Historically our angel investment criteria have always focused on the ability of a management team to prove they can deliver on a high growth business concept. Our return on investment has been tied to the entrepreneur’s ability to produce the revenue and profit growth needed to create enterprise value. Our exit has always been seen as some multiple of the net profit which the venture can generate, whether this be immediate past or near future, captured in an IPO or trade sale – but always through the efforts of the venture itself.

What we have failed to do is to see two different paths to value creation, one from high growth potential itself and the other through the execution of that potential. In fact, we would have walked away from many deals where the product or service itself was capable of generating high growth but the entrepreneurial team was judged inadequate to execute on the potential. Without the team, there will be no proof of concept, therefore no value creation and thus no chance of a good exit.

However, high growth potential itself has value in its own right separate from high growth execution. Basically, we just need to go find someone else who can execute on the potential. In the case of most high growth potential products and services, this would be a strategic trade sale. We should position these ventures for a trade sale to a large corporation which had the capacity and capability to readily exploit the underlying asset or capability and thus execute on the potential. To prepare the venture for this type of exit might be as simple as sorting out the IP. In other cases, we would have to establish some reference sites and collect some market data. What we don’t have to do is grow a reasonable size enterprise. Rather than walk away from the venture investment, we should see it as a chance for the entrepreneur and the investors to capture value through an early strategic trade sale.

An entrepreneurial team capable of high growth execution is rare. All too often we have undertaken an investment based on high growth potential hoping the team will be able to learn quickly and, with our knowledge and support, overcome any deficiencies in their experience. Our track record of failures would suggest that this model is somewhat suboptimal. We end up with most ventures either failing or delivering small returns. It is only the exceptional ones which result in the 10+ multiple of capital injected.

The other problem we face is that high growth execution, by its very nature, often requires additional rounds of funding. This usually dilutes the original investment, often at lower valuations, but also puts the venture at risk through funding delays or inability to raise additional funds.

We should, in the future, embark on a two pronged approach to investment. Of course, we still want to focus on high growth potential. However, instead of excluding those where the entrepreneurial team is less able to execute, we should fast track those to a strategic exit which can usually be readily achieved by putting a deal team around the venture and limiting the funding to exit activities. Those few ventures which are capable of high growth execution can then be treated very differently and a full growth plan developed with an IPO or longer term trade sale as the exit.

The advantage of this approach is that we will end up funding more ventures with many of them being smaller investments with low execution risk and short exit horizons. Our success rate on high growth execution ventures will improve as we limit investment to those which have both high growth potential and the ability to execute on that potential.

As Angel investors we all want the ‘A’ team managing our portfolio companies, but we rarely expect to find one. What we tend to do is supplement the existing team with people with experience so that we have a reasonable chance of growing the business and avoiding the basic mistakes. We want to see a team with good leadership, strong marketing and operations experience and good networking skills. But aren’t we simply assuming that there is one size fits all and that building revenue and profit is the only game in town.

I have been in number of investor meetings recently where the intention was to build up the team to create a business which had a reasonable chance of meeting higher revenue targets. However, when the discussion has come around to positioning the business for an exit, a completely new set of requirements have been identified with dramatically different timescales. The question of who should undertake the exit strategy activities is a very different one from who could grow the business.

Once you focus on the exit, the set of tasks to be undertaken to prepare the business for, say, a trade sale are often very obvious and some will be of a specialist nature such as IP, legal and deal negotiation. Also you may find that instead of building up a sales and marketing force and establishing a customer base, you only need a couple of good customer sties as proof of concept. Instead of growing the business to 10, 20 or 100 people, you might just need a small team to complete a limited set of development and proof of concept tasks.

While the founder/entrepreneur might not have the leadership skills to grow the business, he or she might be just right for building relationships to the prospective buyers. Alternatively, you might task the entrepreneur with getting the trial sites working and employ an experienced M&A corporate executive to set up relationships with prospective buyers and negotiate the final deal.

What is obvious from the many investor meeting I’ve attended is that they have failed to work back from the exit to establish what needs to be done and who should do it. If the only business model you have in your head is revenue growth, you will always end up with a growth oriented team. If, however, you have a strategic exit in mind, the nature of the tasks to be undertaken are likely to be very different and it will call for a different mix of people. What you will also find is that the existing team you have is more than capable of participating in the exit strategy.

Strategic exits are much less demanding on resources, tend to have shorter execution times, lower operational risks and higher investment returns. What is also obvious is that it needs a different set of skills from a conventional growth oriented business strategy. Before you commit to hiring anyone, take the time to set out your exit strategy and then see how you would use the existing staff and what additional skills you will need to execute the exit deal.

If you want to get into a heated argument, put a dozen CEOs in a room and ask them if they should tell their employees that they’re preparing to sell their company. What you’ll find is that they quickly polarize into those who would tell their staff and those who would not. Each group will advance very strong arguments for their case but few will have thought through the longer term implications of their position on the sale value of their business.

Those who argue for not telling employees will argue that the possibility of a sale will create stress and uncertainly among employees resulting in a drop in productivity, a loss of key employees who decide to leave rather than face an uncertain future and the possibility of the news reaching competitors who will use the information to undermine the business. Those who argue for informing employees believe that the information will leak anyway and that it’s better to inform employees rather than let them imagine worse case scenarios.

When I’ve spoken with entrepreneurs who have sold businesses, I’ve been very interested to find out what they did pre-sale and what they would do differently if they had to do it again. In almost every situation where the information was kept from employees, the entrepreneurs regretted the decision. Employees who had worked diligently for the business felt betrayed for being left out of a critical decision which would materially effect their future. In some cases this had the result of undermining the sale process or in key employees leaving the business prior to the sale. Few entrepreneurs who told their employees had adverse outcomes.

My personal view is that the preparation process itself requires active support of key managers and employees. They are required to create the right foundation within the business so that the sale price can be optimized and they are most often needed to remain with the business so that the buyer is able to best operate the business after the sale. Basically you need your best people to support the process before and after the sale. So involving them in the sale process and providing incentives for them to assist you to prepare the business for sale and for being prepared to leave the business if required, or transition with the business if needed, is an essential part of selling a business. Key employees can be rewarded by being given shares, options or bonuses to assist in the preparation process. Those being made redundant can be compensated for their efforts up to the date of sale while those who are needed by the buyer can be given a bonus after some set period after the sale for staying with the buyer to assist the transition.

While competition is always an issue, businesses which are always open to the right offer can simply portray that position. That is, they are willing to sell out to a buyer who can best develop the business. This allows the current owner to position a future sale positively to customers and staff.

An industry colleague resigned his position today, after a significant stint at his company. With his departure, his company will actually be losing more than a single employee – they’ll be losing a significant marketing asset, in terms of both institutional knowledge and external influence.

The shame of this loss is that it would have been easy to convert into a marketing win – regardless of whether my colleague stayed at his company or not in the longer term.

Internally, “John” was well respected and well versed in best practices. He saved the company from repeating marketing mistakes. But arguably more importantly, externally, John was socially well connected in the industry. If his company had made even a minimal effort to show John appreciation and respect, he would have been an excellent evangelist for the company during his “off hours”. John’s annual salary couldn’t have paid for the word of mouth marketing that he would have done.

Alas, the company viewed John as a resource, not a person. The result is that despite a civil relationship, and significant contributions by John, he never felt any particular love for the company – and finally resigned in search of more fulfilling work.

What a waste.

The moral of the story: your employees can be your best evangelists. Invest in them first.

Periodically we will have posts from local entrepreneurs that provide some sound advice from a slightly different perspective. Today’s post is from Jason McDowall, a local serial entrepreneur that I’ve had the opportunity to work with and get to know over the last couple of years.  Jason was previously the co-founder and CEO of Adhoc Mobile, a developer of a sophisticated mobile ad and content delivery platform, that raised $3M in Angel financing. Jason is now the VP of Product Development at Benchmark Metrics, an angel funded developer of web-based business analytics tools.  Just a brief editorial note…the angel investors he describes below were not from the Pasadena Angels. 

By Jason McDowall

You’ve  shaken the loose change from friends and family, and now you’re desperate for cash to get your startup to the next level.  Do you think any check that doesn’t bounce belongs in your checking account?  In my experience, I believe you should be picky about who supplies the cash.  If your investors aren’t helping your company, they’re hurting it.  Here’s what can go wrong:

Risk: the investor does nothing

Who cares?  At least you’ve got some extra time and resources to build your dream, right?  That hasn’t been my experience.  Sure that convertible debt or silent investor may have bought you extra time, but your milestones and plans are probably wrong to begin with.  You’ll need even more time and more resources to execute than your business plan indicates.  For seed-stage companies, there is so much work to be done, so many adjustments to make, so many relationships that need to be established that you need your investors working for you.  Why waste your time or equity on an investor who cannot contribute essential customers, contacts, or credibility?  Your competitor is already better funded and has that support.

Risk: the investor promises a lot and does nothing

This is even worse than the risk above because you have misplaced expectations and end up wasting a bunch of precious equity/cash/time on a non-delivering member of the team.  If you are lucky enough to have someone offer you money, you owe it to your company/team to do some reference checking on the source of funds.  Talk to other companies that have received investments from the same source, and find out if they have they delivered on similar promises in the past.  If the investor is taking a role in the company (e.g., temporary C-level exec, VP of anything) check the investor’s work references just as you would for any other hire.

Risk: the well runs dry…or loses interest

Chances are the specifics of what your company does and how it makes money will change between the start and the declaration of success.  And to make it more challenging, it will take longer and cost more than you think to get there.  An unsophisticated investor or one unfamiliar with your industry may not have the appetite for the inevitable trial and error process.  You definitely need to be smart about market validation and finding ways to try/learn/adjust quickly

But you also need an investor who appreciates the need for, and can supply or quickly facilitate, additional funding to get you to that next major milestone (assuming you deserve the chance).  Finding an angel who made a bunch of money in real estate to invest and take a board seat in your web widget software startup is probably not the best move.

Risk: adversity strikes and visions begin to differ

At the beginning, everyone is full of excitement and enthusiasm.  But as you struggle to make your milestones and find yourself tweaking the business model, things can quickly get contentious.  It can be hard enough to keep the founding team on the same page, motivated, and making progress.  Having to deal with investors who have different visions of how and where to make necessary adjustments can make life miserable.  I’m not suggesting investors should all be drinking the same amount of Kool-Aid and believe all of the hopeful assurances of the founder.  But you should make sure financial incentives are properly aligned and voting procedures clearly in place to help deal with the hard times.  Also ask other portfolio companies how the investor has dealt with hard times in the past.  If you’re looking for strategic money at the seed stage, understand how that will likely restrict your growth options in the future.  If you’re looking for angel money, he or she needs to understand the likely dilution of ownership and power that will come if you end up needing another round.  And when things begin to diverge from the plan, be clear, be honest, and be prepared to make some concessions.

Creating a successful company is hard.  It requires a market insight, hard work, tenacity, flexibility, and some luck.  And it requires a lot of help.  In addition to cash, seed investors (and board members) should bring or be at least one of the three essential C’s: contacts, customers, or credibility. Remember that due diligence goes both ways.

Now if you could just elicit enough interest to actually have a choice….

Every startup faces the question of who to hire for their first sales position. Do you look for that fantastic VP of sales who is not only a great closer, but also a master strategist? Do you hire that friend of the founder who is young but promising? How do you decide?

Start by considering what you really need. Most startups have several specific needs that your first sales hire must fulfill. Hiring a salesperson is no different than building a piece of technology. Your management team should agree on a specification for the position, and then hire to that spec. Otherwise, you risk “falling in love” with candidates that may or may not bring the skills your company needs.

The likely list of needs:

1. Sales Momentum
Every startup simply needs to begin making sales. Look for someone who has sold a similar product successfully in your space, and who has some small company/unit experience. Dropping a successful corporate salesman into a startup can be a disaster. You need someone who shows evidence of self-sufficiency, not a prima donna. Have they pioneered a new geographic market or launched a new product? Started a new department? Look for the clues. Ask your candidates to cite examples of creating momentum in their past jobs.

2. Raw Sales Talent
Don’t trust resumes—make the candidate demonstrate their sales technique. The best interview “test” I was ever given was being asked to formally present my tentative sales strategy to the entire management team of a startup. I stood up with my PowerPoint presentation, pitched it to the management team, and then took questions on why I choose that approach. That management team got a thorough demonstration of my abilities to make enterprise sales.

Ask your candidate to give you a sales pitch—either for their current product or a rough version of the pitch they’d use for your product.

3. Market Intelligence
Your first sales hire is going to bring back critical market feedback on your product as he sells. The right salesperson will be a very important member of your product development team.

Check their abilities by talking to past or current clients. Does he/she listen well? Can the client describe a situation where the salesperson went “above and beyond” to make their product really work for the client? Talk to at least 2 clients and find out.

4. Process Building
Your first sales hire is going to build version 1.0 of your sales process. They will develop the sales message, build pipeline tracking and forecasting, and lay the foundation for scaling up the sales team as you grow.

The right candidate will be able to show you examples of how they have done each of these tasks in the past. Can they give you a crisp “elevator pitch” for their current product? How accurate has their pipeline reporting been in the past? Look for examples.

The overarching message is this—hiring a sales candidate is no different than building your product. Build a spec, and hire to that spec. Don’t be afraid to test your candidates—have them do presentations, talk to clients, find out why they win and lose accounts. Don’t become obsessed with finding the (probably mythical) perfect VP that you will keep on the team for all time. Just find someone who can get the job done right now.

Parting thought—“Hiring with Your Head” by Lou Adler will help you formulate your thoughts. You can find it at Amazon.

After starting 5 successful companies including 2 acquisitions, 1 IPO and my last company, StrongMail Systems… The first few weeks of starting my newest company, the Rubicon Project, reminded me of how critical it is to have the right team. I have been absolutely amazed by what an A++ team can produce in short periods of time. It has reaffirmed every thought I have ever had about my philosophy that great companies are built by great people.

To me, bringing together the right team has always been a product of trusting my instincts and my initial gut on people. So, I decided to spend some time trying to document what it is that I look for.

Here is what I came up with:

1. Trust
If you can’t trust someone 100%, don’t bring them on to your team. Period. If you do trust them, support them 100%.

2. Winners
Once someone has had a taste of success, they can never shake it. No one wants to do something less than their last win. So, those who have been part of a winning company have set the bar and anything less than exceeding that bar, in their mind, is failure.

3. Fire in the Belly
Hire people with an insatiable appetite for getting things done. You can generally tell who these people are because they can’t sit still in their seats.

4. Good Athletes (versus Good Resumes)
Things are constantly evolving at a startup. It’s more important to hire quick learners that can adapt versus deep experience. Smart people figure things out and will help evolve the business. Plus, they bring a fresh perspective.

5. No Egos
Strong egos will kill the culture of an early stage company. They will bring out the negative egos in everyone. Kill it fast, otherwise it will spread like a contagious, mutating disease. All for all and none for one.

6. Active Communicators
Communication is contagious. The more “in the flow” communication, the better.

7. Diversity
While it is good to have like minded individuals, it is equally important to balance that with people who have different perspectives and points of view.

8. Entrepreneurs
People who are driven to build something, will. Don’t be afraid to hire people with high ambitions to start their own company. These people will be your best leaders.

9. Hard Working
Speed is one of the core strengths of an early stage company. Hard working people that are committed to winning will spend the extra time to learn. It allows them (and the company) to make more mistakes (on the path to finding the right answer).

10. Pride
You can’t teach people to take pride in their work, so find people that do. Pride trumps all other motivators to do a superb job.

11. Purpose Driven - Focused on Results, Not Methods
All too often, people focus too much on the methods and not enough on the results. Find people that are driven by the results and are bored by the methods.
Warning: Stay away from people who talk about things like planning and architecture before they talk about purpose (the end goal). The most productive people start every plan by clearly stating the purpose first.

To me, these are the minimum requirements; all are required without exception. This is not a case where 10 out of 11 is good enough.

Another thing to note, is when bringing a founding team together, ensure that you all share the same criteria and values in people. Great people attract more great people.

While traveling on an international flight recently the seat belt light went off and drinks were on the way. I looked to my left and opened up a typical in flight conversation with my neighbor. After some brief chit chat I introduced myself and told him a little about my executive search experience and my adventures with the Pasadena Angels.

This information perked his interest. He is an engineer with a masters and bachelors working in the aerospace industry and apparently doing very well. He looked me in the eye and said that he wants to go into business for himself and he wanted me to give him a tutorial on how to do it. This request is similar to describing nanotechnology in 10 words or less. We discussed all of the basic ingredients: a unique idea or product, patent protection, a sound business plan and executive summary, capital, etc. Then I paused and said, “it is all about the people.”

In my combined experience as a search consultant and private equity investor one of the most important ingredients to ensure being able to raise money and build a business is to develop a sound, well thought our corporate culture at the very beginning stages of the business. All of your future hires will be based on this template for building effective teams.

My neighbor asked a very good question. “How do I put together a staff to help me launch the business? Very early stage companies , especially first time entrepreneurs, use the most logical approach. They open up their rolodex and ask “who do we know that may be able to do what we think we need and do it for very little or no money?” The first sound advice is to try to resist the temptation of hiring friends and neighbors who do not fit the hiring plan. There will come a time, usually early on in the ramp up that the lack of relevant experience becomes very costly. It is never easy firing your brother-in-law even though he is not making much money. The hiring plan is an essential part of the business plan. Hire the best, most experienced people that fit into the corporate culture matrix.

“How do I do that when I have very little capital? ” At the earliest stages of development, creativity is a key skill set for any entrepreneur. Network! Network! Network! Attend every event, seminar, lectures and make calls to anyone who will listen. If you have a great story there are many people who will listen and want to be a part of that story.

Once the core of the company is assembled you need to continue to network with other successful entrepreneurs who can look at your team and tell you where the holes in the staffing plan are and in many cases point you toward people who can help you fill those holes. “Why would a successful business man answer my call?” He was where you are a few years ago and remembers it and those folks who reached out and helped him. Use the Universities, there are some very bright MBA candidates that will pitch in for little money to gain some tangible experience.

Our cheery flight attendant just provided both of us another bloody mary. My neighbor got to his most important question; “How do I raise capital?” When it is time to go out and raise some money to help launch the venture have some experienced investors review your plan, team, revenue models and help you polish the plan and the pitch. The typical hiring holes in most start-ups are: lack of an experienced financial professional, no experienced marketing and/or sales staff, weak business development skills. One thing that all investors want to see is rapidly growing revenues based on quantifiable models. Early stage Angel Investors are more likely to fund a company that has a working prototype and better yet they are generating revenue. The plasma of the start-up is equity; when designing the financial structure, make sure that you build an adequate pool of stock for current and future hires into the model.

Many start-ups are created by technical people who understand the nuts and bolts of building a prototype product. In many cases they are inexperienced in how to manufacture it, market it and sell it. Get Help! There are many very good companies who can fill in the gaps in a recruiting plan and will do it for equity. This is also true of the “make/buy” decision for hardware and software companies. Investigate outsourcing parts of the development to experienced vendors that will work for equity or a combination of equity and cash. Don’t get blinded by keeping a set percentage of the company for yourself or holding out for a valuation that you think is fair. The market will show you the true answers to these questions.

Many executive search consultants will provide their skills to start-ups and take some equity for services. Early in the formation of the venture, learn everything about the market, competitors and investors in the space. Find advisors from this arena who can help with many of the needs you have and will have. Angel investors provide a great pool of qualified people who are excellent early stage advisors.

As an entrepreneur you will always need good people on your team and you will always be raising money. Hire good people who fit your corporate culture and never stop networking!