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.

Seeing last week’s Venture Capital Dispatch in the online Wall Street Journal, When Venture Capitalists Let One Slip Away, reminded me of Jim Armstrong’s (Clearstone Venture Partners) comment last year about false negatives. “You can afford to have a false positive; you can afford to invest in things and fail, but because the big ones are so rare, you cannot afford a false negative. You cannot afford to be looking the wrong way.”

Some VCs, like Bessemer and their Anti-Portfolio, list their best false negatives on their website. As Bessemer puts it, “Whatever the reason, we would like to honor these companies, whose phenomenal success inspires us in our ongoing endeavors to build growing businesses. Or, to put it another way: if we had invested in any of these companies, we might not still be working.”

If you think VCs and Angels have had some of the biggest investment oversights, here are some of the bigger and more amusing ones from outside the VC community:

“We don’t like their sound. Groups of guitars are on the way out…You really should stick to selling records in Liverpool. Electric guitars are now old hat. (Mike Smith, Decca A&R manager, turning down the Beatles in 1962)

“There is no reason anyone would want a computer in their home.” (Ken Olson, president of Digital Equipment Corp. in 1977)

“You ain’t goin’ nowhere son. You ought to go back to drivin’ a truck” (Jim Denny, manager of the Grand Ole Opry when he fired Elvis in 1954)

“You’d better learn secreatarial work or else get married” (Emmiline Snively, director of Blue Book Modeling Agency to Marilyn Monroe in 1955

“Rembrandt is not to be compared in the painting of character with our extraordinarily gifted English artist Mr. Rippingille.” (John Hunt, 19th-century art critic, on Rembrandt)

“You’ll sink, not like a lead balloon, but even faster, like a lead zeppelin.” (Keith Moon, drummer of the Who, when Led Zeppelin was forming)

“(His) compositions are deprived of beauty, of harmony, and of clarity of melody.” (German music critic in1737 about Johann Sebastian Bach)

“Far too noisy, my dear Mozart. Far too many notes.” (Emperor Ferdinand of Austria after a performance of Mozart’s Marriage of Figaro in 1786

These examples should give you a pretty good idea why Angels and VCs don’t typically invest in music, movies or other forms of content.

On Thursday (10/22) this week, join us for a full day of worthwhile events in Altadena at Tech Week. The morning’s session features a Cleantech program, moderated by Ben Kuo of SocalTECH.com. Along with Ben’s program, there’s a great keynote presentation by Barbara McQuiston of DARPA and a couple of panels featuring Wired Magazine reporters.  [Shameless Self-Promotion Alert]…The last program of the day is the annual Pasadena Angels program on the state of Angel and Venture Capital in Southern California. We’ll have a great group of panelists (no immodesty here, since I’m just the moderator) that afternoon, and I’ll provide some comments and feedback from the event in my next post.

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.

Over the course of this week I’ve come across some great articles and blog posts that should be required reading for any entrepreneur looking for funding—including those that have done it before. Starting with The Entrepreneurs Report from the law firm Wilson Sonsini Goodrich & Rosati (WSGR) there are two articles from outside contributors on Perfecting Your Pitch and How Do I Get Meetings with Investors. For the first piece you can pretty much substitute ‘Angel’ for ‘VC’ and it’s right on the money with respect to the Pasadena Angels. One word of caution, however, when reading the WSGR report, try not to dwell on the VC financing trends. The good news in all this is that although Angel and VC financings are down, there are still good companies getting funded as we speak.

A couple of other good posts/videos that I’d highly recommend are Tony Tjan’s the Great Entrepreneur’s Secret and 10 Things to Know Before You Pitch a VC for Money by David Rose which do a good job of covering the intangibles we look for in entrepreneurs and pitches.

By now everyone has seen the infamous Sequoia presentation, R.I.P. Good Times. From what I can tell traveling around the US and overseas, it looks like these slides have circulated faster than the Paris Hilton video (sorry, no link on this last one–you’ll have to find it yourself). If you’ve already seen the presentation, there’s a good post worth checking out from Silicon Alley Insider that provides a few more details on what was discussed at the all-hands Sequoia meeting.

There’s also a good post from last week by Jason Calcanis of Mahalo, What to do if your Startup is About to Fail. Although it’s vintage tell-it-like-it-is Calcanis and a little disparaging of investors (VCs), it provides some further thoughts and granularity for dealing with the current tough times.  Although Jason’s been in the news this week for not fully vetting a prospective employee and accidentally hiring a felon, don’t discount the worthiness of his advice. Even though we may not agree with his explanation and apology for this recent mis-step, I can vouch for the quality of his advice having been on the other side of the table in a number of startups.

As some of you know I just returned from New Zealand where I shared some of our local startup knowledge and experiences. Overall the trip was energizing with an opportunity to see what we experienced in the early days of the tech communities in Southern California and Silicon Valley. Although I had a chance to see some impressive green tech and web 2.0 companies, the most interesting encounter was with Dr. Tom McKaskill, an Australian entrepreneur, writer and professor who has a lot to say about creating lasting value in companies and exits. In the current climate, where angels and VCs are even more driven by exits and liquidity events, Tom’s wisdom is quite timely. If you have a look at Tom’s website, be sure to check out the articles and two of his more popular books, The Ultimate Deal 2 and Get a Life!. Although his books aren’t sold in the US, you can order them through his website.

Every company has to face it sooner or later—selling against that entrenched player in your space.  You know the one.  They are the guys with the industry standard solution; they have every bell and whistle known to humanity.  No one every got fired for picking their solution, even if it is weak in some areas.  What do you do?

There are a few key steps you can take that will maximize your chances of winning, or minimize the expenditure of resources in an unwinnable situation.  I ran into this situation 3 weeks ago, and was reminded again of all the painful lessons (and a few glorious wins) that I’ve gotten at the hands of the 800lb gorillas in several industries.

Step 1: Tell the customer why they should buy your solution

There is no reason for someone to take the risk of buying a new solution, rather than the industry standard, unless there is a big payoff.  Why should the customer take the risk of buying your service or product instead of the safe choice?  You not only need a crisp answer, but one that translates into dollars and cents.  Be prepared to explain your advantage.  Provide examples and references.  Hammer the point home.

In our case, we presented to a large prospect that wanted internet distribution for their product.  We have an excellent network, with far broader distribution than the gorilla.  We drove the point home, and at least 3 or 4 people in the presentation nodded their agreement.  So far, so good.

Step 2: Understand the politics in your customer’s organization

Picking a new, risky vendor is an inherently politically charged situation.  Is there someone allied with the gorilla at your prospective customer?  You better identify them, quickly.  They will try to shoot you down at every opportunity.  Is there a new person on the scene who has reasons to pick an radical new solution?  Some of my best supporters have been young managers who are anxious to do something new and bold.

In our case, the gorilla-lover constantly argued, and continually raised new challenges.  Can you do this?  Can you do that?  What about a call center solution?  The gorilla has one, so where’s yours?  What about the security certification that the gorilla announced last week?  Do you have one yet?  I wanted to throw something at him.

What he didn’t know was that we had an ally on the senior management team.  I had out-flanked the gorilla-lover by having some discussions beforehand.  Without that political support, we would have been on the defensive throughout the presentation.

Step 3: Know when to cut your losses

There will be times when you simply can’t win, and you need to identify those situations before they consume your scarce resources in a losing cause.  Without the support of the Senior Management player I mentioned, my sales effort would have been wasted.  Worse, I could have been drawn into trying to match the capabilities of the gorilla.  There is always a temptation to say “I could build that, too” or something equally foolish.  Why would anyone buy your promise to duplicate the gorilla’s solution over time, when they could by the complete solution from your competitor now?

To win, you need a decisive advantage, but that is not enough.  You need to cultivate allies in the target company that value that advantage, and are willing to take some risk to get it.  If either of those key components is missing, think hard about whether you should proceed.

These are hard calls.  Prospects are few and far between, especially large ones.  Giving up on prospect runs counter to our belief in our business, and can be hard to explain to the rest of your team and your investors.  Know yourself, and pick battles you can win.  Remember, if you engage to early and lose decisively, you may never get another chance at the prospect.  If you choose to fight again another day, you are still in the game.

By the way, we ended up getting part of the business at the prospect I mentioned.  Politics carried the day.  Our Senior Management ally gave us 40% of the business.  Wisely, he chose to test our services, and use our presence to beat down the gorilla’s prices.  Everybody won, except the gorilla.  We got a healthy fraction of the business, and our executive ally looked statesmanlike for testing us in a prudent way.

Intellectual property litigation can be the death knell of a startup.  Not only is the litigation costly, it distracts the company founders from operating and growing the business, and  it makes it a lot it harder (if not impossible) to raise capital.  If the litigation turns out really badly, an injunction can be issued that shuts down the business and there can be a substantial damages.

It’s impossible to completely protect a new business against an intellectual property lawsuit.  However certain steps can be taken, including:

1. Have trademark clearance searches conducted on all trademarks adopted, the name of the business, and the domain name used.

2. Have a right to use study conducted for any new products and methods.

3. Confirm ownership of all intellectual property of the business.

Even if these steps are taken, litigation can still result.  The diagram below can be helpful and gives you a rough overview of what happens if litigation occurs in a Federal Court. Hopefully this graphic also provides good incentive for avoiding it. I also have a good summary that compares patents, trademarks, copyrights and trade secrets, Send me an email at info@pasadenaangels.com if you’d like a copy.