Recently I was on a panel at a reverse investor pitch event hosted by The Network Connect. After the talk, an audience member suggested I put some of my comments down on paper so to speak. As a fledging entrepreneur turned corporate agitator and an under capitalized angel investor, I take a bit of a contrarian view to my approach as an investor. Specifically, I look at the following criteria when evaluating an opportunity:
- Team
- Market
- Intellectual Property
- Regulatory Hurdles
- Location
From a team perspective, I want someone who is all in on their idea, they have left their job and have 100% put themselves at risk for failure. I find that failure usually breeds motivation and fuels passion. In addition, I like to find individuals or teams that have failed before. There are so many obstacles to navigate when building a company, I want a team that knows how to overcome adversity.
I tend to invest in businesses that I know, but the market opportunity may be too compelling for me to overlook. I like companies that have found niche markets to disrupt, like the management and distribution of scholarship funds, on-demand fueling for consumer cars, or niche e-commerce sites that focus on a passion/hobby vs. the mass consumer. I want a market that ideally is highly fractured or tightly controlled, where a small upstart can nip away at market share.
So many companies these days tout that they have something new that is going to change the world and make them a billion dollar start-up. Well, I start with asking what patents that they have filed. What IP hurdles do they have to navigate to steer clear of others patents. How they approach that process is telling to me on how committed they are to working the details to succeed as a company.
The amount of regulatory hurdles a new company has to navigate can be both a competitive advantage or a major hurdle to overcome. Open industries like Retail have such a low barrier to entry that anyone can do a me-too startup. However, finance, energy, healthcare, food all have regulatory hurdles to navigate. The barrier to entry is high, but not insurmountable. Entrepreneurs that are focused on starting companies that help address or navigate regulatory hurdles are very intriguing to me, because you have a built in customer base if you solve the problem well.
Finally, I look at location. With the lack of money in the mid-west and the fight for talent globally, being in a desirable location which is accessible to financing, talent and your customer base is important. Being away from the coasts can be advantageous, but it has its barriers as well. Specifically when it comes to tapping into the Angel Investor community.
I find that in the mid-west many Angel Investors approach a start-up investment similar to analyzing a stock investment. They are overly focused on their returns, dilution and the risk of losing their money. On the coast, many Angels operate with the same approach as a VC, they put in a limited amount of money in each company with the ability to participate in follow-on rounds. They take a long-term horizon view on their investment and expect that 9 of 10 investments will fail. I find in the mid-west that many angel investors don’t have the capital or risk tolerance to operate this way, making it difficult for the entrepreneur to win them over.
There are two questions that you have ask to gain insight into a potential angel investor. First, what is their expected time horizon for a return on their funds? Second, what multiple do they expect to be returned. If their answers are 3 — 5 years and 10x, than I would personally consider walking away. These investors may have unreasonable expectations and may not be able to weather the ups and down of angel investing and would be better off participating in an early-stage VC fund or a PE fund than directly investing in a start-up.
There are however several points you may want to bring up with your potential angel investor as you seek the answers to these two questions. First, they may be better off participating in a debt-financing round with an option to convert to equity at a preferred price in a later financing round. This limits their risk, guarantees them a favorable valuation in a future round (vs. dilution) and allows them to earn interest along the way. Another would to allow them to invest, but give them an option to sell their shares back at the current market value in a future financing round. This allows you to limit dilution of prior investors and allow them to cash out. Your future financiers should be made aware of these types of arrangements and will usually appreciate the minimizing of dilution. However, some may balk at seeing some of their funds used to buy back prior investors shares.
You should also discuss with any investor their ability to invest in future fundraising rounds. Ideally, an investor will continue to support your business with financing in future rounds. However, if you have an investor offering you $100K and they state that would not have the means to invest in a future round, you may want to consider asking for only $50K, asking them to consider using the other $50K in a future funding round. This may seem counter intuitive, but it is looking out for both parties interest. Of course you run the risk that they opt to not invest, but at the same time you establish immediate credibility and trust.
Fundraising is a complicated and exhausting activity. Be thoughtful on who you want to raise funds from and cast your net wide for those types of investors you are looking for. In my mind you want an investor who is willing to commit time and money to your company. Someone who can mentor you through challenges you are having and connect you to others you may be able to learn from. Ideally each investor has the ability to lead you to other investors. Once they invest in your company, they have a high motivation to see you succeed. Use that motivation to help you grow your network of mentors, resources and future investors.
