The recent downturn in the economy and resulting freezing-up of financial markets has made the already difficult process of raising funds for early-stage businesses next to impossible. Increasingly, early-stage business owners are turning to angel investors as their last, best option. In this article, I will explore the process through which the early-stage business owner can approach angel investors to secure funding by describing the process from the perspective of a local business owner who successfully navigated the angel investor funding path, and through the eyes of a local angel investor.
Angels are typically high-net-worth individuals and entrepreneurs who have successfully built one or more businesses, interested in mentoring other entrepreneurs, actively engaged with the ventures they fund. Although many angel investors prefer to operate independently, in the past several years an increasing number of angels have joined together to form angel groups in order to pool resources and investment expertise. There are an estimated 200 such angel investor organizations in the United States.
Entrepreneurs who launch start-ups or have early-stage businesses know that commercial banks generally do not lend funds to ventures with little or no assets, customer base or sales track record, especially given the current economic climate. Venture capitalists typically work with business concepts that are already up and running with an established record of revenues and in most cases profits. According to Eric David Greenspan, co-founder, Chairman and CEO of Make It Work, the Santa Barbara-based computer support company, venture capitalists are known to put business owners to the test, and to view equity investments as purely money-making ventures, and to demand large chunks of equity for their involvement. In contrast, angel investors can provide funding and even some much-needed expertise and referrals to help business owners execute their business plan.
Angel investors got their name 100 years ago in New York City when struggling playwrights with limited financial means had theatrical productions funded by a wealthy and visionary individual, usually at the last minute. It was likened to an angel floating down from heaven with money so the show could go on. But these were also very astute investors with a keen eye for plays with great market potential for tremendous profitability.
Greenspan’s involvement with angel investors began in 2005 when he was looking to expand Make It Work. He had already completed an initial round of financing, through a so-called friend and family round in which he was able to raise capital from people he knew, and from existing customers of Make It Work who saw how well he was doing and wanted to participate. At the time, Make It Work was generating about $2 million in annual sales, which according to Greenspan is a bit advanced for many angel investors who prefer to get in earlier in the development of a company.
Greenspan first approached Keiretsu, one of the largest angel networks in the country, presenting to chapters in Los Angeles, Hawaii, Orange County, and Oakland. “The response was very positive,” relates Greenspan, “with lots of questions and applause, but no one wrote me a check. The one exception was in Oakland when I presented to a group of 125 at a country club. After I completed the presentation and no one signed-up to invest, I was walking to my car when a member of the country club, (not a member of Keiretsu), who had been listening outside the room, stopped me and wrote me a check for $150,000. This motivated me to persevere.”
With nothing much to show for his efforts with Keiretsu, Greenspan approached Tech Coast Angels (TCA), another prominent angel group that operates throughout Southern California and is organized into five regional networks: Los Angeles, Orange County, San Diego, Santa Barbara / Westlake Village and the Inland Empire. Each member is affiliated with the network that covers his or her office or residence, and membership is by invitation only.
Greenspan advises that TCA does not want a PPM (Private Placement Memorandum) or the typical 75-page business plan, but instead wants a 1 – 2-page executive summary that is well-written, covers everything of importance in describing the business, catches the screener’s eye, and contains the all-important exit strategy so the investor(s) can see how they will make money. “It is also extremely helpful to know someone in the angel group who can help get you through the screening process to get you to the next stage, which is a meeting with four or five group members. This meeting is another screening, during which you are allowed to make a brief presentation, which is followed by a barrage of questions, some of which are about your industry, just to see what you know, some are business plan-specific, and some are general questions to see if you can execute your business plan,” states Greenspan.
If you make it through this meeting, you are then allowed to present to the full membership of a local chapter, which could be as many as 125 members or more. The typical presentation is 30 minutes long, and includes a slide presentation with a Q&A session to follow, and finally a sign-up sheet is passed around, with anyone interested in funding the venture signing their name.
“To raise the money you need from the group, you really need someone to take the lead and really get behind your deal to organize the group members interested in funding your business. This person is known as the ‘lead’. I was lucky enough to have two members of TCA champion my deal, and was able to raise $1 million in that round,” says Greenspan.
Ralph Iannelli, a local entrepreneur, owner of Essex Capital, and angel investor states that when he looks for opportunities, they must fit within his area of expertise; “I need to understand the business, and for me that means healthcare and IT primarily. The business’ executive summary must impress, the opportunity must be compelling, and it must tell the complete story of the business succinctly. It needs to answer the question: Why am I looking at this deal? The valuation metrics are not as important as having a strong topic sentence that states; here is what it is and why it will work. If it’s a good idea, I go immediately to the jockey—the person running the company has to be able to monetize their business plan; they have to be able to execute.”
“As soon as I am satisfied that the idea is worth considering, I go directly to the person’s CV. If their background is strong, and relates directly to running the business, especially if they have already run successful businesses in the same space, I will meet with them,” continues Iannelli.
Iannelli says that referrals matter, and that he will typically meet with someone if they are referred to him by someone he trusts. Iannelli focuses on companies that are already generating revenues, although he will consider start-ups if the idea is strong. A recent investment he made was in Givezooks! A company that allowed him to combine his passion for philanthropy with a great business model that generates profits by helping charities raise funds, as he puts it; “It’s a win-win for everyone involved.”
Early-stage businesses would be well-advised to do some homework, to understand what angel investors are looking for, and to format their presentation materials accordingly. For the right businesses, there are funds available, but competition is fierce, and cash is king, so entrepreneurs should be prepared to negotiate hard for funding, and for the amount of equity they will give-up for that funding.