Angel Investing is Vibrant and Getting More So

Not much surprises me these days, particularly during this mud-slinging political campaign season.

However, Marcelo Calbucci’s Tech Flash post (http://www.techflash.com/seattle/2010/10/have_we_killed_the_angel_investor.html) did. How my posts could be so misunderstood by someone I respect baffles me, especially when that misunderstanding is posted to a widely read blog.

My previous post on Angels forming LLCs for their investments IS entrepreneur friendly, and based on national best practices. Any entrepreneur who has a successful venture with 50 angel investors knows the pain (including excessive legal fees) for getting signatures on every shareholder issue. If a large number of these angel investors are in an LLC, you only need one signature – much more efficient and much less costly. This is the practice in many places, including some of the largest angel groups in the Bay Area and East Coast. It is not widely done in Seattle. And it is not a way to get better terms in seed and A round investments; there really is no relationship between the two.

It is a way for Angels to preserve their rights in the face of a VC round that follows. VC’s typically don’t like to have to get 50 signatures, so they reserve certain rights to “major investors” in their term sheets. This typically either washes away or severely limits the investor rights of Angels, once VCs have entered the deal. It is definitely in the interest of the entrepreneurs, Angels, and the company to make sure that a broader base of investors has a say in the future of the company; the trust from shareholders (the owners of the company) that they will be treated in an open and democratic way is the basis of our entire equity system.

Angels who work together to learn best practices make for a much stronger ecosystem. That is why I spend so much of my personal time trying to learn from other angel groups, both locally and nationally, about what works and doesn’t work. My colleague Angels do likewise. We run a bunch of educational events locally to share our knowledge and insights and encourage other Angels to strike deals that are balanced between return and being entrepreneur friendly. It is why I spent so much time crafting a “Series A Angel Term Sheet,” (http://drosenassoc.com/Draft%20Term%20Sheet%20for%20Alliance%20of%20Angels.pdf) that is now being widely used, not just in Seattle, but around the world. It simplifies the process of bringing in early money for startups, while lowering the costs. All of these activities lower the barrier for entrepreneurs raising money, not as you assert, making it more difficult.

Angel groups are a fabulous way for an entrepreneur to raise money. It is much more efficient to present once to 60 active angels than to set up 60 individual meetings. I don’t know one entrepreneur who would argue with that proposition. And, through the Angel Capital Association (a Kauffman Foundation spinout), we are now sharing best practices, participating in educational events, making sure that public policy encourages early-stage investment (e.g. http://blog.drosenassoc.com/?p=41), making sure that as many Angels as possible enter the ecosystem, and encouraging each other in bleak economic times.

As part of this socialization, it is evident that Seattle IS progressive. We have funded as many or more early stage deals at a slightly higher price than our peers in the Bay Area and Boston. Your assertion that entrepreneurs in the Bay Area are getting their deals funded without a financial projection or a solid plan is an urban myth that is not supported by fact; it encourages behavior that neither helps entrepreneurs or investors. We do help the “the next great idea from two guys who are just finishing their computer science degree at The University of Washington” in part by helping them understand what it means to create a great business. In my 25 years of experience, I have not seen a success where throwing money at people without a great business concept created a great business. It is the marriage of great technology, great people, and a great plan that makes the breakout companies. Yes, this takes some discipline and hard work. Saying that the best model is angels willing to throw money at entrepreneurs who are not committed to a disciplined approach is not only wrong, it does a great disservice to the entrepreneurs willing to quit a high-paying job to risk everything to build a great company.

And during the last year, I’ve spoken at events throughout North America without reimbursement. Like you, Marcello, for me this is a passion, not a business. But most Angels need a return on their investment, if they are going to continue to invest. We need more maturity in the process, not less.

We all want to see more intelligent, high-net-worth individuals in Seattle become Angel investors. They way to do this is NOT by telling them that they should “invest and pray”. It is by showing them how to be successful angel investors, how to lead deals without as much pain as in the current process, and by making it easy to pull the trigger on their first few investments. One way that other communities (e.g. Bellingham) have used is the deal-specific LLC that started this conversation.

Success will come by finding more ways for entrepreneurs and Angels to communicate and understand common goals and then achieve extraordinary results. And success will build more success.

Investor Relations for Private Companies

One of the questions I am asked by first-time startup CEOs: what is an appropriate level of communication with my investors?

This is both a difficult and profound question. It is simple to say that more is better than less. It is also simple to say that any good investor would rather have you spend your time executing your plan than spend your time chatting with investors.

So.. my simple rule of thumb is that you should treat your investors (and the money that they have invested in your company) with respect. And you should recognize that their support, encouragement, and trust that came with that money are incredibly valuable commodities that will continue to pay dividends over time. Let me give rules of thumb for great investor relations by private companies and some issues that need to be considered.

Ten Simple rules for great IR for private companies:

  1. Get the bad news out fast and first. Even if the news in embarrassing (like we are running out of cash sooner than we anticipated, or our customers found a flaw in our product), share it first and fast. Be very candid about the failings as well as the successes.
  2. Don’t bury bad news at the end of a report.
  3. Don’t wait to issue the report until you have good news to share.
  4. Don’t forget to share your passion for your business – that’s generally what made your investors invest!
  5. But don’t allow your passion to obscure the operational facts, like the numbers are not what we anticipated.
  6. Communicate frequently, but not too frequently. These communications should never be less than once a quarter. But remember that your investors are not your employees, so you don’t need to send daily/weekly updates with operational trivia. This just defeats the purpose of making sure that your investors know the state of the business by burying them in the minutia.
  7. Communications can written or in person or a combination. Face-to-face quarterly meetings are a great idea for a company that is growing and needs support and help from its investors. They are especially good for a company that needs to show its product. But they take some time to prepare.
  8. Communications can be short, but never skipped. For example, a simple note to all of your investors that “we have had to revamp our product plans and details will follow within 30 days” is an OK message. As is, “we have received an acquisition offer, but the terms require us to keep the details confidential, so we will let you know as soon as the deal is consummated.” Don’t surprise them!
  9. Your investors are smart, so treat them accordingly. Be very realistic and forthright about the impact of any misses/changes. Early stage investors know the risks. Tell them if the board insisted you take a salary cut or that you have had to lay off key people. These things happen. Sometimes the impact will be that their investment will never realize the potential you had hoped for, but that you will work for the best possible outcome.
  10. And, lastly, NEVER have the communication of the change of your company status come via a package of documents from your lawyers! Even in the case of good news (which is rare), you owe it to your investors to be the one who communicates FIRST. Even if it’s an email (or cover letter in the legal package) that says, “we have had to do X, because of Y, and the result is that your shares have to be changed in the following way. You will be receiving a package by FedEx to implement that change. I will be holding an emergency investor meeting tomorrow at 9am to explain these changes. Those who can’t be there can phone in.”

Even with these simple rules in hand, there are a number of issues that you need to consider.

  • Can I share proprietary information with my investors? This is a tough question. Seek counsel from your lawyer. In general, most startups do share proprietary information, but make sure your investors know it is proprietary. Make sure that they know they can’t redistribute or share it further. Only give info in writing that is less sensitive.
  • Know your investors. Ask them if they have investments in competitive companies. If they do, it doesn’t disqualify them from investing in your company, but make sure that they know they can’t share the info you give them.

Simply put.. if you treat your investors well, they will be there to support you when you need them. Not just in this company but in future ones.