The Way I See It… by Michael C. Volker
Angel
Angles and Angel Arithmetic
A business
angel is a technology entrepreneur’s best friend. The definition I like is the
one that identifies an angel investor as a successful entrepreneur investing
her own time and money in a new startup. This is a sharp contrast to most
venture capital investors who have never been in the driver’s seat and are
betting other people’s money.
Let’s take a
look at what angels want – both in terms of the type of company as well as the
numbers that will attract them. Often, a committed angel will bring in a few
co-investors to raise the ante. Many of the deals I see comprise a few
investors putting up $500K or so to get a venture launched.
With respect
to what they want, it’s got to be an opportunity that gets their attention.
Since angels have varying interests, ambitions and styles, this part of the
process boils down to talking to finding one that can identify with the
specific opportunity being presented. That’s the easy part as it depends mainly
on entrepreneur’s finesse and tenacity in identifying a potential fit. The
tough part comes when they assess you, the
entrepreneur, to determine if you and your team are worth the risk.
Angel investors
will tell you that the three bases that need to be covered by entrepreneurs
are: their knowledge, their goals and their capability. Of these, the
“knowledge” component is the most important. A thorough knowledge of the
industry, customers and the competition is paramount. Then, knowing what needs
to be done is the first step towards success.
Goals are a
matter of choice. Is the entrepreneur sufficiently ambitious to be of interest
and does he have a chance at achieving these goals? Are the goals – personal
and corporate – even articulated? This is a matter of both credibility and
confidence.
As for
capability, this can be acquired over time and by recruiting the right talent.
One has to allow for the fact that first-timers may not have proven abilities.
But, getting back to point number one, a good entrepreneur is one that knows
what his shortcomings are.
Given that
these bases are covered, let’s now take a look at the numbers and the valuation
approaches that make angel investing work. Forget about doing anything overly
sophisticated like a discounted cash flow analysis. A startup’s value is based
on future events and without angel support, these events may never happen. If a
group of angels puts $500K into a deal, what piece of the pie will they get?
There are two
ways to arrive at an appropriate number. First, what might be the maximum
upside value of this company in five years? If it hits its projections, could
it be worth $50 or $100 million? That sounds pretty good, but if the angel
valuation is $5 million, that means an upside of “only” ten or twenty-fold.
Angels are looking at multiples of at least that and more often closer to 100X.
Since targets are rarely hit without glitches, perhaps a going-in value of $2
million is more likely to produce a 10X return. We’ve all heard VC’s say that
they look at hundreds of deals for every one they invest in and of those that
they do invest in, only one or two in ten will be shooting stars.
Second, who is
committing what to the startup? What’s an appropriate equity allocation for the
sweat equity already and yet-to-be contributed? What’s the technology worth
relative to the cash needed to commercialize it? If this deal is going to be a
big win, there’s little point in being too inflexible. Entrepreneurs sometimes
forget that an additional five percent dilution suffered by offering fifteen,
instead of ten, percent to an angel makes a fifty 50 percent difference to the
angel!
The way I see
it, getting an angel investor on board is a critical first step for technology
entrepreneurs. This entails finding someone who is empathetic with their cause
and then striking a deal that takes into account both the up-front
contributions as well as the future upside.
Michael Volker is a high technology entrepreneur and director of Simon Fraser U's University/Industry Liaison Office. He oversees Vancouver’s Angel Technology Network and is Chairman of the BC Advanced Systems Institute and past- chair of the Vancouver Enterprise Forum. He may be reached at mike@volker.org.