Angel Investing in the Current Economic Environment

I recently was interviewed about the impact of the current economic environment on Angel Investing.  Since these are questions I’m asked frequently, here is the post. Reporter:  Are angels less willing to part with their money now? e.g. Angel investment was down 26% in 2008…what do you see so far in 2009? Dan:  There are two different categories of angels.  One is “fair weather” angels, who think it’s really cool to do some angel investing, but are more driven by environment.  The second are more “professional angels,” who understand that: (a) angel investing requires a long-term attitude – results don’t come quickly; (b) a portfolio approach is essential and one or a few investments is not a successful strategy; (c) the first investment in any company is rarely the last – you need to reserve for follow on rounds; and (d) “doubling down” on a good company leads to better returns, as does shedding a non-productive investment.  “Professional angels” continue to invest in down markets, knowing that the best returns are often made during these periods.Reporter:  Overall trends you’re seeing: e.g. investing more in existing deals? Giving more runway to portfolio companies? more disciplined approach to investing/how so? Dan:  I believe in a disciplined approach.  Create a portfolio and support your companies.  That discipline applies even more when markets are buoyant – maintaining post-money price at a level that won’t lead to later down rounds.  When exits are few and far between, the discipline is equally important – an investor needs to be balanced and not try to foist an unfair deal on an entrepreneur.  The entrepreneur also must be cognizant of market conditions and make sure that the are disciplined in the amount of money they are trying to raise, the value they give for that money, and the use of that money – efficiency is the key.Reporter: What will get an investors’ attention–now? e.g. have the type of companies you’re interested in shifted in anyway/how so? (green technology? distressed properties?) Dan:  Great entrepreneurs, building great businesses, with solid plans.  This is a constant.Reporter:  Benefits of launching in a down market e.g. for entrepreneurs: cost of starting a company is lower? more talent is available? e.g. for angels: reduced valuations/get more company for less? Dan:  In this down market, more talent is available at competitive prices.  This is good for startups.  For Angels, deal terms and valuation are also competitive, but as I said earlier, this should be reasonably constant.  The biggest difference is that VCs can no longer be counted on to finance startups that have made it through the seed stage successfully.  This implies that Angels will need to carry deals further – often to profitability, so deals.  This does raise the financing risk of many deals and also requires that Angels need larger syndicates and more reserves.Reporter:  How many deals do you/your firm evaluate in a year? month? is the number increasing/decreasing? Dan:  I look at about 15 deals a month.  This number has been pretty constant.Reporter:  How do the deals look right now? lots to choose from? less? (trying to gage to what degree the market is saturated or open)Dan:  This is a great time to be an angel investor.  It would be better if there were more positive exits.Reporter:  Getting to “yes”.  What does it really take for you/your firm to say “yes” to a deal today? How has that changed over the last 18 months? Dan:  Since financing risk has increased, capital efficiency (which was always important to me) has become even more critical.Reporter:  First impressions: how long does it take you to get to yes or no? why? what are you looking for…. Dan:  I will usually know in 10 minutes if I am going to do due diligence on a company and spend the next 90 minutes looking at it.  (This is the primary reason that the AoA does 10 minute pitches).    Then, based on the impressions of the company’s leadership, answers to questions, and their market/business model, I’ll typically do another day or two of due diligence to reach a decision, but those days might be spread over a month.  I am often influenced by who else is looking at the deal and will rely on their due diligence and experience.Reporter:  What are the top 3-5 reasons you say no to a deal? explain with examples e.g. what it is about a business model that you know won’t work…. Dan:  The main reasons for passing on a deal are: not capital efficient, insufficient confidence in the management team, no chemistry with the CEO, any hint of deception, too small a market, a management team that believes its own marketing more than the reality of the market (which will lead to many problems and surprises going forward).The main problem I see with business models is the inability to scale from the initial customer set to critical mass.  (Usually I hear words like “viral marketing” or other external ways to build market.  These rarely work.) Reporter:  Top 3-5 reasons you say yes to a deal? Examples?  Dan:  If I really like and admire the Founder or CEO, that gets me a long way to yes.  Then I need to see a large market potential, good plan to attack that market, and a good dose of realism.  And lastly, I like to understand how the company might achieve an exit.  Sometimes a company will meet the first criteria, but I can only see one path to exit – something I find risky.Reporter:  Explain your “feel for a deal”–what it is in your gut that tells you, this will work…. Dan:  The passion of the management team starts the process.  It helps if I understand the market.  And, of course, the ability to take what is a good idea and turn it into a good business.  Often I see great features, that might become a great product over time.  But rarely does a good feature/product make a great business.  That requires product lines that can hit multiple segments.Also, you often see entrepreneurs think about how to build their company to sell it to someone.  It is really important to build a great business and not focus too much about who will buy you.  That doesn’t mean you don’t think about potential exits – just that focusing solely on that rarely pans out.Reporter:  Advice: 5-7 tips to offer an entrepreneur presenting to you today….Dan:  I can’t manage 7 things at once.  But the #1 tip for an entrepreneur is: “tell them what you do.”  Too often an entrepreneur will want to educate me on how smart they are, or why what they do is so difficult.  Without the context of what you do, the rest might be interesting, but has limited relevance.  And remember that you are talking to investors, so your discussion has to be tailored to that audience.  And lastly, listen to questions – be willing to have a discussion and not present your slides.