Last Part of a Continuing Series on How to Select an Angel Group

In my original Top 10 list of criteria for selecting an angel investor, there were two items that aren’t often discussed, but are worth scrutinizing during the fundraising process:

- Honesty and integrity
- Are they respectful of entrepreneurs

If you talk to founders and CEOs that have gone through early-stage fundraising, many will share their personal stories about dealing with as***le angels. In partial support of this, Frank Peters wrote a recent post on the Top 10 Lies Angels Tell that contains a few chards of truth. On several occasions I’ve observed angels (and not members of the Pasadena Angels) publicly berate entrepreneurs. Probably the most memorable was when a member of another angel group looked a founder square in the eyes and told them in an obnoxious manner they weren’t CEO material—a rather ironic comment, since this angel had probably spent their working life as a service provider and had never been in an operational role, and especially not one in a startup.

Given all the turmoil and upheaval that’s occurred in the Angel community over the past two years, one question that invariably perplexes me: How do as***le angels survive and why isn’t there a self-correcting mechanism that purges them from our ecosystem?  In addition to losing bad angels for economic reasons, it also seems reasonable that the best entrepreneurs would avoid working with them and would force/encourage these angels to ply their trade somewhere else.

According to the Angel Capital Association, approximately 225,000 people have made an angel investment in the last two years, which would somewhat qualify them as angel investors. I suspect the majority of these individuals are decent people. As with other professions—or life in general—there will always be some bad apples.

Based on my experiences as an angel investor over the past seven years, I have three theories about why this occurs:

1.    There’s a significant imbalance between early-stage capital and good fundable companies, which means it’s a buyer’s market for investors, and companies can’t be as discriminating. I’ve talked in past posts about the funnels for most institutionalized angel groups and VCs, and that only about 1% of all the companies that apply get funded. Since this metric was from better times, I suspect it’s now even lower in the current economic climate.

2.    Entrepreneurs hear the hype about particular angel investors and that they’ve done the most deals and/or they’ve been around the longest, and are completely blinded by it. In many of these instances, entrepreneurs have done little/no diligence on these angels and have tended to overlook their negative character traits.

3.    Money talks and entrepreneurs get blinded once the term sheets and money appear, and once again don’t do sufficient diligence on their investors.

In addition to understanding why they survive, it’s also important to understand what created the as***le angels in the first place. For the good angels it’s an opportunity to give back and they enjoy working with entrepreneurs. For the as***le angels, it’s often they’re wanna-be VCs and/or relish the opportunity to express themselves in ways they weren’t able to in their previous careers. Apparently they’ve seen some VCs behaving badly and figure acting this way will give them some VC cred. (note to these types: you’re not really a VC if it’s personal and friends & family money, as opposed to institutional—unless you happen to be Haim Saban).

Even if an angel is on their best behavior during the early stages, you should still do some diligence on their personalities and post-investment reputations. Another good barometer for predicting these behaviors can be found in your initial experiences with the admin staff-or gatekeepers—for an angel group, as these people frequently reflect the attitudes and corporate culture of the angels that employ them.

Given the continued tough financing climate this year, let’s hope you can avoid the as***le angels on your quest for funding.

Part IV of a Continuing Series on How to Select an Angel Group

Several months before Jason Calcanis’ crusade (or jihad—depending on your political affiliation) against for-profit angel groups, I wrote a post about evaluating angel groups and the criteria to use when seeking investment. For those that didn’t see the earlier post, the list included:

1.    Do they charge fees
2.    Do they actually have capital and a track record of investing their own personal funds
3.    How transparent is their organization and investment process
4.    How do they say ‘no’
5.    Honesty and integrity
6.    Rolodex and connections
7.    Advice
8.    Are they respectful of entrepreneurs
9.    Do they help entrepreneurs, regardless of whether or not they invest
10.    Do they support the local entrepreneurial community

Although pitching fees—or pay to play—is a good litmus test for weeding out disreputable angel groups, you’ll also find that for-profit angel groups typically have a poor track record with these other criteria.

Most angel groups have money, and one group’s money isn’t any greener than another’s. Beyond cash, the other ways an angel group adds value to a startup is through great advice and personal connections.

One of the easiest ways to assess an angel investor’s ability to provide advice and connections is to read their bios on their website. High-caliber Angels with a lot of experience at both large and small companies, tend to have strong Rolodexes and skills that can be applied to helping portfolio companies. When reviewing their experience, consider both their work history and the companies they’ve backed as investors.

You can also judge the caliber of the group through your initial experiences, as many Angels provide worthwhile advice and introductions to their networks in the early stages and prior to investing. If you’re further along with an angel group, consider doing more diligence on the group and its members by contacting CEOs of their portfolio companies.

When it comes to connections, one of the most important when evaluating an angel group are links to VCs. Although many of our portfolio companies have told us the Angel round is the last tranche of money they’ll need (and they even say it with a straight face), most startups will invariably require follow-on funds.

A couple of years ago, William Quigley of Clearstone Venture Partners wrote an appropriate blog post, Value of Certain Angel Investors:

As a VC, I divide angel investors into two buckets.  The first group includes angel investors who know the space they are investing in. Perhaps they previously started a company in the same industry or were part of a successful company targeting the same market.  As it happens, angel investors in this category usually know the VCs who invest in their space and can be a great help in introducing a start up to smart venture capital investors. Better still, these angels typically know the going terms for a start up in their market. Accordingly, they can help the entrepreneur get the best deal warranted given the progress of the business.

The second bucket of angel investors are those who have some spare cash to invest but don’t have any familiarity with the target market. These investors are generally not known by VCs active in the specific market the start up is pursuing. In most cases, they can’t help with follow on fund raising. Because they don’t know what the going VC terms are, they often set terms for their investment that make it harder to raise money in the next round.

VCs can’t know everything about an industry. So how do they get comfortable with a new business? They rely on smart people who are accomplished and well connected in that industry. If someone of that caliber happens to already be an angel in your business, raising venture capital just got a lot easier.

Given that Clearstone has invested in one of our portfolio companies—LeisureLink—that’s managed by two of our members, it’s a pretty good bet that the Pasadena Angels fall into the first bucket.

In the current environment, CEOs and entrepreneurs don’t always have a choice when it comes to selecting their investors. However, when you do, it’s important to pick an angel group that can deliver the intangibles, such as advice and network, along with the cash.

Interesting post on Jason Calcanis’ blog this week (also picked up by Ben Kuo and SocalTECH) with further thoughts on Angel groups charging startup companies to pitch. All of his posts on the topic are not only good reading, but accurately describe what goes on within some Angel groups (e.g., These pay-for-play scams remind me of the “modeling agencies” that charge people for representation, acting lessons and to have their headshots done.). Although I’ve written on this topic and share Jason’s ire,  I’m not yet at the point of ‘jihad’ (crusade maybe) or calling out particular Angel groups. Other than what Jason and I have already mentioned, the only other advice I can give is beware of for-profit angel groups based on a franchise model–as those are typically the ones that charge companies. If they don’t make money the old fashioned way and exclusively through investment returns, then they aren’t worth talking to.

As I was writing another installment on what the Pasadena Angels look for in company pitches, I came across a good post from Steve Blank about sufficiently understanding your customer and target markets and decided to use that instead. Steve’s observations are pretty representative of what we regularly see when companies pitch.

Lastly, Jeff Sheldon, a longtime member of the Pasadena Angels and well respected IP attorney and litigator put together a good reference on Patenting Inventions.

Have a great weekend. Patenting Inventions

A few years ago, Joe Torre (when still managing the Yankees) wrote an article for Business Week (Joe Torre on Winning) that’s well worth reading. One of the lines in the article pretty much sums up one of the hardest things for Angel investors to do and something that happens on a regular basis: “I have had to release guys I loved, and keep players I didn’t necessarily care for.”

In the world of startup investing, Angels invariably come across a lot of great entrepreneurs that they get to know on a personal level and think the world of. Unfortunately they sometimes have to say “no” to these individuals because they aren’t completely comfortable with the company’s market space and/or technology. Conversely there are company founders that drove us crazy, where we ended up investing in their companies because we knew the venture had a very high likelihood of success. What also makes saying no particularly tough is knowing that many of these entrepreneurs have leveraged themselves to the hilt through credit cards and second mortgages and have given up well-paying jobs to pursue their dreams.

In an earlier post I mentioned that 1-1.5% of all applications submitted to the Pasadena Angels get funded. Realistically—and with a finite amount of time and investment dollars—our group can do a maximum of 12 investments each year. In our world, that means saying no to many entrepreneurs.

As you work with Angel groups (and also VCs), there are three pieces of advice related to this topic worth considering. Since fundraising can be a real (but necessary) timesink with a substantial opportunity cost, focus on getting a quick yes/no from prospective investors. Even if the answer is no, you’re way better off getting a quick answer and not consuming time with those that are not likely to invest.

Secondly, look at how the group says no to evaluate them as investors. Although this won’t make a lot of sense at the time you’re rejected, it’s worth doing since you may have another venture in the future where they’d potentially invest.. For reputable investors, the experience should be constructive, positive and polite.

Lastly Bill Burnham, a former VC, has a series of great posts on The Art of Saying “No” and goes into considerable detail about the process and some of the unsavory tactics used by VCs.  In his third post, Bill summarizes the four reactions he typically gets from entrepreneurs when hearing “no.” The best advice I can share is always make sure your reaction is #4– Thanks, this has been helpful.  Let’s talk if we raise another round.

Part III of a Continuing Series on How to Select an Angel Group

Imagine going to a VC or bank and receiving a bill for a few thousand dollars for your first meeting. Imagine also that the requests for payment only get worse the further into their funding process you go. By now you’ve probably figured out that I’m making this up. However, there are Angel groups that operate in a somewhat similar manner.

Here on the west coast there are angel groups that charge $3000+ for the ‘opportunity’ to present your company to them. These organizations are sometimes based on a franchise model and try to extract money from entrepreneurs any way they can. I’ve heard all the excuses from these groups, including that they have to charge entrepreneurs to cover their management expenses. Reputable Angel organizations typically cover their management expenses out of their own pockets and don’t ask struggling company founders to shoulder that burden. In reality the best Angels make money the old fashioned way—working with entrepreneurs to generate investment returns upon exit.

There are a couple of exceptions to this that are worth mentioning. Some reputable Angel organizations charge a nominal fee (~$50-100) to submit a funding application. The intent here is not to use this as a money making opportunity, but to provide a filter or sincerity test for the entrepreneur and to reduce the number of poor and incomplete business plans (aka junk) that get submitted. Secondly—and this applies to the vast majority of Angel groups and VCs—companies receiving funding (and only when that happens) will be asked to cover the investor’s legal expenses (~$15-20k) with the proceeds at the time of closing.

The Angel Capital Association (ACA) has some good guidelines about this on their website. They also “recommend that angel groups charge entrepreneurs no more than nominal fees for applying for and/or making presentations for angel capital and that all fees are fully disclosed, ideally appearing on the group’s Web site.” Out of 82 groups they also mention that two thirds of all Angel groups don’t charge any fees. Since starting in 2000, the Pasadena Angels has never charged companies fees for anything short of closing (applying, presenting, mentoring, etc.) and we’re proud to state this on our homepage.

In last week’s post I talked about how to evaluate an angel group with my Letterman Top 10 list. Today’s headline covers #2 of that list (Do they actually have capital and a track record of investing their own personal funds) and is from a story I’ve told at several entrepreneurial events. Although most people would assume it’s a reference to the Bible story, it’s actually from working overseas in a previous life.

Years ago while working in a country that had heavy-handed currency laws, I always had to go to a bank or other government-sanctioned business to exchange money at a ridiculously unfavorable exchange rate. As is always the case in these locales, you could find some enterprising entrepreneur that would exchange your US dollars at a more favorable rate. For many that ventured to do this, the common ploy was to receive an envelope of what looked like a big wad of local currency. In reality there were some actual bills on the outside of the stack and newspaper that had been meticulously cut and placed in the middle to make it look like you were receiving actual money.

With angel investing now in vogue in the US there is a similar con game for startup companies raising money, with many organizations masquerading as angel groups or individual investors. Although it could as easily be described as the angel equivalent of the email scam from my good friend the Nigerian Prince.

Several years ago one of our portfolio companies was invited to present to one of these purported ‘angel’ groups. At the presentation, the founder was approached by several members of the group who claimed to be angel investors. In reality—and after getting their legal hooks into the company and extracting exorbitant fees—were nothing more than consultants that offered to help the company raise money.  At the time the Pasadena Angels invested-and many billable hours of legal time later—we were able to extricate these individuals from the company—although not until considerable damage and expense had been incurred. Unfortunately this is not an isolated instance and occurs frequently.

Aside from making entrepreneurs aware that this goes on, the best advice I can share is twofold. Before proceeding with someone or an organization that claims to be an angel (or any other type of) investor, do some due diligence on that investor. Through websites such as SoCalTech it’s easy to access the old press releases announcing that an angel group has invested in a particular company. Call these companies and ask the tough questions—including how much of the investors’ personal funds were contributed.  If you can’t find any companies, ask the investor for specific ones that you can speak with.

Lastly, the only agreements you should be signing with an investor are the typical investment documents that are prepared just prior to closing on your investment and the money going into the bank. If you’re asked to sign an agreement early in the process or long before an investor has done sufficient diligence, be wary and always seek the advice of a good lawyer. In all of the situations where we’ve had to undo the damage to a portfolio company caused by these unsavory individuals, it was because an unsuspecting company founder had signed one of these consultant’s agreements.

Last summer, Jason McDowall wrote a guest post about his own personal experiences raising angel capital (not from the Pasadena Angels) and some of the challenges that followed. I recently re-read Jason’s post from June ‘08 and thought it would be a good lead-in to evaluating an Angel organization and the process of finding ‘smart money.’  Based on past conversations with Jason, my own personal fundraising experiences and discussions with other entrepreneurs, I’ve come up with my Top 10 criteria that entrepreneurs should consider when deciding which investors to work with. Although these criteria are rather self-explanatory, I’ll be doing some further posts on some of these topics over the coming weeks.

Top 10 List

1. Do they charge fees
2. Do they actually have capital and a track record of investing their own personal funds
3. How transparent is their organization and investment process
4. How do they say ‘no’
5. Honesty and integrity
6. Rolodex and connections
7. Advice
8. Are they respectful of entrepreneurs
9. Do they help entrepreneurs, regardless of whether or not they invest.
10. Do they support the local entrepreneurial community

The current economic crisis which we are facing is having a major impact on business everywhere. As one might expect, it is also having a significant impact on funding of early stage companies.

Earlier this month, Sequoia Capital communicated the seriousness of the situation with their portfolio companies (http://tinyurl.com/3sqrgy). The presentation started with a slide entitled “R.I.P Good Times” and ended with one which said simply “GET REAL OR GO HOME” before the Q & A. In between, there was substantial data presented on the economic reality along with strong advice on the need to preserve capital and to achieve profitability in short order.

Benchmark Capital communicated a similar message to their portfolio companies (http://tinyurl.com/3ku6es). They related the advice of a CEO who took a company during the dot-com crash through a 78% reduction in staff size, but was able to achieve profitability and eventually an IPO. The message was clear- survival mandates rapid course correction by all participants.

It appears that companies are starting to take heed of this advice. Just today the Financial Times reported a rapid reversal of the previously good mood, and a wave of job losses in Silicon Valley (http://tinyurl.com/5vrz3y). They cited the Sequoia meeting as a catalyst. Furthermore, CNET has started a live “scorecard” of tech layoffs to track the trend (http://tinyurl.com/5hcgkf).

So what does this all mean for the early-stage company which is trying to raise its first round of angel capital? First, it is important to understand that the cost of risk capital at all levels will go up substantially. This will directly translate into lower valuations and more stringent deal terms. Second, some companies which might have been fundable one year ago will no longer be able to raise funding- the bar has gone up. Third, it will take longer to close a funding event and may require the participation of more than one angel group to achieve the needed momentum. Fourth, turning to the operating plan, future funding needs, the cost of that money (higher), and the timeline needed to obtain it (longer) should be factored in. Revenue projections need to account for the current and anticipated future economic climate.

On the other hand, the door is not closed for focused entrepreneurs who have created disruptive new technologies in large and growing markets. There are major areas of unmet need in the green space, in healthcare (such as heart disease, obesity, and neurology), and in other areas. The key for the start-up today is to obtain market traction and profitability as quickly and as financially efficiently as possible.

Question: What kinds of things have entrepreneurs done (and should do) to increase the odds of getting funded?

From Matt Reno, Human Global Media

Answer: For this year’s LA County Tech Week, John Isaacson our Chairman did a presentation on “How to impress and Angel and get your company funded.” This presentation, which can be found on our website, provided a comprehensive overview of the common denominators (both good and bad) we’ve seen from companies pitching the Pasadena Angels over the past eight years. For John’s talk, he divided the presentation into the following topics:

• - What Every Entrepreneur Should Know
• - What We Look For
• - Investment Criteria and Cheat Sheet
• - Getting Inside the Mind of the Angel
• - Top Deal Killers

For this post I’ll address what every entrepreneur should know and provide some additional granularity to John’s main points on this topic:

1. Having a good idea is not enough

Every so often we come across an entrepreneur who believes they’re investment worthy based on how bright they are or because they came up with a good idea that was well articulated in a 2-page summary. Along with the funding criteria on our website, there are two other things we look for in companies: (1) a prototype or proof-of-concept that validates the company really can deliver on its idea; (2) the “plan” behind the plan, which I’ll address in a later post and covers how you’ll execute once you’re funded

2. Raising capital requires both time and money

Periodically we’re impressed by an entrepreneur that has left a well paying job so they could devote all of their time to their startup. To financially support their new venture, they will often take a second mortgage on their house and max out all their credit cards. The net impression when we see this is that he/she really believes in themselves and their business and have some serious ‘skin’ in the game. At the other extreme we’ve seen people who keep their day jobs, devote a few hours per week to their fledgling business and have invested only a few hundred dollars of their own money. Although you don’t have to follow the first scenario to secure funding, you should make sure that at a minimum you’re at least half-way between the two.

The two key points on this topic are you’ll need to invest sufficient time and money into your business to get to the point where a prospective investor will be interested. Secondly, the process of raising money will invariably be the hardest part in a startup—which also translates into time and $$$$$.

3. You can save time and money if you understand the investment process

Although this is stating the obvious, you’d be amazed at how many companies don’t take the time to do this.

4. Identify and contact prospective investors whose investment criteria match your situation

Once again, it’s pretty much stating the obvious. One added benefit of doing this is that this research may also help you discover things about the investor that you can use to get your company noticed.

5. It’s like college…you’ll be graded on a curve

Back when I was in college I was surrounded by a lot of very bright people. As if the situation wasn’t challenging enough, my class grades were often determined by how I did relative to them (and the class average), and not on an absolute scale.  Raising money is somewhat like that, because investors make only a limited number of investments. For the Pasadena Angels, it’s typically 12 per year. Although your company may be great on an absolute scale, the chances of getting funded will go down if an investor is simultaneously considering more investment worthy (i.e., stage, market, team, exit, etc.) companies. Historically, there’ve been many good, potentially fundable companies we’ve had to forego because of this.

6. Don’t stop till it’s done

At times we’ve watched entrepreneurs reduce the amount of time and energy they invest in the fundraising process after hitting a milestone along the way—but before actually having the money in the bank. The most common time that we’ve seen them ease up has been after receiving the term sheet and investment agreements. The amount of time and enthusiasm that you expend during the latter stages should be the same as when you’re first pitching. Remember, don’t stop until all of the money has closed and it’s in the bank.

For more advice on raising money (particularly the human intangibles that we look for), you can find a good presentation by David Rose of the New York Angels on TED.com.

Question: I’d like to read more about your process–flaws and all.

From Andrew Warner, Mixergy Nation

Answer: Let’s assume that before applying, you’ve reviewed our website and fully understand our investment criteria (you’d be surprised at how many entrepreneurs/companies don’t do this). If so, the first step is the online application. Three years ago we went to a much simpler format that takes 10-15 minutes to complete. In return for simplifying the process, we ask that the executive summaries included with the application address all of our key points and investment criteria.

With the executive summary, you should emphasize the most important details about your idea/company (how you’ll make money, exit event and returns for founders/investors). Since we don’t always do well with deductive reasoning (i.e., looking at tons of data and drawing our own conclusions), you should be direct and to-the-point about this. Although most companies are good about explaining this, we get many applications each month that are well off the mark.

On the second to last Wednesday of each month, I get together with about 20 of my colleagues and we engage in some healthy discussion and debate about the companies that have submitted funding applications. It’s a very democratic process (and well moderated by Bill Zimmerman and Chuck Stephens), compared with other angel groups where you have to get past the ‘gatekeepers’ and/or there’s a small cadre of members that control the agenda.

The companies we review usually fall into one of three categories: 1) The top six companies that are invited to present that month; 2) Companies that are not quite ready for funding, but where we’ll help develop the business further through mentoring, and where if things go well may have a chance to present in the future, and 3) Companies that are turned down, often because they’re in sectors where we don’t invest, too early a stage, or are not likely to generate sufficient investment returns vis-à-vis risk. If you fall into Category #3, keep in mind that the ‘door’ is never completely shut and there’s sometimes an opportunity to present in the future

If you’re in the top six, you’ll be invited to do a 30-minute presentation to some of our members on the last Wednesday of the month. Assuming that goes well, you’ll then be invited to present to all of our members at our monthly breakfast on the first Wednesday of the month. If there’s sufficient interest from our members, we’ll begin the due diligence process, which is a fancy term for further vetting of your company, technology, target markets, finances, team, etc. For companies that we’ve funded, the process from initial application to money in the bank is typically 3-4 months.

Post-investment is where the real fun and heavy lifting begins. Our help to our portfolio companies has ranged from informal assistance to having a board seat to providing the CEO and VP (Erik Hovanec and Steve Reich) to LeisureLink. The bottom line here is that you’ll have access to a network of experienced executives and value-added contacts that can provide significant guidance and assistance in the growth of a company.

One other way to put the overall process into perspective is to talk about the numbers on a monthly basis:

80-100 funding applications
6 invitations to present at the screening meeting
1-2 invitations to present at the member breakfast
One company funded per month (on average)

As you can see, it’s a little like applying to Harvard—similar percentages, but without the elitism and having your father donate a library in order to get in.

In my next post, I’ll talk candidly about some of the things entrepreneurs have done during our fundraising process to increase the odds of getting funded—along with some of the most common deal killers. Since Andrew’s original question asked about ‘flaws and all’, I’ll discuss these as well.