Two years ago, when I was raising capital for my new software company, Abuzz, I invited two potential investors to a presentation I was giving. They invited two other investors, one of whom, after asking questions about Abuzz's market focus, started to criticize our strategy. Rather than question what he, an uninvited guest was doing asking questions in the first place, I let his negativism take over, and it turned the whole meeting sour.
My unfortunate experience suggests two lessons about securing money from "angels," private individuals most likely to fund companies in the very early stages. The first is that angels are idiosyncratic. Rather than dealing with institutions (as you'll do when your company gets big enough for you to go to venture capitalists), you're dealing with individuals--and their whims. The second lesson is that you, the entrepreneur, can and must manage and master those whims. But you need to prepare.
More and more very young enterprises are turning to angels for initial rounds of financing. Based on my experience raising capital for two companies--yes, I finally did raise $335,000 for Abuzz--I've developed a checklist of dos and don'ts. I've divided the list into two parts: what you must do prior to making human (or should I say angelic?) contact and how you should handle the angels once you do get in touch.
Prior to Making Contact...
- Write a Presentation and a Business Plan
I suggest starting with a presentation that contains 10 to 15 slides and runs for no more than 20 minutes. In the course of your presentation, you should outline your product, your market, your management team, and the reason you think your product will sell. You should make the presentation before a few people you trust, get feedback, revise it, and give it again, this time taping it. When you view your taped version, make sure you are making a compelling case for your company.
Only after you are satisfied that your presentation does make your case, are you ready to write your business plan. Crafting such a plan is a fairly standard exercise. You can find tips in books, Web sites, and software programs. I recommend making an outline, using simple prose, and keeping your document to a maximum of 20 pages. Don't submit an 80-page plan!
- Identify Potential Investors.
Having developed a presentation and a plan, it's time to identify potential investors. One rule of thumb: Approach only those individuals who are less than two degrees of separation from you. Get references from people you know, but should those new acquaintances refer you to their contacts, you're on thin ice. Referrals from referrals rarely invest.
Another tip: Stay local. You won't need to go beyond your geographic area to find pockets of people eager to invest. It is, however, a good idea to approach people you don't know (and who may not be in your locale) if you believe they have a unique understanding of your product.
- Create a Term Sheet and Specify a Valuation
You're now ready to create a term sheet, a one-page outline of the investment opportunity your company affords. It should include a "valuation," your best estimate of what the company is worth. Determining valuation is tricky. I suggest that you not try to gouge your investors. Aim for a fair deal. If you think your company is worth, say, $3 million, and your investors offer $1 million to $2 million, go with the $2 million. From the beginning, you want investors always to feel as if they're making money. Even though they'll own more of your company with the lower valuation, during later financing rounds, your company's stock will be more likely to increase.
Even though some angels are sophisticated investors, it's a good idea to warn them about the risks involved. (Each state has its particular disclosure requirements. You should check with your attorney or CPA to make sure that you are in compliance.) At the very least, you'll save face, and in the unfortunate event that your venture fails, you'll still be able to have lunch with your angels.
Finally, structure the investment as common stock, rather than preferred stock. While savvy investors often push for preferred stock, I'd recommend that the first money into a business--the "seed" capital--be in the form of common stock, because it puts the investor on equal footing with the entrepreneur. If the company's valuation is fair, getting common stock shouldn't be too difficult.
If your investor insists on preferred stock, which comes with privileges that aren't available with common stock, make sure that you have a fair liquidation preference." Such a clause addresses the way the money is allocated in case of an acquisition or bankruptcy. Don't allow angels "double dipping" that provides for their getting back their original investment as well as their pro-rata percentage. It's best if they get only their pro-rata percentage of the company's sale or liquidation value.
- Contact Prospects and Arrange Meetings
Armed with a list of potential investors and your term sheet, you're ready to begin dialing the telephone and filling your date book. If an investor asks for a business plan, explain that although you'd rather meet before handing over a formal plan, you're willing to forward a two-page executive summary of the plan. Angels invest in people, not plans. You want an investor's first impression of your business to be you, not a piece of paper. Next, prepare for the meeting! Do your homework, fine tune your pitch, and even during introductory sessions, make sure you ask for an investment.
- Create Excitement Around the Investment
After a handful of angels have expressed any degree of interest, you, the entrepreneur, should move interest into action and investment. Set a realistic deadline for the investment, and then, tell investors that the supply of available equity is fast dwindling.
- Keep Investors Informed
Once investors have put money into your company, your relationship isn't over; it's just beginning. To state the obvious, angels have a vested interest in seeing your business succeed. Make a point of involving them in your success. Send them quarterly updates. Tell them about the company's achievements: new hires, new contracts, new partnerships, stories in the press. Be scrupulous about sharing bad news, and express your willingness to talk with your investors individually about their concerns.
. . . . .
Investors can be a great source of contacts. They have access to sales leads, job candidates, potential partners, and other investors. Let them know what you need and how they can help you. Considering that I allowed an uninvited investor to steal my thunder at the presentation for Abuzz, you might conclude that I could have done a better job of following my own advice. I could have been more aware of the idiosyncratic nature of angel investors, who are, after all, only human. I also could have been better prepared.
And all entrepreneurs should prepare. If you follow my guidelines, you'll be doing your part to make the process manageable, productive--and profitable.