Steve Mock, the founder and CEO of GiftVenture, was recently interviewed on Frank Peters's podcast. Giftventure is a new offering to make giving a gift to a child much more interesting. Steve applied to Vegas Valley Angels in Las Vegas through Angelsoft - since GiftVenture is located in Nevada. Frank Peters of Tech Coast Angels went to Las Vegas, saw this deal and brought it back to TCA in Los Angeles. The TCA members loved this deal so much, one said, "I want the best deals, I don't care where they are from."
This is a deal that would have otherwise been overlooked by TCA because the company is not located in Southern California - yet it turned out to be a perfect deal for their membership.
Angelsoft makes co-investing with other early-stage investment groups easy, wherever they may be located. VC's, Angel Groups, and other groups across the globe are all using the power of this shared back end system to accelerate and find the best deals — period — and make sure that those deals are getting funded.
Frank Peters put it best: "I gained an insight into just what collaborating on deals via Angelsoft could mean to the future of angel investing." The thinking now is as long as a trusted, local group has some skin in the game, groups from outside the region are more and more willing to participate. For the most part, an outside group will need a local group to run due diligence anyway. At Angelsoft, we are delighted that more groups are using our platform to connect and invest across a much wider region than ever before.
"As has been discussed for several years, Birmingham is in dire need of additional startup capital for our many worthy high growth and high tech businesses and BAN will be a great resource for many of those companies."
Watkins is Managing Member of the Watkins Law Firm, one of the few firms in the area that works with early stage companies on all manners of financial transactions, and adds he is looking forward to "seeing the group grow and become a powerful driving force in the Birmingham and Alabama economy."
One of Angelsoft’s angel networks in Europe, the BiD Network, has launched an new opportunity for angels across the globe. Taking a cue from the success of micro-finance and the problem with finding any type of early stage funding for SMEs in emerging markets, the Business in Development Network has created a way for angels to start investing in newly emerging markets. Investments with comparably high risks, but often in untapped markets with unlimited opportunities.
In our rapidly globalizing world, it is vital to keep up with the latest investment opportunities. Read on for a short interview with a business angel without borders.
Why are you committed to the BiD Network and her entrepreneurs? "I think I can meaningfully support SMEs in emerging markets, by sharing my expertise and by providing access to finance to promising entrepreneurs. I consider this an important personal objective. The BiD Network offers a professional platform to get in touch with the entrepreneurs I am looking for."
In which BiD Network entrepreneurs did you invest? 'In 2006 I invested in Stewart Craine and his business called Barefoot Power (click here). Last year I decided to continue with another two entrepreneurs: Peter Meijer and Victor Mfinanga.
Peter is starting up a workshop in Malawi. He is going to manufacture bicycle carts as a mean for transportation, as mobile shop or even as an ambulance. Peter knows Malawi very well, saw a clear opportunity and is highly dedicated to make this business a success. I will provide Peter a loan of about 23,000 US dollar.
One of my friends went on business travel to Tanzania. He did me a favor to also visit Victor Mfinanga whom I already met at a BiD Network event in the Netherlands. My friend reported positively on Victor, proving my gut feeling to be right. I am currently negotiating with Victor on a 20,000 US dollar equity investment in his milk business. I believe that Victor is the right man to make it happen.'
What do you expect from the investments? 'I do not have calculated expectations. But obviously the repayments and financial returns will influence my possibilities to make new investments as well as the confidence I have in the entrepreneurs I invested in.’
To learn more about the entrepreneurs and matchmaking services of BiD Network, please visit www.bidnetwork.org/matchmaking or send an e-mail to matchmaking@bidnetwork.org. To learn about more examples of business opportunities, please click here. If you would like BiD Network to tell you when relevant deals come in, please indicate your investment preferences in the “Expression of Interest”. Access to deals relevant to you will be provided via Angelsoft.
The BiD Network is a member of the European Business Angel Network and is headquartered in the Netherlands.
The question of whether angel investments in early stage companies should be in the form of a loan that converts (usually at a discount) into the equity, and at the valuation, of the following (usually VC) investment round, or instead in the form of Convertible Preferred stock (typical of a venture capital investment round) is one which generates a lot of heat in entrepreneurial circles. It also frequently leads to disagreements and hard feelings between entrepreneurs seeking funding and the angels who may be in the best position to fund them. But in reality, the answer is very simple:
"Smart Money" does NOT invest in convertible debt. Period.
This is not a negotiation, or a matter of what is right, or a matter of choice, or anything else. It is simply a definitive, rational, factual statement.
But it does have one corollary, and one exception.
The multiple reasons that smart money (which includes venture capitalists, modern organized angel investment groups, and the leading independent angel investors) simply won't (and shouldn't) do convertible notes are amply and clearly spelled out by Bill Payne, formerly Entrepreneur in Residence at the Kauffman Foundation and generally regarded as the world's leading trainer of angel investors. The primary reason, of course, is economic: the angel is investing at an earlier, riskier stage and therefore should expect a higher return than the VC, who is coming in when some of the risk has been removed, and after the entrepreneur has made the company more valuable using the angel's money. For the angel to wait until the next round to value the company results in exactly the opposite: he or she takes the early stage risk and ends up with later stage valuation: a lose/lose proposition!
Another perspective on why convertible debt sucks comes from Furqan Nazeeri, a serial entrepreneur with EIR experience who is an extremely perceptive observer of the startup financing scene. He points out that from the side of the entrepreneur, doing a convertible debt round correctly is complicated, creates a perverse incentive for the angel investor to work against the company, and ultimately doesn't make a big difference for the entrepreneur.
The practice of convertible debt had its heyday about a decade ago, when inexperienced angels found themselves getting hammered by VCs in follow-on rounds, and decided that it would be better to join them instead. Since then, serial angels have gotten a lot smarter, best practices in angel investing have been standardized, and a funny thing happened to all the serial angels who started out doing convertible notes: they found themselves losing money because of the poor risk/reward relationship, and therefore either (a) stopped angel investing, or (b) got smart and stopped doing convertible notes.
But wait, you say. I mentioned earlier that there was a corollary and an exception. OK, here they are:
Corollary: "Not-Smart Money" SHOULD invest in convertible debt.
Huh? Why? Because the primary trick to raising early stage money in a 'priced' round of Convertible Preferred stock is to price it to value it correctly! And this is the essential difference between 'smart' and 'not-smart' money.
Perhaps the single biggest problem we see with companies applying for funding to New York Angels is that they have done an earlier Friends & Family round that valued the company at a significantly higher valuation than we (the so called "smart money") believe it is worth. In this situation, there are only three possible outcomes, none of which are good: (1) the entrepreneur won't do a 'down round', so we simply walk away and don't fund; (2) the entrepreneur does a down round, and poor Aunt Edna, who invested $50,000 of her retirement money, sees her investment lose half it's value; or (3) the entrepreneur falls on his/her sword and protects Aunt Edna by taking the full valuation hit personally. Ugh.
In cases like this, the BEST thing the entrepreneur can do is take the unsophisticated money in a convertible note, because that way it will end up getting priced correctly when the smart money comes in. But one thing to beware: the next round investors, whether professional angels or venture capitalists, will be the ones to ultimately decide what discount the convertible note will get...regardless of whatever was written into the original note. In practice, few sophisticated investors will have a problem with a 10% discount, which will usually stand. And if there has been a fair amount of time between the note and the venture round (say, six months to a year, or more) a 20% discount has a decent chance of holding. But don't bet the farm on the new investors accepting anything much more than that. If the note has, say, a 50% discount, it will almost certainly be eliminated, or, in a best case, factored into the lower pre-money valuation the VC offers.
Exception: Smart Money should consider a convertible note as a bridge to a legitimate term sheet, and should always have a backup price.
Bill Payne walks through these economics in detail, but in a nutshell, if a VC has already signed (or is thisclose to signing) a term sheet, it will be at a fixed valuation, so the angel bridge will be at a known discount to a known 'correct' price. In this case (a) the 10-20% discount is a fair benefit for the risk being taken (which is that the term sheet might fall through), and (b) if the term sheet DOES fall through, the angel now has debt, which is a better thing than equity to have when things go bad, which they will if the VC walks. Nevertheless, even in this case the convertible note should have a fallback feature of a set price, so that if the term sheet doesn't happen the angel will STILL end up with an investment at a known, appropriate, valuation.
Note to angel investors: As Ben Franklin said, "experience is a hard school, but some will learn through no other." Let me add one more piece of advice: no matter HOW iron clad a term sheet you think you are bridging to, NEVER make the bridge loan subordinate to other debt, and ALWAYS ensure that you are first in line (ideally, make the loan secured.) Don't ask me how I know this.
So, there you have the definitive answer on convertible debt vs. preferred stock. It's not hard. It's not emotional. It's just business.
Since Bill Hewlett joined with Dave Packard in 1939 to create what is today the world's largest personal computer company, there has arisen an evergreen debate as to who is more important in starting a tech company: the techie or the business guy? Steve Jobs or Steve Wozniak? Bill Gates or Steve Ballmer? Jim Clark or Marc Andreessen?
I propose that it is time to reject the notion of the “business guy” (or “business gal”) entirely. The underlying problem is that there are really three different components here, and like the classic three-legged school, they are all essential for success, albeit with differing relative economic values. What gets things confused is that the components can all reside in one person, or multiple people. And what gets people upset is that there are different quantities of those components available in the economic marketplace, and the law of supply and demand is pretty good about consequently assigning a value to them.
Perhaps surprisingly, the components are NOT the traditional coding/business pieces; nor are they even coding/UI/business/sales, or whatever. Rather, here is the way I see it, from the perspective of a serial entrepreneur turned serial investor, listed in order of decreasing availability:
1) THE CONCEPT
A given business starts with an idea, and while the idea may (and likely will) change over time, it has to be good on some basic level for it to be able to succeed in the long run. How excited am I likely to be when I see a plan for a 2008-model buggy whip? another me-too social network? The 87th investor-entrepreneur matching site with no investors? The base concept has to make some kind of sense given the technical, market and competitive environment, otherwise nothing else matters. BUT good ideas are NOT hard to find. Not at all. There are millions of them out there. The key to making one of them into a home-run success brings us to:
2) EXECUTION SKILLS
It is into this one bucket that ALL of the ‘traditional’ pieces fall. This is where you find the superb Ajax coder, AND the world-class information architect, AND the consummate sales guy, AND the persuasive biz dev gal, AND the brilliant CFO. Each of the functions is crucial, and is required to bring the Good Idea to fruition. In our fluid, capitalistic, free-market society, the marketplace is generally very efficient about assigning relative economic value to each of these functional roles, based upon both the direct result of their contribution to the enterprise and their scarcity (or lack thereof) in the job market.
That is why it is not uncommon to see big enterprise sales people making high six figure, or even seven figure, salaries or commissions, while a neophyte coder might be in the low five figure range. Similarly, a crackerjack CTO might be in the mid six figures, but a kid doing inside sales may start at the opposite end of the spectrum. Coding, design, production, sales, finance, operations, marketing, and the like are all execution skills, and without great execution, success will be very hard to come by.
BUT, as noted, each of these skills is available at a price, and given enough money it is clearly possible to assemble an All Star team in each of the above areas to execute any Good Idea. That, however, will not be enough. Why? Because it is missing the last, vital leg of the stool, and the one that ultimately–when success does come–will reap the lion’s share of the benefits:
3) THE ENTREPRENEUR
Entrepreneurship is at the core of starting a company, whether tech-based or otherwise. It is NOT any one of the functional skills above, but rather the combination of vision, passion, leadership, commitment, communication skills, hypomania, fundability, and, above all, willingness to take risks, that brings together all of the forgoing pieces and creates from them an enterprise that fills a value-producing role in our economy. And because it is THIS function which is the scarcest of all, it is THIS function that (adjusting for the cost of capital) ends up with the lion’s share of the money from a successful venture.
It is thus crucial to note that the entrepreneurial function can be combined into the same package as a techie (Bill Gates), a sales guy (Mark Cuban), a UI maven (arguably Steve Jobs), or a financial guy (Mike Bloomberg). And that it is the critical piece that ultimately (if things work out) gets the big bucks.
Who do you think got the biggest relative return from the development of Trump Tower? Architect Der Scutt (the IA)? Engineer Irwin Cantor (the coder)? Broker Louise Sunshine (the sales gal)? EVP George Ross (the biz dev guy)? Or whomever happened to be The Entrepreneur in that deal?
The moral of the story is that for a successful company, we need to bring together all of the above pieces, realize that whatever functional skill set the entrepreneur starts out with can be augmented with the others, and understand that the lion’s share of the rewards will (after adjusting for the cost of capital), go to the entrepreneurial role, as has happened for hundreds of years.
Angelsoft, in providing software for ALL types of early stage investment groups, sees deals that flow and get shared in all types of directions. From business plan competitions to angel groups, from angel groups to VC's, from group to group, from VC to VC, from VC's down to angel groups, and basically any combination that you can think of.
Angelsoft makes all of this easy and it happens live within our software all the time.
It's starting to get a lot more press in the blogosphere, as well. David Spreng of the National Venture Capital Association and Knox Massey of the Angel Capital Association authored an article that was posted on David's blog, Lightbulb. The article discusses how VC's and Angel Groups are starting to work together with increasing frequency.
Perhaps the single biggest area of confusion in the world of early stage investing is the answer to the question "what should an 'appropriate' return be for a VC or angel investor in a startup company?" This is crucial, because the answer directly affects the valuations that investors are prepared to give early stage companies, and the assumptions that underlie the answer are the context for the long term relationship between the investor and the entrepreneur.
Before the question can be answered, however, there are several different numbers and theories involved, and it's important to understand each of them in context:
IRR (Internal Rate of Return) is the return on an investment OVER TIME, usually expressed as an annual percentage rate (that is, if you invest $10 on January 1 and get back $11 on December 31, that would be a 10% IRR.)
ROI (Return on Investment) is the return on an investment REGARDLESS of time, and is usually expressed as how many times the original investment is returned (that is, if you invest $10 and get back $30 at some point in the future, that would be a 3x ROI.)
PORTFOLIO TARGET RETURN is the IRR that an investor hopes to receive in total, taking into account ALL of the investments, profits and losses made in a given time frame.
ASSET CLASS TARGET RETURN is the IRR that an investor hopes to receive from all investments of a certain type (such as CDs, stocks, bonds, venture capital, angel investments, etc.)
TARGET ROI is the ROI that an investor hopes to receive on any one particular deal, taking into account the typical holding period for an investment of that type.
TIME VALUE OF MONEY is a fundamental economic concept that means $1 in your hand today is worth more than $1 a year from now (because you can put that dollar to work during the year, and make more money with it.) As such, ROI calculations are meaningless without an associated time frame. A 10x return that an investor would be ecstatic about if it came back in six months, would be a major disappointment if it took twenty years to come back.
RISK/RETURN TRADEOFF is the principle that the more risk there is in an investment, the higher return there needs to be to compensate for it. As such, an investor willing to take a 2.3% annual return on a US Treasury bill (essentially risk-free), might require a 12% annual return to be enticed to invest in a higher-risk corporate 'junk bond'. (See tinyurl.com/6fby2v)
PORTFOLIO BALANCING means that most investors aim to diversify their risk/return profile by investing in several different types of asset classes, because in any given year one class will do better than another...but it's difficult to predict which. It is therefore not unusual for the same investor to hold both US T-bills AND junk bonds, as well as several other asset classes. (See a fascinating historical chart of the relative returns from different asset classes over the past 20 years: tinyurl.com/5jygn2)
VENTURE/ANGEL INVESTMENTS in early stage companies are considered (for good reason) among the riskiest possible investments one can make. A majority of startups, no matter how promising, fail completely within a couple of years, losing 100% of the money that was invested in them. On the other hand, there is no way that an investment in T-bills (or General Motors) could ever have the potential return of an investment in a company like Google or Facebook.
Sooo...all of the above leads us into the following scenario: Mr. Typical Investor would like to get a somewhat higher total return from his investments than he would get by investing only in T-bills, and is therefore prepared to take some risk to get it. He decides to create a diversified portfolio with an overall annual target return of, say 5%. Since this is more than double the return of the average money market fund over the past five years, Mr. Investor's safe (but low return) investments have to be balanced by some higher risk investments, such as small cap growth stocks, or international funds. But for investors who have an appetite for real risk, and the consequent ability to lose some of their investment if things go wrong, they can go even further up the risk/reward scale to...venture capital.
VC funds in general target a 20% or so annual return to their investors, which can certainly bring up the overall average return on Mr. Investor's diversified portfolio. That sounds great, but with that high return comes equally high risk. Last year, a majority of US venture funds actually lost money and had negative returns, let alone not making their 20% IRR target!
Indeed, venture capital is only one part (the riskiest part) of an asset class called "alternative investments" that include things like private equity buyout funds, commodities, hedge funds, etc. And most institutional investors (the university endowments, pension funds and insurance companies who provide the majority of money to VC funds) nevertheless put only 2-3% of their capital into alternative investments as a whole...because they're so risky.
Let's look, therefore, at what it takes a VC fund to get that elusive 20% IRR. Well, it turns out (in case we didn't already know) that investing in entrepreneurs is indeed a Risky Business. VC's fund fewer than one in 400 deals they look at, but even with that discriminating judgment they are resigned to the fact that between 30% and 50% of their prized investments will crash and burn. Completely. And another 30% or so will end up being "walking dead", that is, making just enough money to keep themselves alive, but not enough to provide any return on the investment. Indeed, statistics over many years have shown than virtually ALL of a VC fund's returns will come from fewer than 10% of their investments. It's the one home run with Google that makes up for all the WebVans, Pets.com and eToys.
Thus, continuing with our math lesson, and taking into account the facts that: one in ten companies in a VC portfolio need to come up with all the return for the portfolio; the average holding time for a VC investment is 5-7 years; and the return for the whole VC portfolio needs to be 20% or so, we can calculate at the end of the equation that ONE company needs to deliver an ROI after six years of something north of 20X! And therefore, since the VC doesn't know WHICH of his investments is going to be The One (otherwise, of course, he wouldn't invest in the other nine!), EVERY one of his investments must have the potential to hit a 20X return.
It's because of all the forgoing realties, concepts and math that there is typically an enormous disconnect between entrepreneurs and investors. The former figure that 'risk adjusted return' means that an investor should be delighted if his/her/its investment brings back a 20 PERCENT profit (which is five to ten times the return from less risky asset clases), while the latter realize that if they don't aim on each deal for a 20 TIMES profit (which is required on a deal basis to deliver the 20% return on a portfolio basis), they will be out of business.
The result? A two-order of magnitude misunderstanding.
Rachael Qualls, Founder and General Manager of the Angel Capital Group in Tennessee, sat down recently with Marc Krejci of Patrons of Change, a refreshing new podcast devoted to a range of topics including entrepreneurship, technology, philanthropy and other important issues.
Rachael provides valuable insight into the mind of an angel investor. She discusses how her group got started, ways entrepreneurs can reach out to her angels, and the steps they go through when deciding which companies to invest in.
In addition, Rachael reveals how the group uses Angelsoft to track and collaborate on deals. Rachael is extremely enthusiastic about what she and her group are doing and adds that she is having a ball doing it! Rachael, if we can in some way help facilitate funding ideas that may one day change the world, then we are happy to do our part!
Entrepreneurs interested in applying to the Angel Capital Group, click here and follow the instructions.
You can also subscribe to the podcast to receive new episodes as soon as they are released.
About Patrons of Change:
Patrons of Change is a podcast exploring topics including entrepreneurship, technology, philanthropy, social justice, the environment and other issues affecting our world and ways that we can make an impact.
Portfolio.com posted an article on-line yesterday talking about how the credit crisis has positively affected angel investing across the U.S. Angelsoft customer Eric Rosenfeld of the Oregon Angel Fund in particular mentions how his fund is still able to raise money and promote entrepreneurs.
Also mentioned in the article is Angelsoft customer New Vantage Group, led by John May, the current chairman of the Angel Capital Association. He mentions that despite the credit crunch, deal size has remained the same or become larger.
It is interesting for us to note that both entrepreneurs listed in the article who were successful in raising money, TalkShoe and Acuity Mobile, did so through the Angelsoft platform.
