What does an angel investor want?

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Thursday, March 01, 2007

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The list starts with drive, discipline

Angel investors in the United States provide about 90% of all seed and early-stage private equity capital for startup entrepreneurs. In effect, they are backing the jockey rather than the horse, so they need to be confident an entrepreneur/CEO can successfully bring a product to market and sell it.

The importance of investors thoroughly investigating the entrepreneur and key early hires was a recurring theme at a recent seminar on angel investing in Portland presented by the Ewing Marion Kauffman Foundation, the Oregon Entrepreneurs Network and the Women’s Investment Network.

Sue Preston, an entrepreneur-in-residence at the foundation, says that ideally investors are looking for entrepreneurs who are “kind of schizophrenic — they need to be passionate, outrageously enthusiastic about their venture but also, and this is crucial, coachable.”

What an investor wants, she says, is a driven and decisive leader who is more interested in the success of the company than in being in control. Someone willing to share equity and even hand over the reins to others, if necessary. She acknowledges this can sometimes take tough negotiation.

Entrepreneurs are always optimistic when estimating revenues, but Preston says they should be able to articulate a clear and structured path to profitability, have a realistic assessment of their potential market and a deep understanding of their competition. “It’s a big red flag for investors when someone says they have no competition,” says Preston.

Once the investor feels she can work with the management team and the business plan looks good, it’s then time for due diligence — what Preston calls “the meat of investing.” That’s when the investor needs to go over key issues — the market, the business plan, the money, the numbers, and of course, the management — with a fine-tooth comb.

Angel and entrepreneur Kathy Long Holland of LongSherpa Design in Lake Oswego points out some risks of ending up with the wrong CEO. “There’s both market risk and organizational risk. Often the CEO brings in key members from his/her network to be on the team and, worst-case scenario, investors may find themselves having to do a complete team change-out. The company will be in a start-over phase when it should be playing full court press.”

With the rise of angel investment groups, procedures for assessing the management team have become more standardized; gut sense is no longer the only guide. Due diligence checklists now often call for resume review, reference checks and third-party background checks.

In general, says Preston, the entrepreneur should be forthright, and investors should be able to talk to customers and be welcomed at site visits. Also, “The entrepreneur should have some skin in the game. You want them to be as committed as you are,” says Portland angel Spencer Brown. Some investors say they will invest only if this is the case.

Another investor, Sydney Joyner, of the Joyner Group of Portland, says that integrity, toughness and the ability to listen are all important. Are they comfortable with risk? Do they have high endurance? Also, pay attention to how the founding team treats money. “How creative and frugal are they? Are they cavalier about investment money?”

Long Holland likes to be involved in putting the team together from the start and recommends close questioning on a company’s sales process. For example, she has salespeople take a personality profile test to see if they really can sell.

Long Holland says investors should at this stage be thinking, “What’s the end game here?” She adds, “It’s a good idea to design an exit strategy from the beginning.” These days, that exit is far more likely to be by merger or acquisition than by IPO. But whatever the route, it’s essential the management team be open to it.

Serial entrepreneur Mark Owen of Phoseon in Hillsboro cautions that some entrepreneurs will turn down money rather than submit to overzealous and time-consuming due-diligence investigations that they think will hinder them from running their businesses.

But, he adds, angel investors are also in a unique position to add value to a startup by contributing industry knowledge and a network of contacts. He says one of his angels took him to a trade show and “gave me personal introductions to every vendor on the floor.” 

Successful entrepreneurs, says Owen, always will look for the smart money — rather than just money.

— Rebecca Koffman


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