Angel Investing Is a Team Sport
Vernon W. Yates, Chairman, Board of Govenors, Tech Coast Angels
Until the mid 1990s, entrepreneurs seeking angel investors had to find investors one at a time or in small groups. Although some informal groups of investors had formed around the country, there were no groups that founders could approach for investments until the launch of Band of Angels in Silicon Valley later in the decade.
During this period, moreover, venture capital firms were making fewer seed stage investments, and focusing instead on larger investments in businesses that had already gone through the start-up phase. Entrepreneurs found it harder to attract venture capital, leaving them almost totally dependent upon friends, family, and angel investors. In addition, companies had to raise more money because the minimum threshold for venture capital investing had increased to $3 million to $5 million.
Raising angel money prior to the formation of angel groups required the development of a large network of contacts. Investors were usually contacted individually, a time-consuming and sometimes wasteful activity. Often entrepreneurs would attract unaccredited or unsuitable investors and end up with a capital structure that was inappropriate for the company.
For their part, lone angel investors found it difficult to independently verify the claims and assertions of entrepreneurs and devote the time and effort to doing a good job of due diligence. Unless the angel investor was writing a large check, he or she had little leverage in company valuation, board representation, or term-sheet negotiation.
Filling a Void
Since the mid 1990s, more than 200 angel groups have been formed to step into this capital void, providing a number of benefits for both the entrepreneur and the angel investor. These groups, or networks, bring a diverse set of talents and skills that can be leveraged to the benefit of both the entrepreneur and the angel investor. By participating in an organized group, angels can do a more professional job of identifying and funding the most attractive companies.
Specifically, as part of a team, an angel investor has better deal flow, can perform better due diligence, can control the investment process, can negotiate better terms, and has access to additional capital. The knowledge and experience of a team helps the angel gain a more complete understanding of the investment. Another major benefit is the learning experience. As a result of participating, the angel investor learns a great deal about the market, the product, and the underlying technology of a given investment. At the same time, members strengthen and expand their network of contacts.
As for the entrepreneur, significant benefits include being able to deal with one group rather than many individuals and to gain enhanced knowledge from the financial sophistication of the angel group and from the special expertise and skills that individual members can contribute to the company.
Working as a Team
In short, angel investing has become a team sport. To be effective, groups divide the work among the members so that any one person doesn't have an undue workload. Frequently, Web-based technology enables enhanced communication, information sharing, deal tracking, a member database, and portfolio tracking.
Typically, teams are assigned to deal screening, company presentations, and due diligence. Deal screeners apply standardized criteria to business plans to identify those with the most promise. Routinely scheduled company presentations provide a venue for hearing the company management present its case for investment.
Members who are interested then meet with the company for in-depth discussions. If there is sufficient interest, a due diligence team is formed. Again, the workload is divided among those who are interested, and often, other members of the group are asked to contribute their expertise in areas such as intellectual property or deal structure. If due diligence is positive, a team is assigned to meet with the company and negotiate a term sheet on behalf of the group. Again, in this effort, other members of the group may be asked to contribute based on their individual knowledge and skills.
If those who have led the due diligence and negotiated the term sheet are willing to write checks, the company is invited to present to the whole group. At this point, the entrepreneur and the investors are on the same side of the table, working to bring other angel group members into the deal.
Benefiting All Players
A closer look at the benefits to angels investing as members of a group explains why the practice represents a better way for both the financiers and the entrepreneurs whose promising companies are the ultimate beneficiaries.
When angel groups are formed, the service providers in the local community will refer clients seeking investment. Over time, if the angel group is actively making investments, the most attractive business plans will be referred. As an individual, it is unlikely that the investor would have the opportunity to routinely see the best deals.
Better Investment Decisions
Due diligence can be complicated, especially for companies in the high technology and biotechnology industries. By splitting work among the members, the team can acquire a more complete understanding of the product, the market, and the intellectual property issues. In addition, the team can share the work involved with customer reference checks and team background checks. Pooling this knowledge helps the team make better investment decisions, and the companies often benefit from the knowledge gained in this process.
Control of the Investment Process
Working as a team, the angel group can control the investment process rather than having the entrepreneur control it. All entrepreneurs are anxious to get the money and often set arbitrary time periods for investment decisions. This leads to quick decisions on the part of the investor that are regretted later. The potential amount of money represented by the team usually allows control of the process. Proper due diligence and patient consideration lead to better investments.
Pooling Investment Capacity
By pooling the investment capacity of the group, the angel investor can obtain a better valuation and better terms. Negotiating a realistic valuation is easier when you can provide the total amount of capital sought. Individual investors are generally at the mercy of the entrepreneur unless they are prepared to write the biggest check. Also, issues of board representation, observer rights, and liquidation terms can be addressed more favorably.
Access to Additional Capital
Often early-stage companies need additional capital at a time when they are not yet attractive as a venture capital investment. Without the support of the existing investors, a company can fail or be critically hurt when the almost inevitable financial crisis arises. It is comforting to have other investors involved who can provide additional investment and possibly bring in additional participants.
Now that angel investing has become a great team sport, it has the potential, like all team sports, to be rewarding and enjoyable for all of the players. If the game is played well, both investors and entrepreneurs will benefit.