Managing Your Angel Investment

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Managing Your Angel Investment
Presented by W. Daniel MothersillPresident,
National Angel Organization
In partnership with NOEG FedNor Ontario
Centres of Excellence
April 2007
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So Youve Made Your Investment

• Now what?

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Risk Elimination

• The reality is that you cant eliminate all the
  risk when you invest.
• However, Angel investors must understand what
  those risks are, and take steps to keep them at
  acceptable levels.
• VCs, who make their living by investing in SMEs
  get it wrong more often than they succeed.
• 20/60/20 Rule

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The Angel Advantage

• Angels can and most often do better than venture
  capitalists for one major reason
• Involvement
• Angel Involvement goes well beyond monitoring
  company milestones.
• It centers on mentoring, becoming actively
  involved in a company when things go wrong and
  they often do.

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Angels Versus VCs

• VCs, for the most part are professional investors
  of other peoples money.
• They monitor their investments, but most often do
  not have the educational or experiential
  background for running a company.
• Angels are generally successful business people.
• They have made their money in starting, running,
  and profitably exiting from one or more
  enterprises.
• They know business and how to make a business
  work.

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A Preliminary Evaluation

• Question 1
• What is your attitude or appetite for risk?
• High you are an Angel, but take great care
• Medium you are the perfect Angel candidate
• Low employ your surplus cash in other
  investment vehicles
• Question 2
• Do you plan to put all your money into one
  venture?
• Successful Angel investing is not about taking
  big risks but balancing risk and return by
  investing in several entrepreneurial companies

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10 Common Mistakes

• Relax. Dont worry. The money will come in.
• Treating the Angel investment as a mutual fund.
• Passively waiting until things get better.
• Treating the entrepreneur as the only expert and
  leaving him alone.
• Becoming overwhelmed by the technology/science
  complexity.
• Failing to understand the needs (shortcomings) of
  the entrepreneur.
• Expecting that nothing major will go wrong.
• Failing to diversify the Angel investment
  portfolio.
• Setting terms for the investment that bar the
  investor from active participation when required.
• Not knowing when to hold em and when to fold em.

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When the Investment Process Begins

• Managing the Angel investment begins long before
  the money exchanges hands.
• The process starts
• Talent Triangle evaluation
• Due Diligence stage
• Term Sheet creation and evaluation

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The Talent Triangle

• John Doe, President CEO
• Serial entrepreneur
• 10 years executive experience
• Two successful businesses built and sold

• Jack Brown, COO or CTO
• Developed delivery chains for 3 Fortune 1000
  companies
• Expert in inventory management

Business acumen

• Joan Gray CA, CFO
• 6 years in major accounting firm
• 2 years CFO at major competitor
• Established budget and cost-control program

• John Smith, VP Sales, or VP Business Development
• 12 years senior industry positions
• Built 3 sales teams and increased annual revenues
  by 50 percent on average

Domain knowledge
Operational expertise
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Talent Triangle Deficiencies

• Every entrepreneurial management team has holes,
  especially around business acumen and operational
  expertise.
• This should not be seen as a problem, but rather
  an opportunity for the investor to get involved
  in guiding the fortune of the enterprise.
• Investments should be made not only on the
  strength of Technology/Science/Service but on the
  ability of the Angel investor to make an active
  contribution.
• The savvy Angel, however, knows when to jump in
  and assist.

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The Major Risks

• The technology doesnt perform as promised.
• The market appetite changes and the product is
  introduced too late in the cycle.
• The company is squashed by the competition.
  There are too many large and established
  competitors fighting over too small a piece of
  the business pie.
• Management does not have the ability to run a
  business profitably.
• The company stays at a barely break-even point.
  There is little ROI for the investor. It limps
  along, falling into the category of the walking
  dead.

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The Major Risks

• The technology fulfills all expectations, but the
  company cant create a market for it. Sales
  efforts meet with market indifference.
• The company is folded by a later stage investor.
• The company is sued, draining the monetary and
  time resources of the enterprise.
• An 800-pound gorilla steals the technology and
  markets the product successfully.
• The company fails to keep proper accounting and
  is bankrupted by lending institutions or CRA.

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Risk Management Tactics

• Managing risk begins before the investment is
  made.
• The ability of the Angel to force changes within
  the company to protect the investment need to be
  clearly set out in the terms sheets.
• Also, effective due diligence will uncover many
  of the potential problems and deficiencies long
  before an investment is considered.
• However, mentoring remains the most positive form
  of risk management.

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Risk Management Tactics

• Risk The technology doesnt work.
• Tactics
• Invest in technologies that are in Alpha stage,
  at least.
• Ensure that patents are filed.
• Hire or consult an expert who gives a written
  opinion on the viability of the technology.
• Note that above applies equally to medical
  devices.

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Risk Management Tactics

• Risk Market appetite changes and late
  introduction of product.
• Tactics
• Ensure that the founder has provided clear
  third-party support for current and foreseeable
  market appetite.
• Insist on clear milestone deliverables that
  ensure the product will be available against
  pre-set deadlines.
• Build into any term sheet agreement that the
  competition will be monitored closely and shifts
  in market trends red flagged early.

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Risk Management Tactics

• Risk Overwhelmed by the competition.
• Tactics
• Analysis of the competition is an ongoing
  process. Built into any investment agreement
  must be a commitment on the part of the founder
  to provide a detailed analysis of competitors
  that is updated and reviewed on a regular basis.
• A strategic and tactical plan that outlines in
  detail
• How the company plans to deal with competitors
• Methods for turning competition into strategic
  partners or potential acquirers
• Specific targets for gaining market share.

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Risk Management Tactics

• Risk Poor management.
• Tactics
• Investor holds a series of management reviews
  with performance targets and milestones that must
  be met.
• Failure to produce the necessary changes will
  trigger a change in management roles. While the
  founder still holds all his shares, his title and
  responsibilities may shift from president to VP
  and he is replaced by an internal person or a
  qualified individual from outside the company.
• Note This change in management often happens
  with
• entrepreneurial companies.

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Risk Management Tactics

• Risk Failure to produce an adequate ROI for the
  investor.
• Tactics
• Change of management.
• Enhanced sales and marketing approach.
• Sell shares to another investor.
• Invoke a management buyout.
• Force the sale of the company to recover assets.
• Note under no circumstances should an investor
  walk away from
• the company without exhausting all channels for
  recovery.

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Risk Management Tactics

• Risk Lack of market appetite.
• Tactics
• Thoroughly examine the principal objections to
  the product offering.
• Commission and third-party study for this.
• Develop a new branding of target market approach.
• Reposition the product to fulfill a complementary
  market niche.

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Risk Management Tactics

• Risk Company is folded by a later stage
  investor.
• Tactics
• Form a syndicate and buy out the investor.
  (Angels should always keep additional funds
  available for contingencies.)
• Involve management in the buy-out process.
• Seek a strategic partner who will participate in
  the buy-out, retaining at least the original
  money to the investor.

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Risk Management Tactics

• Risk Lawsuits.
• Tactics
• Since most companies face litigation in one form
  or another, especially in the U.S., this type of
  action is not necessarily a company ender.
• Ensure that there is sufficient DO insurance
  carried by the company to cover the investor.
  Note an Angel investor should always have
  representation on the board of directors.
• Seek qualified legal counsel ASAP. Dont put off
  this action. The problem will not go away by
  itself.

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Risk Management Tactics

• Risk Technology theft.
• Tactics
• Fly below the radar screen as long as possible.
• Do not take the technology to a major competitor
  before the company has traction.
• Once a significant customer base is established
  with revenues and profits, then begin discussions
  with the 800-pound gorillas. Cisco may sue a
  small company, for example, but they would be
  highly reluctant to face Microsoft if they were
  in negotiations with a entrepreneurial company.

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Risk Management Tactics

• Risk Failure to watch the money.
• Tactics
• From Day One, an entrepreneurial company should
  keep accounts as if it were a public entity.
  Proper outside accounting and bookkeeping
  capabilities are table stakes before any
  investment is made.
• Management must report financials on a monthly
  basis to the board.
• Failure to meet financial obligations must never
  be allowed to pile up and must be dealt with
  immediately.

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The Musts in Managing Angel Investments

• Board Representation/Governance
• Excellent governance and exceptional boards are
  the most important controllable factor in
  building outstanding companies.
• Note what happened in the 1990s small-cap
  carnage largely due to companies that did not
  have effective governance.
• It became the financial Wild West for many Angel
  investors.
• An Angel investor must have a seat on the board
  of directors. If an Angel group is providing the
  funding, one investor should be selected as a
  representative, become actively involved, and
  report back to the other Angels in the syndicate
  on a regular basis.
• Ensure there is adequate DO insurance.

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The Musts in Managing Angel Investments

• From an Angel perspective, the items that must
  covered at each meeting include
• Progress against milestones product development,
  sales marketing, strategic alliances, human
  resources requirements review.
• Review of the financials.
• Red Flags.

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The Musts in Managing Angel Investments

• Assisting with Further Financings
• Most often, when companies fail to provide a
  return to their shareholders, its because they
  ran out of money.
• Angels should be prepared to
• Provide additional funding,
• Enlarge the Angel group syndicate,
• Syndicate with other Angel groups,
• Co-invest with a seed VC,
• Raise additional funding through a CPC.

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The Musts in Managing Angel Investments

• Mentoring
• Ascertain the holes in the management team
  expertise. These may not be instantly obvious
  and often take some time to unearth.
• Ensure that the term sheets have allowed you to
  take an active role in mentoring.
• Decide where you are most qualified to help.
• Actively work toward building an advisory board
  to cover company needs outside your area of
  expertise.
• Hold management meetings to map out plans and
  execution strategies.

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The Musts in Managing Angel Investments

• Mentoring
• Mentoring often focuses around the following
  areas
• Technical/product development advice.
• Management advice the strategies and tactics
  that make small businesses work.
• Growth strategies domestically and globally.
• Branding, positioning, marketing sales.
• Developing joint venture partnerships.
• Locking in IP protection.
• Human Resources development.
• Accessing additional sources of financing.

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The Musts in Managing Angel Investments

• Mentoring
• Many believe that the value provided by Angel
  investors is roughly half cash and half
  mentoring.
• It is one of the rare occasions in the life of a
  start-up that sweat equity can be monetized.

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The Musts in Managing Angel Investments

• The Exit Strategy
• It is not unusual for half of the eventual value
  created in a successful company to be generated
  by the design and execution of the exit
  transaction.
• The requires that the Angel investor become
  actively involved in the exit process.
• Exits are achieved through
• MA a buy-out of the company by another entity
• Management buy-out.
• IPO, RTO, CPC

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Value Creation for Investors
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Thank You Questions
W. Daniel Mothersill 416 368 8770
x222 dan_at_ciris.biz