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Angel InvestingGary Rowe

Tech Coast Angels (TCA)CA Non-Profit Founded in 1997The largest angel group in the US investing primarily in Southern CaliforniaLos Angeles(92 members)Inland Empire (16 members)Central Coast (22 members)Members are encouraged to collaborate within and across networks.attend any TCA meeting or activity. participate in any member-led investmentSan Diego (102members)

Orange County(70 members)Over 300 members organized in five networks overseen by a Board of Governorssyndicate larger deals (new)provide mentoring and guidance as well as capitalSierra AngelsDesert AngelsAlliance of AngelsLife Science AngelsGolden Seeds2OutlineFunding Alternatives

Angel Investing

Angel Investing Decision Process

3Starts with the EntrepreneurAn idea for doing something better, faster, cheaperYou build on the idea and bring in othersThe frenzy startsthis will be great, we will be richthe euphoria peaks with the first Excel spreadsheetRevenue from nothing to $1 billion in 5 yearsit must be true, its in Excel

Then Reality sets inI only have $5K in the bankI have to cover my monthly living expensesIll have to leave my current job/salaryI need outside funding or my idea will never see the light of day

Funding AlternativesSelf fundmay limit growth, but no dilutionFriends/Familyearly stage fundingAngel Investments$250K - $1.5 millionVC funding$3million - $20+ millionAngel Investing

7What Is Angel Investing?

Angel investors provide Seed Funds forproof of concept, product development, market research, business plan development, recruiting management and early production.

TCA$$$$$$Angel investors also provide Startup Capitalfor early stage product development, initial marketing, expansion and growth.Stages of Firm Development

Seed Stage: The entrepreneur has only a concept for a potentially profitable business opportunity that still has to be developed and proven.

Start-Up: The newly formed business is completing product development and initial marketing. Its typically one year old.

Early Stage:The firm is usually expanding and producing and delivering products or services. Often less than five years old, it may or may not be profitable.

Later Stage:Also called the expansion stage, at this level of development the firm is mature and profitable, and often still expanding. With a continued high-growth rate, it may be acquired or go public within six months to a year.8Who are Angel Investors ?

TCAAccredited* investors who invest their own capital

CEOThey come from diverse operating backgroundsC-Level Managers, Entrepreneurs,Senior Executives & Other Professionals

They mentor and coach entrepreneurs Serve as directors Provide industry contacts & adviceAssist with team building, strategic planning and subsequent fundraising

They can devote time and add substantial valueTechCoast Angels*Securities Act of 1933 - net worth > $1 M, income exceeding $200,000 in each of the two most recent years or a trust with assets > $5 M

Accredited InvestorsUnder the Securities Act of 1933, a company that offers or sells its securities must register the securities with the SEC or find an exemption from the registration requirements. The Act provides companies with a number of exemptions. For some of the exemptions, such as rules 505 and 506 of Regulation D, a company may sell its securities to what are known as "accredited investors." The federal securities laws define the term accredited investor in Rule 501 of Regulation D as:a bank, insurance company, registered investment company, business development company, or small business investment company; an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million; a charitable organization, corporation, or partnership with assets exceeding $5 million; a director, executive officer, or general partner of the company selling the securities; a business in which all the equity owners are accredited investors; a natural person who has individual net worth, or joint net worth with the persons spouse, that exceeds $1 million at the time of the purchase; a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

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% of All Start-Up Firms> 90%< 10%< 1%< $10 M$10 M to $50 M$50+ M5-Yr Revenue Projection< 20%20% to 50%> 50%Annual Growth RateInternalBootstrapping & AngelsAngels & VCsPrimary Sources of FundingAngel Investing, Osnabrugge & BrownSpectrum of Start-Up InvestmentsLifestyle FirmsEntrepreneurial FirmsMiddle Market FirmsHigh-Potential Firms

ANGELSINTERESTEven though small entrepreneurial firms have great ability, through their rapid growth, to generate jobs and high returns for potential investors, only a minority of small firms actually grow into large ones. These dynamic small firms can show rate of growth that large firms can match only by resorting to acquisitions and mergers.

Entrepreneurial FirmsRepresent fewer than 10% of the ~ million start-ups in the U.S/yearRepresent 4-8% of all small business, but generate 75% of new jobs

20% of this small minority of high growth firms are responsible for about half of this small minority of high growth firms are responsible for 50% of all jobs created by autonomous new firms.

BOOTSTRAPINGFunding growth internally using credit cards, second mortgages or personal loans is a good way of to further the company while retaining entrepreneurs equity in the company. However, it often does not generate enough finance to support rapid growth.

ANGELSMeans of obtaining necessary financing early since they fund more money to more young entrepreneurial firms than any other type of fund provider. 10

Investment Per Round (Millions)Number of Investors$5.0$7.5$10$2.5 Power of Angel Investing, PayneAngelsVCsGapInvestor FocusScarce capital very few deals Wealthy, solo, private investors Strategic partners corporate investors Boutique VCsAlliances between Angels and VCs

Seed Track FundingEquity Gap ( $750 K< $150 K$150 K - $250 K$250 K - $500 KSeed/StartupExpansionLater StageEarly StageSource: 2009 Angel Capital Association - Angel Group Confidence Survey and 2008 Member DirectoryWhat Do Angels Bring to a Start-Up ?

Guidance & Team BuildingMentoring and CoachingActive on Board of DirectorsAdvisory Board Participation

Business ContactsAdditional ManagementCustomersVendorsStrategic PartnersService ProvidersFollow-on Financing

FundingDirectVenture Capital Affiliates

15Member Portfolio Considerations5-10% of net worth (asset allocation)8-10 investments (risk diversification)

Most of ROI from 1 - 2 of 10 companies

High tech, low tech, no techVariety of involvementsLead investorBoard, advisorPassiveMember Portfolio StrategyExpect to exit in 3-7 years (assume 7)You want a balanced portfolioSeek to build a portfolio of companies covering all stages of developmentPerhaps in multiple business sectorsBuild to a 10 company portfolio graduallyInvest in 2-3 companies per yearDiversify (stage, sector, )

Getting Funded by Angels

TCA Investing ProcessPre-Screen40+ Applications/Month

MembersVC AffiliatesSponsorsWebsiteUniversitiesWord Of MouthPRScreening 33%Due Diligence 10%Network Dinner 7%Funding 5%

20+ Companies Funded Each Year19Angel Investment Decision ProcessHow TCA (and other investors) make decisionsInvestment is about maximizing returns while minimizing riskearly stage companies are higher risk which is why investors generally need more equity to offset higher riskUnderstanding what investors look for is valuable in helping entrepreneurs shape their business plans and funding strategiesFollowing slides are how TCA evaluates invesmentsStart With The Idea & Why Its Valuable?

What urgent problem does it solve?

Who is going to buy it?What would they pay to get this value?

How is it better, faster, cheaper than alternatives?

Will they adopt your new technology before you run out of money?

Good Ideas

The next Big Thing

Disruptive Technology that can form the core of a new businessA new application enabled by the Convergence of New Technologies

A novel New Application of an existing technology.

A new Killer App

Then Determine if the Idea is Fundable ?

A market opportunity sufficiently large to create a business with at least $50 to $100 million in annual revenues. A compelling, well articulated strategy for capturing and defending a significant market share.

Proprietary technology or other strong barriers to entry.

Strong management (not necessarily a complete team) with relevant and successful experience.

An exit strategy for the investors.

Lastly, the company valuation must fit within TCAs risk/reward expectations for the investment.A desire for advice and coaching

TCAWill They Use the Funds Raised Effectively ?

Capital sought must take the company to the next level and materially increase its valuation.

Prototype

Patent Filing

Product Development

Market Research

Product Launch

Major Contract

Management Team Proof of Concept

Will They Need Follow-On Funding ?Early money is inferior to later money

Later

EarlyEarly money (Angel) must be used for growth

$$$$$$Early money investors need to see significant increase in value

Later money (VC) is used to ready the company for acquisition or IPO

HOWEVER SO Early money investors will want a significant (30%-50%) ownership stake in the companyCompanyAngelsAnd

YourCompanyThe most desirable companies are those that dont need further funds or will quickly become attractive to VCsVCLook for Deal Killers

Look For Deal Killers

We have no competition!

I must remain President - FOUNDERITIS

This is the Valuation. Take It or Leave It.

All I need is Your money

If we build it, they will come

I cant explain the technology in simple terms Its just too complicated

We dont own the IP

We want to use your money to pay our salaries and retire the companys debt.

Weve been too busy to put together a business plan

We dont have a shareholder/partner agreementQuestion Exaggerated ClaimsOur projections are conservative.In 3 years our market will be $50B.Our key customer will sign our contract next week.

Our competitors are too slow to be a threat.Beta sites will pay to test our software.Our patents make our business defensible.All we have to do is get 1% of business.

Key employees will join us as soon as were funded.No one else is doing what we do.Several outside investors are doing due diligence.

Examine Pro Forma201020112012201320142015Revenues0.271.002.505.3310.3122.17COGS0.190.631.612.784.549.07Gross Profit0.080.370.892.565.7713.09R&D Expense0.300.770.390.500.540.64Sales & Business Development0.010.400.901.501.752.00G&A (Include Clinical & Regulatory)0.010.350.881.251.501.50Profit (B/Tax)

0.787.75Cash Flow(Cumulative)

3.71Financing0.151.501.501.75Cumulative 0.151.653.15$4.90 MHeadcount711192123% of Niche Market?Consistent w/ # of units sold & sales cycle?GPM ~ 50% Does this match business sector?Reasonable % of Revenue?Sales, R&D and G&A High/Low?Follow-On Rounds4 Yrs Negative Profits

Agree on TermsTypical Terms to Consider

Required FundsDebt vs. Equity

DebtEquityValuation

Cap TableShareholder Rights

Debt vs. EquityConvertible debt financing is an investor loan that has a future conversion-to-equity feature. Convertible debt typically converts (often at a discount & sometimes with a cap) to equity the next time capital is raisedConversion to equity is based on the valuation set at the time of qualified financing.

Convertible Debt

Equity

Investors capital is exchanged for company equity The exchange rate is determined by the pre-money valuation for the companyConversion to cash or to common stock is based on the valuation set at the time of the next qualified financing round.Valuation - Berkus Method (Early Stage Start-Up)Attractiveness of Core Idea Upon Which the Company is Founded

$500,000Good management is in place to execute to the plan in the early stages of rapid growth

$500,000The company has struck impressive strategic alliances with either vendors or customers, adding to barriers of entry for other businesses.

$500,000The company has a completed product or prototype and has demonstrated its attractiveness before an appreciative customer candidate. (Which further reduces the risk of investment, adding to value.)

$500,000AddCompany Attribute$2,000,000SummaryMany entrepreneurs need outside fundingAngel investors fill a valuable need for high-potential start-ups seeking $100K -$1.5 millionAngel groups such as Tech Coast Angels bring investors together to collaborate on deals, due diligence and fundingUnderstanding angel investor decision criteria will help entrepreneurs get fundingThank you

Entrepreneurial Playbook blog: http://garyjrowe.com