VC Primer from an Entrepreneur’s POV – What About Angels?

Angel investors go where venture capitalists fear to tread.  That’s an oversimplification but it’ll do for starters.

You’re a wannabe entrepreneur.  You have a great idea.  To go any further with your idea you need some money.  Let’s say you’re gonna need to quit your day job but that you did build a prototype of your great idea on nights and weekends.  You figure you need somewhere between $100,000 and $250,000 to live on, to hire come contractors to do some programming, and to do a little bit of marketing.  These being the days they are, you don’t think that hosting or Internet access bills will be significant until your service really grows and starts to bring in business on its own so you’re not worried about those bills.  You already own all the computers you’ll need for a while and you’re planning to work at home so no office space to worry about.  Your spouse is OK with all of this… sorta.

Trouble is you can’t go to a VC for this small amount of money.  Too expensive for them to do all the things they need to do in order to put so little money to work.  Remember, they are usually managing funds whose total commitments are over $100 million.  It would take too many deals like you to put all that money to work in any reasonable amount of time.  And then there would be too many deals to manage if any significant proportion of them were this small.

One alternative is to make a more extensive plan that needs more money.  If you had a track record of entrepreneurial success, a huge reputation of some other kind, tens of thousands of users a week after you went live, or absolutely excellent contacts with some VCs, that might work even though there are still reasons (to be covered later) that you don’t want to raise a lot of money sooner than you have to.  You’re a wannabe entrepreneur with no track record and your service has no users yet; inflating your need isn’t going to attract VCs.

What you need is an angel, a wealthy individual who’s willing to come up with the cash you need.  The angel, if he or she has any experience in this, will make an investment very much like the investment a VC would make. They buy a part of your company, get a lot of control, get the right to ask all kinds of questions, become board members.

But angels can make smaller investments than VCs both because they are typically not running huge funds and because they don’t require the same kind of information a VC does in order to make an investment.  VCs perform more “diligence”.  This diligence costs them money as well as costing you time.  They can’t afford to do the diligence for a small deal and they might not like the answers anyway since there is no track record either for you or your service.

Are angels stupid or reckless, then?  Are you looking for an idiot with money to throw around?  Absolutely not!  At least you shouldn’t be.  Angels invest because they have some private piece of knowledge which THEY trust to guide their investment decision.

In the simplest case, the angel investor is someone who knows you well – a family member, an ex-boss, a neighbor.  That person’s special knowledge is her faith in you.  This is both the best and worst kind of investor to have.  Best because this angel is investing in YOU and doesn’t even necessarily have to understand your idea.  Worst because you will feel terrible if you lose this person’s money – it will mean, to you at least, that her faith in you was not justified. Worst because the socialization you used to enjoy with her will be haunted by whatever is happening or whatever is scary in the business.  You can’t, for example, complain that you feel overworked to the angel whose money is riding on you. If she asks about your health, you’ll wonder whether she’s really asking about the health of her investment.

Nevertheless, more angel investing is done by friends and relatives than anyone else.  You really do have to consider friends and relatives as source of angel funds if you’re a wannabe entrepreneur.  Two pieces of advice from experience: DON’T take money form anyone who can’t afford to lose it.  That IS the likely outcome. Also don’t put together a consortium of small angels.  You don’t want to lose all your friends at once and you won’t make good business decisions when you are worried about explaining failure to all of them.

Another type of angel has special knowledge about a particular field.  In Princeton, NJ, home base to many drug (I mean pharmaceutical, of course) companies, there are angel investors who rely in their own understanding of pharmacology and medicine and the businesses which surround them.  If you can find an angel who has special knowledge of your field and he likes you and your idea, you may have found the ideal angel investor.  This type of angel is also likely to have good advice for you and may well have contacts who can help you in your business.

Some VCs are angel investors on the side.  They trust their own judgment enough to make an investment of their OWN money in an opportunity which is too risky or too undeveloped for their clients’ money.  You might say their specialized knowledge is the investment process.  They already know a lot about how to structure an investment; they can just cross off a zero or two on the documents they use for VC investments, get rid of some over-elaborate provisions, and turn them into contacts for an angel investment. These are good angels to find as well.

Rich individuals, especially ex-entrepreneurs, make angel investments. They THINK they have special knowledge because they succeeded.  Some do; some were just lucky.   They also have connections which give them some good deals to pick from.  According to John Battelle in The Search, Google co-founders Larry Page and Sergey Brin got their first $100,000 investment from Andy Bechtolsheim, a founder of Sun, to whom they were introduced by Stanford faculty advisor David Cheriton.  Bechtolsheim wrote the check at their first meeting!

Sometimes a vendor or supplier can be an angel investor.  Their unique knowledge is where you fit into the supply chain of your industry and how good you are. VoIP software company VocalTec was an angel investor in my wholesale Internet telephony service provider startup ITXC because their CEO, Elon Ganor, knew there had to be middlemen in order for there to be a VoIP industry into which he could sell equipment.

OK, you say, been through the friends and relatives and there’s no money there.  How do I meet an industry expert, a VC investing on the side, or an ex-entrepreneur burning to invest?  That’s the rub.  You shoulda been networking all along and maybe you’d know them.  Note that Page and Brin were networking just being in the graduate program at Stanford.

There are associations of angel investors; you can Google and find them.  One is New York Angels who were very helpful with some information I was looking for.  Other than that, I have no personal experience angel associations.  Glad to have comments from those who have worked through these groups.

If you’re looking for angel money, use all your contacts; you may be surprised how many angels there are just one degree of separation away from you.