Friday, February 12, 2010

What Do an Angel Investors Expect?

I’m often asked what the expectations of angel investors are when it comes to creating a relationship with a small business owner or entrepreneur.  The entrepreneur is obviously interested in business financing, potential contacts that the investor may bring as well as the valuable experience contributed by the angel investor. So what does the angel want in return? Well, there are almost as many answers to what angels expect as there are angels. Each has their own criteria and needs because they are individuals. Almost all want a board position and possibly a consulting role. All want good communication although for some that means quarterly reports, while for others that means weekly updates. Return objectives range from a projected internal rate of return of 30% over five years to sales projections of R20 million in the first five years to the potential return of five times investment in the first five years. Most are looking for anything from a five to 25 percent stake in the business. Some want securities - either common stock or preferred stock with certain rights and liquidation preferences over common stock. Some even ask for convertible debt, or redeemable preferred stock, which provides a clearer exit strategy for the investor, but also places the company at the risk of repaying the investment plus interest. Additionally, the repayment may imperil future financing since those sources will not likely want to use their investment to bail out prior investors.

Some angels ask for the right of first refusal to participate in the next round of financing. While this sounds eminently reasonable, some venture capitalists will want their own players only or certain investment minimums so this strategy may limit who future participants might be.

Future representation of the board of directors also needs to be clarified. When a new round of financing occurs, do they lose their board right? Or should that could be based on a percentage ownership - when their ownership level drops below a certain level, they no longer have board representation.

In order to protect their investment, angels often ask the business to agree to not take certain actions without the angel investors approval. These include selling all or substantially all of the company's assets, issuing additional stock to existing management, selling stock below prices paid by the investors or creating classes of stock with liquidation preferences or other rights senior to the angel's class of security. Angels also ask for price protection, that is anti-dilution provisions that will result in their receiving more stock should the business issue stock at a lower price than that paid by the angels.

To prepare to solicit an angel, several critical factors will aid in making the approach successful. First, assemble an advisory board that includes a securities accountant and an attorney. Two important functions of the board are to recommend angels to contact and to work with the management team to develop a business plan to present to the angel. The business plan itself should define the reason for financing, how the capital will be spent and the timetable for going public or seeking venture capital funding. It should include: an executive summary (description of the business, opportunity and strategy, target market, projections and competitive advantages); the industry, the company and its products and services (including entry and growth strategies); market research and analysis (customers, market size and trends, competition, estimated market share and sales); the economics of the business (including gross and operating margins and break-even analysis); marketing plan (overall strategy, pricing, advertising, promotion, and distribution); design and development plans (product/service improvement and new products/services); manufacturing and operations plans (geographic location, facilities and capacity improvements); management team (organization overview, biographies and compensation plans for key employees); financial plan (tax returns, profit and loss forecasts, pro forma cash flow analysis and balance sheets, 5-year projections); and proposed company offering (desired financing, securities offering, capitalization, timetable).

Most of all, take your time in forming a relationship with the business angel you have in mind. You are going to be spending a number of years together at a critical time in your business' life. Take the time to assure yourself that this is a person who you are comfortable with through both the ups and downs the future will bring.

Our Sponsors

This Blog is co-sponsored by
SA Investors Network
SA Business Plans