The term "angel" investor originated not in the well-known epicenters of business
startups, but on Broadway. To the actors, playwrights, producers, and choreographers
in New York City, wealthy patrons who funded new musical and theatrical productions
were angels who helped the artists' dreams about getting to the big stage come true.
Thereafter, wealthy individuals investing in emerging companies became known in
finance circles as angel investors.
The problem with this term is the tendency for
many first-time entrepreneurs to assume that angels are warm-hearted rescuers of
their cash-poor enterprises.
The truth is that angels, especially members of angel
investment clubs, are demanding.
They set high standards and expect entrepreneurs
to be sophisticated about the fund-raising process.
Here's what entrepreneurs need
to do and know before approaching angel investors for funding.
1. Select the right business
structure.
Most angel investors prefer to invest in businesses that are organized
as standard "C" corporations. The primary benefits to investors of C corporations
are that they operate with board of directors’ oversight, can issue different classes
of stock, and have no limitation on the number of stockholders. In contrast, businesses
that are organized as "S" corporations can’t have more than 75 shareholders or any
international investors. Similarly, businesses organized as limited liability companies
and partnerships are usually asked to restructure to C corps before receiving funds
from investors.
2. Understand the different classes of stock.
Most founders of new
C corporations receive shares of common stock. Investors, however, usually insist
on receiving a separate class of stock, called "preferred stock."
All the terms
of a company’s preferred stock are negotiable and different investment rounds are
likely to give stockholders different advantages over common stockholders.
For example,
when a company is acquired, all preferred stockholders receive a payback of their
original investment plus a cash premium before common stockholders receive compensation.
3. Solicit accredited investors.
Accredited investors, also known as "qualified
investors," are defined by Regulation D of the 1933 Securities Exchange Act as individuals
who have a net worth of $1 million or more, or income of at least $200,000 in the
two years prior to investment.
Entrepreneurs who raise money through accredited
investors generally don’t have to put together a costly legal document called a
"private placement memorandum."
A private placement memorandum ("PPM," or "offering
memorandum") provides prospective investors with detailed information about the
terms of the securities to be sold in the investment round. This comprehensive legal
document also covers a broad range of investment risks, a description of the company,
expected use of investment funds, and other information federal and state securities
agencies require.
Most first-time entrepreneurs assume that a traditional business
plan is a satisfactory substitute for a PPM. Not so. Retain an experienced securities
lawyer to help you prepare a credible PPM document. While it may seem more difficult
to attract wealthy investors to your company, soliciting non-accredited investors
will ultimately be more time-consuming and expensive.
4. Hire an experienced corporate
lawyer.
Given the complexity of state and federal securities laws, it is unwise
to try to raise money without legal guidance. Interview at least three attorney
candidates and ask how many angel fundraisings he or she negotiated during the last
year.
Your money should buy experience. Simply stated, if you don't have a great
lawyer at your side, you won't get a great deal from investors.
5. Demonstrate restraint.
Effective fund-raising requires showmanship, professionalism, tireless energy, and
an optimistic attitude. However, because of securities laws, entrepreneurs have
to be careful about how they publicize their deal to potential investors.
In general,
promoting the sale of securities through public Web postings, spam, and print advertising
is not allowed. Entrepreneurs also have to be careful not to offer any guarantees
of a successful outcome to potential investors.
6. Address investor issues.
Nothing
makes us wince more than listening to entrepreneurs waste precious presentation
time talking about issues that just don’t rank very high with angel investors.
Yes,
it's fun to talk about cool features of new Web sites and gadgets — but not at the
expense of addressing the marketing, partnership, and pricing strategies that will
make a business successful against competitors. Angels also want to know how entrepreneurs
will spend their money, and when a business will reach cash flow break-even and
profitability. Entrepreneurs who are vague about these issues will lose out to other
entrepreneurs who know their numbers, their industry, and their game plan.
7. Keep
your cool.
Potential investors are entitled to ask detailed questions about a business,
its managers, and its competitors. Entrepreneurs who express frustration with questions
or try to rush investor decisions won’t like the fast answer they will get from
investors. Basically, smart angels are intuitive and watchful.
They assume that
impatient entrepreneurs will eventually turn off potential customers and damage
a company's long-term prospects.
8. Make it convenient for investors.
Entrepreneurs who think their work schedule is more important than a potential investor's
schedule are likely to have an empty bank account for a long time. Because most
angel investors lead active business and personal lives, they review business plans
during their spare time. As such, entrepreneurs should not expect immediate return
phone calls. Keep e-mail messages brief, and schedule meetings wherever and whenever
they are most convenient for the prospective investor. Raising money from investors
is an impressive accomplishment. Not only can the effort provide working capital
for a growing business, it elevates the founding entrepreneur's knowledge of securities
laws, accounting, contract negotiation, and so much more. In fact, with the right
attitude and information, the fundraising process can be interesting — even fun.