For a startup company, Angel Investors can be considered the entrepreneur’s best friend, their saving grace, their answer to a prayer. Some say they are called “angels” because they are an answer to the entrepreneur’s prayer for money to get their business launched, or to respond to accelerated growth, or to bridge the capital divide and reach profitability.

Angels are the financial fuel of the economy. Before Venture Capitalists get involved, before banks will loan a company an unsecured note; Angel Investors provide the capital that fuels the entrepreneurial spirit and helps inventions become products and ideas become reality. I like to refer to them as Compassionate Capitalists. “Compassionate” because they have figured out that even though they can lose all their money, by providing investment capital to an entrepreneur with passion and purpose to see his or her company succeed, they are providing a hand up, not a hand out, that will fuel the economy by creating jobs and potentially whole markets by bringing innovation to the market. “Capitalists” because they aren’t donating to a charity, they are investing in a risky venture that banks won’t loan to and venture capitalist won’t even look at, with the intent of creating a big return on their investment. High net worth men and women become angel investors to create great wealth, never with the intent to lose money.

Angels are wealthy individuals who provide seed capital and growth capital to companies in the startup and early stage of their company’s life cycle. Their capital can be offered in exchange for equity in the company or as some specialized form of debt facility. Investing in this stage of company is the most risky, but it can also be the most rewarding. Rewards come not just from the financial returns, but also from experiencing the purest form of capitalism…bringing value to the market by supplying a product or service to satisfy a market demand. There is a definite sense of pride and accomplishment from being able to say you were an early investor in a block buster like MicroSoft or Starbucks, and surprisingly, there is little regret from the early stage investors in the near misses like WebVAN and PETS.com because they got their sizeable returns when those companies went public. It was the investors that followed the advice of their stock broker or financial planner to invest when those companies when public that saw a decline in the value of their investment because they bought at “retail” hoping that the value would increase over time. Angel investors buy stock when the company is still private, and reap their rewards with the company then sells that stock to another buyer or to the public stock market. They learned early in life that profit is made when buying at wholesale and selling at retail. That is how it works for the wise angel investor.

Investing or buying Private Equity of early stage companies is one of the secrets the wealthy use to create more wealth. As Robert Kiyosaki wrote in his best seller book, Rich Dad’s Retire Young, Retire Rich on page 127:

“the rich invest in shares of a company when the company is still a private company”.

To become a successful angel investor, it is important that individuals learn how to identify and screen opportunities for early stage private equity investing. In the eBook Series “How to Be an Angel Investor”, investors are taught how to take what they know from investing in public stocks and real estate and apply to making investment decisions about private equity investments. There are a couple of key points from the 5 volume eBook “How to Be an Angel Investor” that beginning angel investors should keep in mind:

1. Make sure you have a variety of investments to choose from. If you only have deals coming from your accountant or the guy you met at a cocktail party, you need to expand your horizons to get better quality deal flow and not be afraid to invest outside of your geography. Join an angel investor group or plan to attend events where multiple pre-screened companies will be presenting for at least 9 minutes. An investor cannot be expected to determine the validity of a business from a 90 second spiel as promoted in the fast pitch events that have become so trendy of late. The situation to avoid is having a desire to be an angel investor or “silent partner” in a deal, so you put money in to a deal that seems OK but in reality it isn’t a good deal. The investor doesn’t know this because he or she hasn’t been exposed to anything better. You buy the bruised apple because it is the only one on the shelf.

2. Make sure there are other investors participating. It’s OK to be the first investor in a deal if you know they have other investors pending, on the fence ready to join in along with you, or you have a group of investors that co-invest together. If you are the first investor in a deal, and you are investing an amount significantly greater than the minimum investment or the full amount to get them to their next milestone that will increase their value, you can sometimes negotiate more favorable terms for yourself. The situation you want to avoid is loving a deal or the entrepreneurs behind it so you throw your money away because no one else invests and it was an insufficient amount of money to get the company to the next level when they would attract other investors or begin to generate revenue.

3. Don’t get hung up on percentages of ownership. The price paid for the stock and the number of shares held is more important than the % of ownership you have because the % will change over time through multiple rounds of financing. Owning 100,000 shares at 50 cents a piece won’t matter if it is 1% or 30% of the company if the company has a reasonable plan to grow their value of the company so that it can be sold for $5 a share, as an example. A $50,000 investment will return to you $450,000. Often a company’s amount of issued and authorized stock will change over time as the company raises capital and the % will go down, but the amount of shares will remain the same and the focus should be on the strike price of the stock at the next interval of financing.

4. Ensure there is a solid barrier to entry from the competition. The barrier to entry comes in many different flavors. Most often it is in the form of a patent and most novice angel investors focus on having a patent. Patents are good but they aren’t the Holy Grail. If a big company, or a foreign company, chooses to violate the patent instead of buying the company, you can hang it up because the court costs alone will put the early stage company out of business. Patents do not prevent clever inventors of figuring out a better way to do the same thing or even just a different way to do the same thing. The filed patent gave them the idea, yet doesn’t keep them from bringing a similar product to market. Trade Secrets can be a great way to go for many products: software, food formulas, processes and so on. If that is the way the company is going, then you must ensure they have done the necessary steps to actually establish it as a trade secret…aka the formula for Coke. Other barriers to entry can be the management team, strategic partnerships, time lag on being first to market, and product pipeline.

5. Be clear on how the ROI will be achieved. When you look at your asset portfolio to see how alternative investments like private equity investment fits in, you can seek ways to “flip your money”, get a steady income, or hold for a big return years down the road. Your investment decision may vary over time depending on the rest of your portfolio and the situation with the company. A “flip” would be a short term note secured with a contract or order, a convertible debenture that gives you the option to collect the $$ or convert to stock, or bridge financing to a larger investment. Steady income may come if you provide royalty financing, investing to receive a % of the revenues until a fixed amount is paid back or investing in an LLC that pays you cash as the company becomes profitable. The big ROI comes when it is straight equity investment with plans for the company to be bought or to go public 4-8 years or more in the future.

 

Early stage equity acquisition can be great investment opportunities! These investments have the potential to reap big rewards for early investors who have an appetite for the risk and have the liquidity to make the investment. Just ask anybody who invested in Google, Amazon or Home Depot! The bigger the risk, the greater the reward! Success builds confidence! Put your money to work by helping a young company grow. Create wealth for yourself, other investors, and those founders and employees of the early stage company that can then be re-invested again and again.

Author Info: Karen Y. Rands

 

Karen Rands is the Founder of Kugarand Holdings, an advisory firm for both entrepreneurs and angel investors. Entrepreneurs gain valuable insight and resources, and a strategic advantage in the marketplace through the LAUNCHfn Access to Capital System ( http://launchfn.com ). Early stage venture capital & angel investors gain access to qualified deal flow and an opportunity to learn, collaborate and prosper with other investors in the Network of Business Angels & Investors (NBAI). NBAI was recently listed on the 2009 top Angel Investor groups in Inc. Magazine. Academically trained as an economist and a master of business, Karen shares insights gained from interviewing hundreds of investors and entrepreneurs developing the idea of “Compassionate Capitalism” -investing time, capital and resources into early stage companies to bring innovation to market, create jobs and create wealth for the founders and investors. Sign up to get excerpts from the “How to Be an Angel Investor” series of books authored by Karen Rands to help savvy investors understand how to apply their knowledge of real estate and stock market investing to the riskiest, yet most financially rewarding asset class: Angel Investing. http://HowtoBeAnAngelInvestor.com. Follow Karen on Twitter at Karen_Rands

 

© Kugarand Holdings 2010

 

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