David Rose, entrepreneur and Founder of New York Angels, offers seven clusters of useful tips for angel investors in his new comprehensive guidebook, ‘Angel investing: the Gust guide to making money and having fun investing in startups.’ Since angel investors play an important role in the startup journey, this book will also be useful for entrepreneurs to better understand how investors assess their companies. Besides, many successful entrepreneurs themselves become angel investors along their journey.
“Today, any sophisticated investor with a portfolio of alternate assets should consider direct, early-stage investments in private companies as one potential component of that portfolio,” Rose begins. Good choice and management of angel portfolios can yield annual returns of over 25% in the U.S., as compared to bank accounts (1%), bonds (3%), stocks (7%), hedge funds (10%) and top VC funds (15%), Rose claims. Every year, over 600,000 new businesses start up and hire their first employees in the U.S.
Rose’s book is packed with firsthand accounts of startup deals, lists of do’s and dont’s, graphs of company growth, and a 60-page resource section with valuation worksheets, termsheets, due diligence checklists, glossary of terms, and links to useful sites. The writing style is informative, direct and humorous (angel investing lets you have “as much fun as it is possible to have with your clothes on!”).
Angel investing, once dominated by multi-millionaire high-rollers, is now entering the mainstream, with more than $20 billion being invested annually by individual investors in the U.S. alone. Making money is no longer about sitting back and reading stock listings, but also being part owner and active participant of an exciting startup, observes Rose.
Successful angels have to be curious, studious, have an appetite for risk and be able to accept failure, begins LinkedIn founder Reid Hoffman in the Foreword; Hoffman himself was an angel investor in Facebook, Digg, Flickr, Ning, Zynga and Last.fm.
The narrative highlights some of David Rose's successful investments (Realty Mogul, FastTac, G-Force One, Social Bicycles, LearnVest, Comixology), failures (CE Interactive) and even missed opportunities (such as Pinterest, Quirky, Sling Media). Here are some of my key takeaways from this guidebook; each chapter makes for a detailed and informative read. (See also my pick of Top 10 Books for Entrepreneurs from 2013 and 2012.)
1. Understand the basics of angel investing
With proper planning and effort, seed investors stand to gain much more than IPO investors – and also learn from young entrepreneurs, play a formative mentoring role in their growth, have fun and excitement along the way, and even have the satisfaction of giving back to society through impact investing. Angels need to have long-term views of their industries, even temperament, respect for startups and ability to learn from failure. Unfortunately, most startups fail, it is hard to predict which ones will not fail, and it takes years for them to navigate the ‘J curve’ of success.
Rose cites research which shows that an angel typically invests in 20-80 companies over a five-year period, with about $25,000 per company; they also tend to invest along with 5-10 other angels. An angel receives upto 50 pitches per month, and angel groups receive upto 100 submissions per month. While regulations vary across countries, in the U.S. an accredited investor is a person who has net assets of at least $1 million or annual income of at least $200,000.
2. Engage and assess startups
Deal flow begins with sourcing and identifying high-potential opportunities. This happens through personal connections, angel groups, meetups, business plan competitions, startup conferences, launch events, accelerators and incubators. Investors should assess the character, skills, knowledge and experience of startup founders and their teams. Passion, leadership ability, vision, market savvy, flexibility, integrity and commitment are traits to look for, Rose advises.
Is there potential for revenue within five years? What is the competitive differentiation? What is the path to product acceptance? What are the breakeven points and profit margins? How convincing is the pitch? How solid are the company’s IP and financials? These are key questions to ask, and Rose provides many examples of these queries in action.
3. Master valuations, deals and investment rounds
Between the current value of the company and its estimated value after a fixed period lie a number of metrics: Return on Investment, Internal Rate of Return, terminal value and management risk. A number of instruments can be used here, such as preferred stock and discounted convertible notes, and should be formally spelt out in shareholders’ agreements and term sheets. Much negotiation and even mediation skills will be needed during the stages of successive investment from VCs (Series A onwards) and listing.
Assessment can be done via scorecard validation methodology, Dave Berkus method, Cayenne Valuation Calculator and Risk-Factor Summation Method. Rose also cites the work of investor-author Derek Sivers: “Ideas are worth nothing unless executed. They are just a multiplier. Execution is worth millions.” (See his classic and often-referenced table on the multiplier factors of ideas and execution here.)
4. Add value to the startup
Active angels do more than provide funding – they provide networks of contacts, potential customers, assist with recruitment, serve on the board of directors, and mentor or coach the management team. Lead investors will bat for the startup and bring in further investors or make follow-on investments.
Rose provides good real-life examples of how he met the founders of Social Bicycles, LearnVest and Comixology at startup events, approached them to be an investor, helped them raise additional funding and provided mentoring and access to business professionals and customers.
5. Deal with outcomes: failures and exits
Based on his personal experience as an angel investor, Rose cites research which shows that 50% of portfolio companies go out of business, 20% are sold to a larger company, 2% are bought by a later investor and a mere 0.1% make it to an IPO. Angels should look out for financial buyers within a 3-5 year time frame, or preferably a strategic buyer.
Rose cautions angels to be prepared for the heartache of unexpected events despite the best of planning, eg. a startup he invested in, CE Interactive, struggled to scale its business model, took a major hit when its biggest customer went out of business and was finally eclipsed by the 2008 recession.
6. The long term: build your reputation as an angel
Angels with long-term outlooks will map out and engage with the broader entrepreneurship financing ecosystem at the city, state, national and even global levels. Create an online profile, write a blog, engage in dialogue, attend startup events, and participate as a judge or panelist, Rose advises. Joining an angel group helps master the finer aspects of due diligence, and build knowledge sharing networks.
For example, the online forum Quora has regular participation by angels like Dave McClure, Marc Andreesen and Reid Hoffman. Brian Cohen began as a pro-bono advisor at New York Angels - and eventually became the first angel to discover Pinterest. The Angel Capital Association and Angel Resource Institute also host useful industry events.
7. Tap into emerging trends: impact investing and online crowdfunding
Impact investing helps angels grow companies that do well and do good, i.e. they address the double bottom line of financial returns along with positive social impacts, eg. for less-privileged citizens. Crowdfunding and equity crowdfunding are emerging trends to watch, but a lot depends on regulatory conditions in countries around the world.
The angel movement is thriving and scaling thanks to the rise of meetups (eg. NY Tech Meetup), business plan competitions (eg. at NYU), startup conferences (eg. DEMO, Disrupt, SXSW, CES), accelerator demo days (eg. Y-Combinator, TechStars, LaunchPad), online funding sites (eg. for films: Slated; consumer brands: CircleUp; European startups: Seedrs) and angel groups (eg. Mumbai Angels). “I am a committed believer in the social, economic, and personal value of angel investing,” Rose concludes.
About the author:
David S. Rose is Founder and Chairman Emeritus of New York Angels, the most active angel group in the U.S. He is a serial entrepreneur, Inc 500 CEO and a prolific angel investor, and has founded or funded over 90 high tech companies. He is the founder and CEO of Gust, a global online platform for organised professional angel investing used by over 50,000 accredited angel investors, 1,000 angel groups and venture capital funds, and 250,000 entrepreneurs. Rose graduated from Yale, Columbia and Stevens Institute of Technology.