Understanding the Angels: An In-Depth Look at Angel Financing

By CO Staff @canadaone | April 30, 2001

A CanadaOne Interview with Jay Levinson

If you need a fair sum of money to develop an early-stage business with high growth potential, finding an angel investor may be your best financing option.

Angel investors are wealthy individuals who--looking for greater returns than are often realized through traditional investments--invest in early stage businesses. Often highly successful entrepreneurs themselves, an angel may be interested in actively participating in the growth of your company. For the new entrepreneur, this can bring more to the table than just cash, as the angel's experience and network can have tremendous value.

So where can you find an angel? What are angels looking for? And what will it take to get a good deal in place?

To find out more about angel financing, we recently interviewed Peter Hamilton, a successful high-tech entrepreneur. After several successes in the high tech sector, Peter started VentureDrive, a company focused on enabling early stage transactions between angel investors and entrepreneurs. Here is what Peter had to say about angel financing.

CO	Before we get started, please tell us - what is VentureDrive?
PH	VentureDrive is a company focused on the early stage entrepreneur and the angel investor. We also have a network of mentoring partners that work with the entrepreneur, with VentureDrive and with the angel investors to help develop the entrepreneur's opportunity and create a defined transaction for the angel's consideration. In addition to our mentoring partners we also have many professional service providers that we work with and introduce the entrepreneurs to. All of our services and relationships are focused on accelerating the entrepreneur's search for financing and bringing higher quality transactions to our member Angels. We are often called an "Accelerator", which we agree with, but we are not an incubator. Our primary goal is to finance the entrepreneur's deal as quickly as possible by helping the entrepreneur to package his/her opportunity properly for the private equity investor and then presenting these deals to our own Angel members.

CO	What services do you offer to angel investors and entrepreneurs?
PH	Services For Angels One of the most important aspects of the VentureDrive model is the creation of an organized market for angel investors. Therefore the primary service we offer to angels is to provide them with a consistent supply of high quality, early stage deals. This means that every deal they see from VentureDrive has two main elements in place before the angel investor reviews it: The deal has a term sheet with a realistic valuation and a defined share based transaction; and The deal is due diligence ready for the investor. By creating a due diligence ready deal with a realistic valuation we have reduced the cost and risk of the transaction for the angel investor. We will also have shortened the realistic time required for the angel to make a decision about a deal and we believe we will increase the investor's average yield through higher quality investments. VentureDrive maintains a profile of each of our angels and we can match each of the deals to their specific investment criteria. This saves them time and allows them to focus on transaction that they are best suited to. Finally we offer angel investors privacy as well as the opportunity to network with other angels. Services For Entrepreneurs VentureDrive was created with the early stage entrepreneur in mind. We built a company specifically to assist these entrepreneurs with the structuring and packaging of their transaction to receive financing from the angel investors. The specific services we provide for them are: We provide monthly networking meetings where they can continue relationships and make new ones; We offer bootcamps every 4 months to allow them an opportunity to learn how to raise the money they need; We provide them with complete deal development services and professional mentoring to position them for financing; We select the best service providers and make them available to the entrepreneur (lawyers, real estate, insurance etc.); We shop their deal directly to our angel community both with our website and a full time resource in every city (Toronto, NY, London England); We provide connections to early stage VC's for subsequent rounds; We provide the entrepreneur with a brand; We provide the entrepreneur with informative and educational content; and We provide financing for entrepreneurs. There are other subtle services that we provide, but the above are the key ones.

CO	You're obviously in touch with a lot of angel investors. In our current market, how much money will an angel or group of angels typically invest in an opportunity?
PH	The typical angel will invest between $50,000 and $250,000 in a single deal. Sometimes they will invest more, but this is the norm. Angel rounds seldom exceed one million dollars, even with a group of angels involved.

CO	How has the market turndown affected the way that Canadian angel investors are picking and investing in deals?
PH	The market turndown has affected all investing and the angels are no exception. Simply put, they are performing more due diligence, reducing valuations and demanding earlier profitability through more controlled spending. They are looking for deals with the quickest path to profitability and are almost exclusively looking for deals that have completed the R&D stage and have some revenue. With public markets so depressed some Angels are placing funds back into undervalued stocks at the expense of the early stage market.

CO	What are some of the most common things that an angel will look for in an investment?
PH	The most common things that an angel looks for in an investment are: The angel always looks at the people first; The angel then looks at the idea to determine if it has merit and whether he/she can add value beyond the money; The angel looks for excitement and fun in a deal; Is technology proprietary? Are there significant barriers to entry? Is the opportunity simple and clear? An ROI of 2-5 times based on 2-3 year investment; Geographically close; A clear exit strategy; and A plan for profitability.

CO	Once an entrepreneur has the interest of an angel investor, what types of things does he/she need to have in place to close the deal?
PH	You must have the following things in place to close a deal: A term sheet with a clearly defined transaction; A subscription agreement to accommodate multiple investors within a specified time period; A lawyer who understands the deal; A registered company and company bank account; A due diligence document/checklist; and A business plan. These are the key things required.

CO	What are some of the most common things that will kill a deal once discussions have started?
PH	Deals get killed for the following reasons: The entrepreneur has an inflated valuation on the company and cannot come to terms with this; The entrepreneur wants to be paid commercial rates for sweat equity; The entrepreneur and the investor don't like each other; The due diligence information was not available or was wrong; The market changes and the angel or the entrepreneur get cold feet; The technology does not work; Extended negotiations and the angel finds a another deal; and Either party is caught in a lie.

CO	The return on investment is obviously critical to a deal. When will an angel expect their investment to start generating a return, and how will they typically expect to receive this return?
PH	This is a very hard question to answer, because every angel is different and every deal is different, but I will try. First let me say that this answer is different for "passive" versus "active" angels. Passive angels tend to invest in more deals at a time and usually want a quicker return. Probably 12-24 months, cash or liquid paper. Active angels get involved in operating the business and quite often draw an income from the business if it can afford to pay. They will stay in longer - 24 to 48 months - and also look for cash or liquid paper when they exit. Both types of investor would accept shares in an acquiring company if they felt these were of a higher quality than the one they currently hold.

CO	What type of due diligence will an angel investor typically do before signing a deal? What type of conditions will an angel usually attach to a deal that is signed?
PH	Due diligence is a critical part of every deal; however, many factors determine how much and what type is done. Sometimes no due diligence is done if the investor knows you well or has invested in you before, but this rare and risky. The most critical thing to do is to find out if the entrepreneur really owns what he/she is selling. Beyond that there are so many issues I would prefer to provide a more detail answer when I have access to my reference materials. Deal conditions vary but some might be: First right of refusal on future rounds; Restrictions on who can invest in the future rounds; A board seat; Monthly financial statements; Spending limits without investor knowledge; Ownership of IP if company fails to hit certain milestones; and Anti dilution clauses Maybe many more conditions could be involved.

CO	When a deal is struck, what can the entrepreneur expect? Will the money be available immediately?
PH	If the deal is struck the entrepreneur should receives the funds as agreed in the legal paperwork. This also means no money changes hands until the lawyers have papered the transaction.

CO	What type of milestones will the angel be looking for? What normally happens when a milestone is not met?
PH	The typical milestones are: Completion of a prototype; Proof of concept (letters of intent based on prototype); First sale; A key hire; Positive cash flow; and A strategic partnership agreement. If a milestone is missed usually the reasons are discussed and unless a penalty had already been built into the deal for this the parties will define a solution and work together to achieve it.

CO	Any financing deal is a partnership. What sort of provisions should the entrepreneur and angel make to allow for possible disagreements and/or the need for a quick termination of the arrangement?
PH	They could have a formal partnership agreement with shotgun clause or other language that defined the divorce proceedings.

CO	Obviously, the best thing that can come out of a financed deal is that the business is successful and everyone gets rich. What are some of the worst things that can happen when a signed deal is not successful?
PH	The worst things that can happen are: The angel looses the entire investment; The angel has liabilities that are in addition to his/her investment - payroll, leases, law suits, etc.; The entrepreneur suffers the same as 1&2 above; Litigation between the angel and the entrepreneur; and Reputations can be severely damaged.

CO	What can entrepreneurs and investors do to avoid these problems?
PH	They must work together as a team and have clearly defined deal that anticipates these types of situations before they happen.

CO	Is it becoming more common for angel investors to finance deals that can move to venture capital financing? What angel investment trends have emerged over the last 5 years?
PH	The current market conditions are allowing angels to play in deals they would not normally have seen, so at the current moment they are involved in deals that can go public or are already public. This tends to be cyclical. Angels have formed formal clubs in the U.S. over the past five years and it is now starting to happen elsewhere. The rest of the world is not as advanced as the U.S. in the private equity markets, but countries like Canada are catching-up. In the coming year you will see VentureDrive aggregate many of the U.S. angel clubs and become the leading force in angel investments in North America.

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