrong, so the company is much better suited to put its limited resources to use running the business, not drafting 100 page legal documents.