There is a tendency among entrepreneurs to chase money wherever they find it. The pressure to find the financial resources so necessary to build a business can be over-mastering. Most of the time the partnerships which form between founders and angel investors are productive but, in a few cases, I have seen it turn very destructive. Companies that should have realized success have been held back by investor partnerships that have severely limited their potential or, in some cases, doomed them to failure.

Look Beyond the Checkbook

It may be hard to be discriminating when you are in the heat of the ‘money hunt’ but the sins of omission you commit while chasing investors can return ten-fold to destroy any chance of success. The problem can become acute because of the incredible range of circumstances, experience and interests that angel investors bring to the table. Their having money to invest is not enough. You need to understand their basic motivations and what is driving them to act as an angel investor. You also need to understand that all investment money is not the same. Some money will help you succeed while other investments will be a poisoned pill that will reduce your chances of building the business you envision. Here are some ‘sacred cows’ that you need to slaughter:

• Angel investors are in it for a return on their investment: Well, how can you argue with that? You would assume that the primary driver is always a return on investment. But, as you will read further on, that is not always the case. I know angel investors who are simply bored and looking for something to do and others who are frustrated CEO-wannabees. For some investors, it is all about a return but for others the return is secondary. You need to sort these two groups out. Do not listen just to what they say; it is what they do that is important.
• They have money so they must be smart: This is another fallacy. Some of the dumbest and most self-destructive people I have ever met are wealthy. I have found only a weak correlation between wealth and intelligence and a slimmer one between wealth and wisdom. Many a destructive hubris has been built on a fat bank account. Investors have an important role in start-ups but pretense, omnipotence or omniscience can warp an investor’s understanding of that role. Smart investors play their part in a highly professional and constructive manner. Seek them out; they are most likely the winners you want to associate with.
• They have been successful in business so they will know how we can be: Past success is not always a good indicator of wisdom going forward. In fact, great success can be counter-productive when they decide to work with start-up companies. I know one investor who continually regales his CEOs with stories of how he ran his company. Of course, the company was running over one hundred million annually when these stories took place. The CEOs, wanting to emulate his success, take steps that are entirely premature. The result is wasted resources and a dysfunctional corporate culture. Past business success is not a good indicator of professional performance as an investor. Remember, you are seeking an investor, not a shadow CEO.
• They will become my close personal friends and advisers: Not a good idea; the correct focus of investors should produce a tension in the relationship with management. If you want a friend, buy a dog.

The Bad and the Very Ugly

The problem with writing about angel investors is that they come in an amazing variety. I have met lots of them and there is always something different about each. The ease of entry into the field may have something to do with it. The only real entry requirement is wealth beyond current needs. That’s all it takes to become an angel investor. There are no educational requirements, courses to take or certifications to merit. Only a bank account and a decision to ‘invest’ are required to hang out a shingle and open up for business. Watch out for the following:

• The Shadow CEO: I have met investors who purposefully pick weak or inexperienced CEOs to work with. Their real agenda is to run your company from the back seat. These investors are very intrusive and will push you to make decisions and commit resources that will put your company at risk. They are mostly successful entrepreneurs who have built and sold a business. In the process, they have lost touch with the necessary energy levels and passion that is essential to building a start-up into a going business. Mostly they remember the later stages of their company and the extended staff they had. Then they turn the CEO into a kind of executive assistant and attempt to run the company by proxy. Most of the companies in the portfolio of this type of investor remain very small. They generally have very complex Excel spreadsheet projections and poor records in meeting them. Stay away from the Shadow CEO; they are very dangerous investors.
• The Crazy, Rich Uncle: This is probably the most dangerous type of angel investor because they are so easy on the management team. They are mostly retired and living comfortably. Their mission in life is to ‘give back to the younger generation’. A clear indication of this type is the total lack of performance metrics and a weak statement of expectations. They can be very seductive to entrepreneurs but there is a dark side. Without stiff set of performance metrics, the company can develop a culture of permissiveness. That will feel good until the money runs out. A key indicator of this type is the feeling that the amounts of money involved are, at least initially, not sufficient to cause them concern. The expenditure patterns are not carefully monitored and discussions do not turn serious until the money is spent and the wolves are at the door. As an entrepreneur, you need to seek out investors who will be hard on you; insisting on strict performance metrics and precise definitions of roles. Take the easy way out and you will be in for a ride to nowhere with a crazy, rich uncle. Sure you will enjoy the ride but, in the end, you will be let off the bus in the middle of nowhere with a tarnished reputation for failure.
• The Gaggle: Remember the old saying about a camel being a horse designed by a committee? These gaggles are fond of that kind of engagement. The investments that they make are very often selected in a very casual way and supervised fairly loosely. The problem comes as the group itself is very loosely organized. Different participants might have significantly different understandings of what it mean to be an investor and what that status entitles them to. This can range from complete indifference to total immersion in the management of the company. This situation can result in lots of pulling and pushing of the management team without an overarching strategic vision. Investments should be made based on clear and concise understandings codified in a detailed investment agreement.
• The Bottom Feeders: You will meet some investors who are really only interested in your intellectual property. They ‘drag the bottom’ of the entrepreneurial community looking for weak teams with good ideas. Mostly they insist that their funding be used to develop the technology rather than developing revenues. Once the money runs out, they regretfully inform management that they are closing the company down and taking the intellectual property as compensation for their investment.
• The Lead Broker: I have seen these lead brokers promote themselves into central roles in companies without putting much of any of their own money on the line. The net result is that the bulk of the investor group gets involved without much direct knowledge of the business or the management team. In one case, such a broker put together an investment in excess of one million dollars without making any investment of his own. He still managed a seat on the board and a dominate role in the management of the company. Be particularly careful of the broker who can invest but does not. This situation can turn nasty if expectations are not met. Finger pointing and recriminations can come to dominate the relationships among the investors. This could seriously damage chances of follow-on investments by the group.

The Good

Good angel investors always take a highly professional approach to the process and their portfolio companies. They generally focus in industries that they are familiar with. It is a good idea to avoid angel investors whose portfolio companies do not fit a close pattern. The best angel investors will often forgo the option of claiming a board seat and, instead, insist that an independent board member with professional experience be appointed. Beware of investors who seem to see investment in your company as an opportunity to enhance their reputation by sitting on yet another board. Here are some positive things to look for:

• Success Breeds Success: There are angel investors who have the knack to help their portfolio companies thrive; while others seem to doom them to failure or stagnation. I know of one angel who specializes in little deals and has a well developed ability to keep them that way. Other investors seem to have the opposite skill. Their companies grow and prosper. It is a good idea to do some diligence on the track record of the investor. Go with the successful ones even if the deal terms are less generous.
• The Investment Agreement: There ought to be a detailed investment agreement agreed to before any funds are transferred. This agreement should be very specific when it comes to the roles and responsibilities of each party. The best agreements provide for an earn-in by management based on performance. It also sets the ground rules for further investment. Good angel investors will require this as a matter of course. The worst ones will simply require a term sheet and then write a check. Remember that the absence of planning is the road to failure. Think of the investment agreement as a strategic plan for the relationship.
• Strategic Agreement on Roles and Responsibilities: Good angel investors will insist that the roles and responsibilities for each party be very well understood from the very beginning. These roles will be codified in the investment agreement and specify the actions that each party will be able to take under a range of possible outcomes. Although such an agreement can complicate initial negotiations, it will help greatly when performance does not meet expectations and realignment become necessary.
• Use of Proceeds: I have seen investors write rather large checks without insisting that there be an agreed upon use of proceeds. You can imagine what happened then. Entrepreneurs initially like the freedom to simply take the money and spend it as they see fit. But, more often than not, this leads to waste and spending on things that do not connect directly to the success of the company. One company, upon receiving funds in this way, spent a lot of the money on new laptops and cell phones with expensive service plans. They replaced very serviceable units. Another CEO kept paying his salary, even through results fell far below projections, and failed to pay suppliers. The result was a law suit that is almost certain to shut down the company. It is good business practice for the angel investors to insist on a detailed use of proceeds and for control over the spending of their money.
• Insistence on Performance Metrics: As a CEO you should be insisting on performance metrics for every member of your team. That is just good management. Your investors should take the same approach. It may seem initially easier to deal with angel investors who are very lax about this, but it is far from best practices. I am not just talking about Excel spreadsheet metrics. They have to be much more detailed than that. Good performance metrics detail the responsibilities of each member of the management team and the way their performance will be measured. Everybody from the CEO to the receptionist should have a job description with metrics attached. And the metrics should be sufficiently detailed to drive evaluations based on performance. Performance should be the driver in determining both compensation and earned-in interest in the company. Performance metrics are a sign of a professional and productive organization. Start-ups with that culture have a much higher chance of success.
• Focus on Governance Issues and Oversight: “Who’s minding the store?” If the answer to that question is “nobody but us entrepreneurs”, consider that a red flag. In the short-term, it may feel good to be free from oversight but, in the long-term, you are guaranteed to make more mistakes and waste more opportunities. The board of directors has a very important role to fill in any corporate structure and it is not just making sure that the investors get to a liquidity event as soon as possible. Good governance means overseeing the strategic planning process, dealing with issues of succession, audit and compensation, and providing for the protections and expansion of shareholder value. This fiduciary relationship with the shareholders is an important part of the corporate structure. Without it, management is under no effective supervision and the investment looks more like a roll of the dice than an investment.

Keep This In Mind

An angel investment creates a relationship that will help determine how successful you are going to be. Your skill in crafting that relationship is a test of how dedicated you are to the success of your company and team. If you take the easy way out, your chances of success will drop significantly. If you opt for the limp relationship with an inattentive investor, your prospects will suffer. Angel investors, the good ones, bring much more than money to the table. The good ones have helped their companies succeed and will help you do the same.

© Dr. Earl R. Smith II

~~~~~~~~~~

Dr. Smith is Managing Partner of The Federal Circle. The Federal Circle partners with teams and existing companies. We help them up their game and win big in the Federal space. We also arrange funding for acquisitions and expansion by acquisition. Our model is based on the belief that, if you select the very best and work with them in a highly professional and focused manner, the results will be truly amazing. He is the author of Amazing Pace: Turbo-charged Business Development – a book that shows how Advisory Boards can dramatically increase revenue. Dr. Smith is also the author of Dream Walk: Parables for the Living – a book of Raven Tales and exploration.

Eileen has held senior leadership roles at Yahoo!, Skype, PalmSource, Openwave, Sun Microsystems, Apple and Verizon Wireless. She is currently involved in establishing White Bear Yard in London for technology innovation and startups, Eileen is also an advisor to Ambient Sound Investments.

What made you decide to become a business angel?
After Skype I teamed up to work with the founding engineers again, who had set up a small early stage venture fund, Ambient Sound Investments (www.asi.ee), and through the course of evaluating potential investments for them I realised there were certain projects or teams that I wanted to personally support – even if ASI elected not to.  It’s a habit or tendency I’ve been trying to break ever since…!

What do you look for in a business you decide to invest in?
The most important facets of a business I would invest in are its founding team – and the people behind it, starting it and/or also supporting it.  I think life is too short – and there are too many interesting projects out there – to spend one’s time with people who don’t somehow enhance your working/general life and day to day interactions.

How important has your expertise in technology been in helping you choose the right businesses?
I believe that it’s been helpful, but you never do know what you don’t know, so I may actually not have as much expertise as I’d like to think!  I feel that it helps the most in being able to relate to technology founders and in assessing the challenges and decision points in building and growing an early-stage technology business.  By the same token, I try to only evaluate businesses in which I have some basic level of understanding, so for example I would stay away from robotics or artificial intelligence, genomes or an area in which I had no understanding.

Should anyone who hopes to invest in this area have the right technical knowledge to help them make the right decision?
I believe it helps, but with early-stage investment decisions, one’s gut and intuition is often what makes the final call.  So whatever data points will help to influence that are always helpful.  Perhaps sometimes the people (and existing support around those people/team) are enough.

What do you think will be the next big thing in Internet technology?
If I knew that I’d be strictly focused on that – and not investing in or working on anything else!  That said, I don’t know what I feel will bring the biggest change from a “technology point of view”, but I think a lot of opportunities lie in how the technology will be applied, consumed or impact on existing commercial models and products/services.

Is now a good time to start a business in the UK?
I think it’s always a good time to start a business, but particularly now as there is a talent pool established and some tastes of success to whet entrepreneurs, employees and investors’ appetites.

According to the British Business Angels Association only 5% of business angels in the UK are women, why do you think the numbers are so low?
I couldn’t really say and have wondered the same thing myself, but at the same time I feel it’s important to take this statistic into context with the larger business world.  So for example, as I understand it, only 3% of FTSE 100 companies are run by women.  If that’s the case, perhaps the fact that 5% of business angels are female is a positive sign.  Women’s participation/involvement in business (either as employees/team members, executive leaders, directors, advisors or investors) in general needs to be considered – and once that grows, so will the proportion of business angels I’m sure.

What advice would you give to other women looking to get involved in angel investing?
Please go ahead and get started, and feel free to contact me if you want any encouragement or suggestions on where or how!

http://www.linkedin.com/in/eileenburbidge, Twitter handle @eileentso

White Bear Yard website: http://whitebearyard.com

Various firms have been developing psychometric tests to identify the personality traits of a successful entrepreneur and it turns out, that there is no agreement on whether any of these work.  So what can research tell us?

In fact, funding of research into entrepreneurial issues in the academic world is beginning to dry up – as Durham University have closed their department for entrepreneurial research, partly in response to the failed hope of being able to teach entrepreneurial skills to carefully selected students.

So, if business angels can’t find a common personality trait, what should an investor look for when interviewing cash hungry entrepreneurs?

Well, there appear to be two ideas that can be supported in the accademic research.

Firstly, becoming a highly successful entrepreneur is a process. It takes time and you can make a pretty good judgement – after interviewing – where someone is on their business path. A colleague of mine suggested that a really experienced entrepreneur is someone who has built a business and lost it, built a second and exited with a healthy gain and now is on their third business.

Okay, you can discuss alternative formula – but you get the idea.

Secondly, how the entrepreneur is able to respond to what is going on around him or her is a critical factor that determines if they are likely to succeed. Or perhaps, to put it another way, how do they deal with uncertainty and difficult situations?

This reminds me of the famous story of the criminal who said ‘I had no choice, I became a criminal because my father was a drunk’ and his brother said ‘I had no choice either, I had to succeed’ . The successful brother became CEO of a global business.

So, in summary, you can forget personality and therefore personality testing. Look instead for where the entrepreneur is on the path and then asking searching questions about how they dealt with uncertainty.

So, the good news is that there is evidence of there being a way to systematically identify likely successful entrepreneurs – and also the quality of the team – and your fellow investors – that surround the entrepreneur.

Good luck.

Stefan Glaenzer Entrepreneur turned Business Angel

Stefan is London-based entrepreneur and angel investor from Germany. He is the co-founder of companions.de, companionsTV, ricardo.de and myblog.de.

He is also the founding investor and executive Chairman of Mendeley.com and RjDj.me and has been in the same role at Last.fm.

After deciding to invest ‘a few hundred thousand’ in Last.fm this turned into a £22 million profit following its sale to CBS in 2007.  Stefan is a firm believer in European entrepreneurship and remains an active business angel. Outside of his business interests he holds a PhD in foreign exchange risk management and was a professional DJ for 15 years.

How long have you been a business angel?
My first experience as an angel investor was from 2000-2004. In 2005 I stopped investing to focus the vast majority of my time to helping build Last.fm. When we sold it in 2007, I became a full time angel again.

What attracted you towards becoming an angel investor?
It’s a function of age I’m afraid – pretty much the same reason why a football player evolves into a manager position. I love working on innovative ideas, and being an angel gives you more of an portfolio approach instead of putting all your eggs in one basket.

How has your background as an entrepreneur helped you in becoming a successful angel investor?
Even though I’m acting as an investor, my heart still is on the entrepreneurial side. Having been so long on the other side of the table gives a lot of insight in to what these companies are trying to achieve.

What types of business do you invest in?
As long as it is digital and has the potential to change the world I’m up for it. I love to invest early stage and like marketplaces, databases, music…..and revolutionary ideas

Have you made any mistakes along the way?
Any? Plenty! More than I can think of actually. I have passed on some hugely successful companies, invested in really bad companies, invested too early … just to name a few.

We are led to believe that angel investors invest close to home, so what made you travel all the way from Germany and become a business angel in the UK?
Home is where your heart is – and my heart is in Europe. London (even though it’s not on the continent) is certainly the best place to start a digital business in Europe, given the diversity of people, the access to capital and the international culture.

The business angel community in the UK is small compared to the US how does it compare to the size of the business angel community in Germany?
We are a couple of decades behind the US when it comes to successful venture investing, regardless of whether you are comparing it to the UK, Germany, France or Scandinavia. The main difference with Germany is certainly the decentral structure of doing business compared to other countries. You do have a lot of business angels in Germany, but they are distributed over the whole country.

Warren Buffett on a visit to Kansas University Business School

Have you ever asked yourself what would Warren Buffett do if he were a Business Angel?
 
Well, it might be a bit hard to ask Mr Buffett along to attend our investments seminars, so instead we have attempted to summarise the rules Warren Buffett applies to his investments to see if we can apply that to business angel investing?

Yes, we can. With a few adaptations.

From Buffett’s many rules and ideas our take on his work is that it can be summarised very briefly as follows

• lose no money (nor shareholder value)
• buy franchise business (with pricing power)
• align incentives (between management and shareholders)

 

Lose no Money

means
Buy at fair price (neither too much nor too little). Too much and you’ll never make a return, too little and the sellers (who will probably remain in or retain an interest in the business) will resent your presence and are likely to undermine the financial outcome for everyone. What is a fair price? It has to be based on the likely throw-off of cash (net of capital reinvestment required to maintain the business, its assets and its brand) over the next 20 years. It is difficult to assess early stage business values, but that is no reason not to try and Buffett’s method is as good as any and provides a clear starting place.

There are two tricks when assessing future cashflow returns

1. Firstly, most start-up business plans predict steady growth over years one to three and then exponential profit growth. This just means that future costs are unknown, not that the business is likely to experience 80 or 90% profit margins. Nearly all businesses, especially if they wish to maintain growth, will revert to profit margins at or below 30% of revenue. Many mature businesses will have much lower profit margins but are much more stable and reliable. Therefore, use the industry standard profit margin for future returns and never above 30%.
2. Secondly, most businesses forget that they need to re-invest a given amount of cash into the business simply to maintain its value. A good example is brand advertising, which does not have a direct cash generative benefit, but without it the long term ability of the business to grow revenue will be harmed.

Lose no Money

also means
Don’t speculate - but place your money on sure bets at good prices. However, this is not the environment of the business angel investor – who is in early investment sector. The truth is that the early stage investment market is not a sector that Buffett works in. However, the principle can still be applied – albeit that you accept that you are in a speculative environment. iBusiness Angel has written before on how to reduce the chances of losing your money- and it is important to keep these ideas at the front of your mind before making any investment. So Business Angels need to consider reducing the risk of a loss whilst Buffett can focus on ‘Lose no Money’.

Lose no Money

also means
Invest in businesses that you understand. That means that if your knowledge is based on retail businesses, don’t invest in a tech start up, unless it has specific application to the sector that you know about. Buffett famously didn’t invest in Microsoft nor the tech boom. He made his money by sticking to what he knew well so that he could judge a good opportunity clearly and avoid the bad investment options.

Franchise business means
The business must be able to maintain its price position. Hence, it must be creating and delivering a product or service that is unique and protected by intellectual property rights or geography. Without this protection, whatever the business offers is vulnerable to´’cheap immitators’ or ‘me too’ competitors which might not put the firm out of business but will prevent the business maintaining its margin and therefore damaging shareholder value (see point 1 above).

Aligned incentives means
The incentives of the shareholders must be the same as the investors. This is often the case at the beginning of the start up, but if the management start paying themselves large salaries, then their incentive will no longer be to sell the shares but to hang onto the job. The control of future remuneration by shareholders – independent of the management – is critical for any start-up in its middle years. This control needs to be set up right (ie to ensure that shareholders can keep the incentives balanced or have an option to sellout) and it needs to be set up before the business angel invests.

Early Stage investors who can adapt Buffetts rules and principles and apply them to Business Angel Investing stand a far greater chance of success.

This approach does, of course, require a more systematic approach to investing – some might call it ‘professional’ – but the evidence is that this steady handed and cool headed approach is the most successful. And, for the epitome of a cool headed investor, we need look no further than Warren Buffett.

Ps. We’d strongly recommend you keep a copy of Mr Buffett’s thoughts and essays.

There are many books on Buffett, but there is nothing like going directly to the source yourself. The best of the bunch has to be The Essays of Warren Buffett: Lessons for Investors and Managers.

Crazy Risk Taking Business Angels?

Business Angels come in different shapes and sizes. But are they really like? Crazy? Successful? Generous or in it for the money?

That is a question that not only entrepreneurs ask themselves, but also the Business Angels too.

Why?

Most investments that gain Angel investment will have not one single investors but a small team or committee or even a board. And one Business Angel is going to want to know who they are investing alongside. If the Business Angels don’t have mutual respect among them, then the investment is at risk.

This is why Angel investors will often form a small team and, collectively, invest in a number of projects. 

Sometimes the investor team will include a Venture Capitalist and a passionate / dedicated individual in the role of the Business Angel / board or non-exec director. Sometimes the investors might be a group of Business Angels who may have different expectations

However, the image of Business Angels as someone who gives not just his (or her) money (with conditions) and his time, network and experience (more or less for free)… is often not correct.

There are a number of different types of Business Angel – and I propose these these profiles as personal observation – so do feel free to contribute your own.

Quiet Angels – these Business Angels have never invested before – possibly they were an FD in a highly successful company and saw a big payout on sale – and so tend to be looking for that next entrepreneur that will re-create riches like last time. These are perhaps the most nervous of investors as they are not entrepreneurs themselves and are not used to being on the front line.

Sold Up Entrepreneurs- many entrepreneurs who have sold a business just love being around new ideas and are naturally restless. These are probably your ideal investor but they may get bored quickly and want a quick return. Richard Branson might be an example? Hugely charismatic but a bit of a problem if he decides he doesn’t like the direction of the business. May be looking to sell their stake before the founders would wish.

Professional Directors - some investors are professional non-exec directors and have seen a number of business sales plus been on the purchasing side too. These guys have probably seen a few founders ousted by the board. Their knowledge is invaluable and probably they would bring a calming influence. They probably have the greatest ability to play the long game – think Warren Buffett.

Trader Angels - some entrepreneurs made their money less by building a business than by buying low and selling high. They may add great energy to your sales team and have the best networks in your area but they wouldn’t hesitate to sell and do so on their terms.

Institutional Investors - these guys hail from the VC industry and will expect things to be played by the book. Probably they have the least to offer in terms of business expertise and many smart VCs have learned to team up with expertise in the form of Business Angels as this increases their success rate. You might call them the professional money men.

Some investors will, of course, be a mix of all these profiles or even, make take on different roles at different times. Feel free to contribute your profiles of Business Angels – click Comments at the top of this post.