Investment from Business Angels — Nine Rules of the Road for Startup Founders

In 2017, I wrote two blogs for startup founders on why business angels are important, and how they should deal with them. http://bit.ly/FundingfromAngelInvestors http://bit.ly/AngelsandAdvisors I wrote these as a startup mentor. At the time, I was not looking to make angel investments.

Since then, I’ve made a few angel investments, so I’ve gotten some perspective from the other side of the table. I’m also active in helping to screen startups for a UK angel group, Angel Academe, focused on startups with at least one female founder.

I’ve recently gone back and reviewed my earlier blogs, and I’m pleased to say that I still agree with them. Now that I’m also on the other side, however, I have some additional thoughts (and want to reinforce some of the points I made then).

So here are my nine top tips:

1. Network to find the right angel investors.

I have found, in observing startups since 2013 and assessing leading factors in their success, that building a network is absolutely central. Network is critical to securing investment, it is critical to securing customers, it is critical to securing partners and channels, and it is critical to obtaining key advice when you need it.

I don’t welcome this observation, since personally I find networking difficult. So be it.

Particularly at early stage, business angels are a key potential source of network, experience and skills. Founders need to keep this in mind when they recruit business angels (and after they recruit them). In some cases it may make sense to lower minimum investment levels to permit investment by angels who have more than money to bring to the table, such as relevant experience, or contacts in an industry or in another country that is a potential target market.

2. Get the pitch right.

Wearing my angel screening hat, I see a shocking number of bad pitches by early stage founders. Most of the problems are due to the content and flow of the pitch itself; sometimes there are also presentational issues.

It doesn’t make sense to blow a potential investment opportunity because the pitch, or its delivery, doesn’t work.

Pitching is story-telling. Investors need to hear a story that engages their attention, is effectively presented, and makes them want to learn more.

In the early stage startup context, the pitch really breaks down into three pieces:

(a) the startup is solving an important problem, and its solution works/will work and has a good chance of scaling into a successful business;

(b) the business and its strategy make sense — market, business model, go to market strategy, differentiation/competition, technology/defensibility, etc., — and the business is showing appropriate traction for its stage.

(c) this founder team has the ability to execute its vision for the business, the team is looking to achieve clear value-enhancing milestones with the investor funding, the business is investable from a financial standpoint, and the startup is raising an appropriate amount to give itself the runway that it needs.

This is not rocket science. There are many standard pitch deck templates available; while my own (which I am happy to share) may differ in nuance, the basic thrust is the same.

So why do I see so many pitches where the storyline is incoherent, or the fundamental business points are not addressed effectively? I can’t explain it.

However, there is one special case. I see pitches aimed at impact or diversity-focused investors that primarily address those prerequisites, without sufficiently proving the case for the underlying business. That’s a mistake. These investors may insist on impact, diversity, or both, but they expect those features to enhance, not substitute for, the likelihood of a financially-successful outcome.

Moving on to presentation, it is exceptionally important to practice the pitch until it is second nature. A good pitch is an authentic conversation with the audience, not a slick canned speech. Getting to this point requires absolute facility with the underlying content. While some presenters may be better than others, everyone improves with practice and constructive criticism.

Finally, let the best pitcher pitch — that isn’t necessarily the CEO/founder. Language issues, or even personality, can make a big different in the quality of the pitch. Get pitch lessons if you need them. Yes, we need to see the CEO/founder, and ultimately get comfortable that they have the ability to deliver, but the first hurdle is to get us interested to learn more.

3. Be prepared for hard questions.

I continue to be surprised by founders who fumble in their handling of questions, including obvious ones.

Founders should welcome hard questions from potential investors. Investors typically only bother to ask a question if they are interested, at least at some level. Challenging (and possibly even aggressive) questions generally reflect greater engagement. It usually isn’t difficult to predict these questions, and founder responses provide an opportunity to show mastery of the subject matter.

At a high level, the presenter should be prepared to cover most subjects, including financial matters. However, if there needs to be a hand-off of a question to another team member with special expertise, prepare for that in advance — the handoff should seem smooth, and it shouldn’t appear that the presenter has been caught by surprise. Plan in advance how to handle the occasional question that is too detailed for the general audience, or where you don’t have a ready answer.

Also, please — don’t say “that’s a great question” in response to every question. It just comes across as insincere. The best way to show that a question is a great question is to give a great answer.

4. Propose a sensible valuation, or at least a valuation range.

Venture capital investors will have their own ideas about valuation, and founders may be able to get away with not specifying a valuation in the context of initial discussions with VC’s.

Angels need to know founder views as to valuation or valuation range. In most cases, angels won’t seek to negotiate valuation — they’ll make an up or down decision based on what they hear.

Further, if founders get a question on valuation, they should understand that what they have proposed is outside the customary range for that investor. This means either that the founders are out of line, or the investor is unrealistic (or, sometimes, exploitative). In any case, the founder needs to be able to justify the valuation they are seeking, taking into account the market in which they are seeking it. The “I’ve talked to some people and heard it on the grapevine” response to a question about valuation simply results in a lack of investor confidence in the founder.

Finally, keep in mind that angels may be concerned about excessive valuations because they worry about the ability of the startup to raise a follow-on round at a higher valuation. A successive down round may be dilutive for angels, but, more importantly, the obstacles to completing such a round may kill the startup.

5. Be ready for due diligence.

Individual angels may not do a lot of due diligence if they like the founders and the business concept. Angel groups, however, typically will do at least some due diligence prior to making an investment decision. In many cases, this will be the first opportunity for the angels to judge the founders in action — so don’t blow it.

Even before you pitch, you should already have a data room (in Dropbox, using a different cloud-based service, or whatever) that pulls together the documents that a careful investor will want to review. Get hold of a standard due diligence checklist, and gather and organize those documents that you do not already have. For example, if you have failed to get assignments of intellectual property from employees, contractors or others who have touched the IP, don’t wait to pursue those until an investor asks to see them. Not only will that delay any investor process, the founders will appear unprofessional if they haven’t addressed those issues.

6. Communicate directly with your prospective investors.

Own your relationship with your prospective investors. Yes, you may have professionals (lawyers, financial advisors, accountants and others) who are helping you with the raise. However, particularly in an early stage company, your investors are investing in you. Don’t let your intermediaries get in the way of that communication.

For example, your investors should never receive a document from your counsel (or, indeed, from you) for signature that they have not previously been sent by you, with an appropriate explanation (which can be written by your advisors if that makes sense, but transmitted by you). Of course, if your investors are represented by counsel then there will be counsel-to-counsel discussions. Ultimately, though, investors want to hear from you.

7. After completing the round, communicate regularly.

Closing the round is the beginning of your relationship with your investors, not the end of it.

Post-investment, stay in touch with your investors on a regular basis (at least quarterly — although somewhat more frequent e-mails to investors, mentors and friends can help you address your “asks”).

Why — to seek their help, get access to their network, and build confidence before the next round. If you’ve chosen your investors wisely, they will otherwise leave you alone and won’t try to run your business. However, if conditions should get difficult, investors are more likely to be supportive if they have accompanied you on the journey. If you are going to need to make changes that are relevant to their status as investors, explain what those are and why.

8. Good governance is not an afterthought.

Implement good governance, at both the board and shareholder level. I don’t mean that you need to run out and recruit non-executive directors — while there will be a time for that, I personally think you need to be very careful before you put NEDs on your board whom you don’t know well (other than where required by your investors).

Whether or not you have NEDs, however, you should hold regular board meetings with agendas, resolutions and appropriate (typically short) minutes. Why?

First, the discipline of a board meeting with an agenda forces you to stop and think through what you are doing, identify weak spots, get advice as appropriate, and test your proposed actions (at least with yourself and your co-founders). It also provides a formal basis to draw on the skills of your team.

Second, the professionalism shown by regular board meetings helps build shareholder confidence and support. Where shareholder action is required, your shareholders should hear that the board has considered the proposed action and recommends it to shareholders (and why). If you already have a non-executive chair, it may be helpful to let them lead on matters that may otherwise be seen as adverse to existing shareholders.

9. “Dance with the one that brung you.”

Early stage angels invest in founders. They provide funding at valuations that bear no relationship to current business value, out of faith that you, their selected founders, will build something that doesn’t exist yet. Their interests are generally aligned with founders, and they almost always leave founders in control. They passionately want founders to succeed, and not simply because the angels are looking for an investment return. Indeed, available data suggests that many angels (unless they have a large startup portfolio) would find better risk/reward balances in other areas of investment.

Founders should reciprocate, and continue to reward their angels with attention and loyalty after, for example, securing venture investment. First, they should do this because it is the right thing to do. Second, it makes sense because angels can provide continuing value, both to the founder’s current business and to any future business that the founder may start.

Conclusion

A founder’s strong relationship with business angels can yield dividends in a variety of ways. Smart founders will not view their angels as convenient cash machines.

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This discussion is not intended to provide legal advice, and no legal or business decision should be based on its contents. All views expressed are Bob’s own. If you have any questions or comments, feel free to contact Bob at robert.mollen@mollen.uk or via LinkedIn here.

You will find some of Bob’s other blogs for emerging and growth companies indexed here on Medium: http://bit.ly/StartupGuides