Invergarry Partners

A friend asked me for advice about making an investment in an early-stage company. “What’s your angel investing thesis?” I asked him. He didn’t have one, so I gave him these thoughts and share them with you here.

1. Do your angel investing in the context of an overarching personal investment plan. You want to know that if your angel investment portfolio does not return all or any of the principal you’ve invested in it, you’ll still have enough money for college education, retirement and health care. The best way to do this is ask a professional money manager for help – unless you have the time, the talent and the interest to manage your entire portfolio of assets yourself. Most people with wealth do not have all three of these and so they work with a professional. You might choose to manage your own angel investments and allow a professional to manage the rest – with your careful oversight, of course.
2. Make sure you qualify to invest in the eyes of the IRS. You must meet the SEC’s definition as an “accredited investor.” As you are making an angel investment, you’ll sign a document that attests that you qualify. Check out the current definition at The definition is about to change so please check the SEC website again before you invest. Don’t invest if you don’t meet the criteria.
3. Have a Definition of Success. Are you investing first and foremost for financial returns, or do you have some other definition of success in mind? Many angel investors have a primary goal of helping entrepreneurs succeed through their advice and connections. Some want first to create entrepreneurial wealth in their geographies, because they know that successful entrepreneurs will re-invest some or even most of their winnings in other entrepreneurial ventures. A few angel investors put financial returns first. Begin with the end in mind.
4. Set a target for the percentage of your liquid assets you want to invest in this asset class. You may need the help of a professional money manager here. A standard percentage is 10% but your allocation could be higher or lower than that depending on your age, your income, your current asset mix and other factors.
5. Set a goal for how many years you will take to reach this target. It’s tempting to make all of your angel investments in one or two years. You may have better results if you spread your investments out over three to five years.
6. Set a target for the maximum amount you will invest in one year in this asset class. Once the angel community learns that you are starting to invest in this asset class, you will likely get more opportunities to invest than you are willing to make in one year.
7. Set a target for the maximum amount you will invest in one company. This will cause you to decide if you want to be an active angel investor and spread your investable assets over a larger number of companies (say, ten to twenty of them) or if you want to place big bets on one, two or three companies.
8. Decide what your initial investment in a company will be as a percentage of the maximum you are willing to invest in it. You have to assume that the company will ask you for a follow-on investment, either because its capital access plan calls for another round or because it is struggling to meet its goals. In either case, you might be glad you did not put all of the money you’ve allocated for this company into your initial investment.
9. Decide if you want to diversify your angel investments by industry. If you have decided to make investments in multiple companies over three to five years, do you want all of them to be IT companies? You may want to invest in a few biomedical, alternative energy or material handling companies as well.
10. Decide if you will invest alone or with an angel fund or angel group. Groups and funds invest in specific types of companies and create due diligence materials on their targets that will almost certainly be helpful to you. Or you may decide to “go it alone” because you have knowledge about a specific company or industry that angel groups and funds generally avoid (like consumer package goods or companies that are not started with the goal of selling to a strategic investor.) If you are looking for an angel group or fund near you, visit the website of the Angel Capital Association for the best help and advice.
11. Have a reason to invest in each company. Are you investing because of the quality of the management team? Do you have to completely understand the idea behind the company in order to invest in it? Will you only invest in a company whose product or service you would use yourself? These criteria are not mutually exclusive, yet you may want to pick one of them and say “above all else, this is why I invest in these types of early-stage companies.”
12. Provide entrepreneurs with a quick “no thanks.” An entrepreneur’s most scarce resource is his or her time. You will help if you dimension an envelope into which deals you will pursue must fall and, importantly, what deals you will turn down immediately. One approach is to not devote time to any industry in which you have no interest. Another is to only focus ideas which solve significant problems and are not aimed at merely improving levels of frivolous entertainment. A third is to avoid investing in any idea which would not make you proud to read the headlines regarding your being a supporter (e.g. the usual “sin” ideas involving gambling or gaming). Entrepreneurs will appreciate the immediate turn down so they can redirect their time to other investors. Little is as frustrating to an entrepreneur as when an angel declines to invest after many hours of involvement due to the industry or some other factor which was known in the initial meeting.
13. Pick a benchmark by which you will measure your financial returns. Will you focus on your cash-on-cash returns, internal rate of return or some other measure? Using cash-on-cash as your criteria means you are likely to make fewer, bigger investments. Using internal rate of return means you are better able to compare how your angel investments have done to a similar amount of money left in the public markets.
14. Know when to break your rules. If you are sitting on the board of a company or know that the founder and/or CEO of a company have a concrete strategic advantage in the marketplace, it may be time to invest more than your maximum per company or per year in one company.

My attorney would ask me at this point to remind you that I am not licensed to give you or anyone investment advice. If you have any questions, refer to rule number one above!

My thanks to John Huston, founder of the Ohio TechAngels, for his careful reading of this note and one critical addition to it. My wish for you is that you able to find someone as wise as John to guide your journey as an angel investor.

I wish you the best of luck on this journey. If you are starting out on a road trip from New York to California, you’re more likely to arrive there on time if you start with a plan than you are without one. You might get lucky and arrive at your destination even without a plan. But why risk it? The same thing is true of angel investing. You can always change your route along the way!

Angel, Educate Thyself

May 16th, 2010

Would you be surprised to know that about 5% of Americans are qualified to make investments in small companies that are just starting up?  In order to qualify as an “accredited investor” under the rules of the SEC, you must either have $1 million in liquid assets or make at least $200,000 per year.

Would you be surprised to know that only about 5% of these accredited investors actually make an investment in a private company?  This means that an incredible amount of capital is waiting to be invested in small companies, the very engine of our economy.  The people who make these investments have come to be known as angel investors.  The term started with people who invested in Broadway shows.

Would you be surprised to learn that only 5% of the accredited investors who have made at least one investment in a start up company belong to an active angel investor network or fund?  This implies that the other 95% of investors rely on their own business acumen, the advice of friends and relatives, or their intuition.

If you are someone who is curious about making an angel investment in a brand-new or relatively new business, congratulations!  You have a wealth of information available to you.  Go to the website for the Angel Capital Association to learn about their resources.  This is most relevant if you want to learn to make investments in companies that are based on intellectual property.  An idea that can be patented is often interesting to angel investors because it has the potential to serve a large market, either in the US or around the globe.  The bigger the market, the more someone will pay to acquire that company that you invested in when it was just a gleam in the founder’s eye.

Even if you don’t know anyone who is starting a company based around intellectual property, you may want to learn about how these investments are made as a way to become a smarter investor in businesses that are not.  You’ll learn lessons about deal terms, valuation of companies and evaluation of markets, products, management and boards that will serve you well as an investor.

The ACA was started by the Ewing Kaufmann Foundation in Kansas City.  It has an affiliate organization called the Angel Capital Education Foundation (the ACEF.)  The ACEF website has a wealth of opportunities for you to begin to learn about how to invest.

Angel investing is not for the faint of heart or short of cash.  Most angel investors learn their first valuable lessons by making ill-advised investments in companies that fail for reasons that become all too obvious in retrospect.  Angel investors reduce their risk by sharing due diligence material and discussions with other angels who are considering the same investment as they are.  Though an investment alongside other angels does not guarantee success, it greatly increases the chances of it.

I recently attended the Angel Capital Association’s annual Summit in San Francisco.  It was three days of drinking information from a fire hose.  It reinforced some of what I’d learned as an angel investor and made me realize how much I have left to learn.

Angel, educate thyself, then go forward and invest in a company with an idea that is irresistible and is being started or run by someone who has had prior success in doing so.  You can help spur the local and national economy by creating jobs for people and wealth for owners.  Some of that wealth may find its way back into your community in the form of charitable giving and seed capital for the next great start up company.  You will have a great adventure along the way!

  1. Tell the truth.  There is no reason to hide anything from your banker.  By telling them everything about you and your business, it helps your banker do her job to the best of her abilities.  If you try to do her job for her by making assumptions about what information will be helpful or harmful in her underwriting process, you may hurt your chances of optimizing your relationship.  Good news and bad news should travel at equal speed to your banker.
  2. Cash is king.  You should be able to show a history of positive cash flow that is sufficient to cover your payments of principal and interest on your terms loans by a factor of 1.25 times to 1.  The bank wants to see that you have cash cushion so that if unseen factors diminish future cash flow compared to your historical cash flow, you’ll still be able to make payments.
  3. Keep leverage low.  You should have enough equity in your business so that your debt is no more than two or three times equity.  If you are taking all of your earnings out of the business in the form of dividends or other cash payments, leverage may exceed the amount that makes your banker comfortable.  Again, she wants to see a cushion that you can fall back on if your business changes adversely.
  4. Don’t ask for more debt when you really need equity.  Business owners are wired to run their businesses on other people’s money to the greatest extent possible.  Bank debt is the cheapest and, until recently, the most available form of cash for a business.  If your banker tells you she cannot provide more debt until you raise more equity, it is a sign that your leverage is too high and/or your cash flow cannot support new debt.  Consider asking friends and family for equity injections that have repayment terms that are favorable to you and your business.
  5. Pay for professional advice.  You will distinguish yourself from other bank clients by presenting financial results that are examined and ratified by an outside firm, that are professionally presented with clear and concise narratives and footnotes and that are clearly the work of a professional.  Unless you are in the business of doing this very thing for others, use a professional.  Get into the habit early in the life of your business, and its value to outsiders who may be considering selling to you, buying from, investing in your business and buying your business will increase enormously.
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