Angel InvestingGary Rowe

Tech Coast Angels (TCA)• CA Non-Profit Founded in 1997• The largest angel group in the US –

investing primarily in Southern California

Los 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

investment

San Diego (102members)

Orange County(70 members)

• Over 300 members organized in five networks overseen by a Board of Governors

– syndicate larger deals (new)

– provide mentoring and guidance as well as capital

Sierra Angels

Desert Angels

Alliance of Angels

Life Science Angels

Golden Seeds

Outline

• Funding Alternatives

• Angel Investing

• Angel Investing Decision Process

Starts with the Entrepreneur

• An idea for doing something better, faster, cheaper

• You build on the idea and bring in others• The frenzy starts…this will be great, we will be

rich…the euphoria peaks with the first Excel spreadsheet…

• Revenue from nothing to $1 billion in 5 years…it must be true, it’s in Excel

Then Reality sets in• I only have $5K in the

bank• I have to cover my

monthly living expenses• I’ll have to leave my

current job/salary• I need outside funding or

my idea will never see the light of day

Funding Alternatives

• Self fund—may limit growth, but no dilution• Friends/Family—early stage funding• Angel Investments—$250K - $1.5 million• VC funding—$3million - $20+ million

Angel Investing

What Is Angel Investing?

Angel investors provide Seed Funds for• proof 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.

Who are Angel Investors ?

TCA

Accredited* investors who invest their own capital

CEOThey come from diverse operating backgrounds

• C-Level Managers, • Entrepreneurs,• Senior Executives & Other Professionals

They mentor and coach entrepreneurs • Serve as directors • Provide industry contacts & advice• Assist with team building, strategic planning

and subsequent fundraising

They can devote time and add substantial value

*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

% of All Start-Up Firms> 90% < 10% < 1%

< $10 M

$10 M to $50 M

$50+ M

5-Yr

Rev

enue

Pro

jecti

on

< 20%

20% to 50%

> 50%

Annu

al G

row

th R

ate

Internal Bootstrapping & Angels Angels & VCs

Primary Sources of Funding

Angel Investing, Osnabrugge & Brown

Spectrum of Start-Up Investments

Lifestyle Firms Entrepreneurial Firms

Middle Market Firms

High-Potential Firms

ANGEL’SINTEREST

Investment Per Round (Millions)

Num

ber o

f Inv

esto

rs

$5.0 $7.5 $10$2.5

Power of Angel Investing, Payne

Angels

VCsGap

Investor Focus

•Scarce capital – very few deals •Wealthy, solo, private investors •Strategic partners – corporate

investors •Boutique VCs•Alliances between Angels and VCs

Seed Track Funding

Angel & VC Markets Are Large, Complementary

$19.2 B55,480 Deals

Mostly Early Stage

2008 Angel Investments

UNH Center for Venture Research

Mostly Late Stage3,808 Deals

$28.3 B

2008 VC Investments

National Venture Capital Association

Ear

lyL

ate

STA

GE

Connect Framework Presentation - Jack Florio

WHAT DO ANGEL INVESTORS EXPECT?

ROI = 30% - 40%Revenue

Experienced management team

Ongoing relationship with management

12 3 4 5

Investment Horizon 3 - 7 years

67

Preferred Raise

0 20% 30% 40% 50% 60%

Connect Framework Presentation - Jack Florio

80%

60%

40%

20%

0

Preferred Investment Stage

How are Angels Currently Investing ?

$500 K - $750 K

> $750 K

< $150 K

$150 K - $250 K

$250 K - $500 K

See

d/S

tart

up

Exp

ansi

on

Lat

er S

tag

e

Ear

ly S

tag

eSource: 2009 Angel Capital Association - Angel Group Confidence Survey and 2008 Member Directory

What Do Angels Bring to a Start-Up ?

Guidance & Team Building• Mentoring and Coaching• Active on Board of Directors• Advisory Board Participation

Business Contacts• Additional Management• Customers• Vendors• Strategic Partners• Service Providers• Follow-on Financing

Funding• Direct• Venture Capital Affiliates

Member Portfolio Considerations

• 5-10% of net worth (asset allocation)• 8-10 investments (risk diversification)

• Most of ROI from 1 - 2 of 10 companies

• High tech, low tech, no tech• Variety of involvements

– Lead investor– Board, advisor– Passive

Member Portfolio Strategy

• Expect to exit in 3-7 years (assume 7)• You want a balanced portfolio

– Seek to build a portfolio of companies covering all stages of development

– Perhaps in multiple business sectors• Build to a 10 company portfolio gradually

– Invest in 2-3 companies per year– Diversify (stage, sector, …)

Getting Funded by Angels

TCA Investing Process

Pre-Screen40+ Applications/Month

MembersVC Affiliates

Sponsors

WebsiteUniversities

Word Of MouthPR

20+ Companies Funded Each Year

Angel Investment Decision Process

• How TCA (and other investors) make decisions• Investment is about maximizing returns while

minimizing risk—early stage companies are higher risk which is why investors generally need more equity to offset higher risk

• Understanding what investors look for is valuable in helping entrepreneurs shape their business plans and funding strategies

• Following slides are how TCA evaluates invesments

Start 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 business

A 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 TCA’s risk/reward expectations for the investment.

A desire for advice and coaching

Will 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 moneyLater

Early

Early 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 companyCompany

Angels

And

YourCompany

The most desirable companies are those that don’t need further funds or will quickly become attractive to VCs

VC

Look for Deal Killers

Look For Deal KillersWe 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 can’t explain the technology in simple terms – It’s just too complicated

We don’t own the IP

We want to use your money to pay our salaries and retire the company’s debt.

We’ve been too busy to put together a business plan

We don’t have a shareholder/partner agreement

Question Exaggerated Claims

1. Our projections are conservative.

2. In 3 years our market will be $50B.

3. Our key customer will sign our contract next week.

7. Our competitors are too slow to be a threat.

8. Beta sites will pay to test our software.

9. Our patents make our business defensible.

10. All we have to do is get 1% of business.

4. Key employees will join us as soon as we’re funded.

5. No one else is doing what we do.

6. Several outside investors are doing due diligence.

Examine Pro Forma

2010 2011 2012 2013 2014 2015Revenues 0.27 1.00 2.50 5.33 10.31 22.17COGS 0.19 0.63 1.61 2.78 4.54 9.07Gross Profit 0.08 0.37 0.89 2.56 5.77 13.09

R&D Expense 0.30 0.77 0.39 0.50 0.54 0.64Sales & Business Development

0.01 0.40 0.90 1.50 1.75 2.00

G&A (Include Clinical & Regulatory)

0.01 0.35 0.88 1.25 1.50 1.50

Profit (B/Tax) <0.05> <1.35> <1.58> <1.84> 0.78 7.75Cash Flow

(Cumulative)

<0.05> <1.40> <2.98> <4.82> <4.04> 3.71

Financing 0.15 1.50 1.50 1.75Cumulative 0.15 1.65 3.15 $4.90 MHeadcount 7 11 19 21 23

% 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 Rounds

4 Yrs Negative Profits

Agree on Terms

Typical Terms to Consider

Required Funds Debt vs. Equity Debt Equity

Valuation Cap Table

Shareholder Rights

Debt vs. Equity

• Convertible 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 raised

• Conversion to equity is based on the valuation set at the time of “qualified financing.”

Convertible Debt

Equity• Investor’s capital is exchanged for company equity • The exchange rate is determined by the pre-money

valuation for the company• Conversion 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

$500,000

Good management is in place to execute to the plan in the early stages of rapid growth

$500,000

The company has struck impressive strategic alliances with either vendors or customers,

adding to barriers of entry for other businesses. $500,000

The 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.)

$500,000

Add Company Attribute

$2,0

00,0

00

Summary

• Many entrepreneurs need outside funding• Angel investors fill a valuable need for high-

potential start-ups seeking $100K -$1.5 million• Angel groups such as Tech Coast Angels bring

investors together to collaborate on deals, due diligence and funding

• Understanding angel investor decision criteria will help entrepreneurs get funding

Thank youEntrepreneurial Playbook blog: http://garyjrowe.com