This is the first post in a series of blog entries designed to explain the funding process in different stages for the typical startup company. This post focuses on financing at the beginning – angel investments.
So you have an idea. An idea that will obviously change the world and make you a trillion dollars. There’s just one little hitch in your plans – getting your hands on the money together to pull it off. Since your company is often not actually a company at this point, it can be a little difficult to convince investors to take a leap of faith on you. The investors who take this leap of faith with early stage startups are typically referred to as “Angel Investors,” and at least when writing the check, they really can be seen as angles to the entrepreneurs they are financing.
Angel investments are often incredibly risky investments, however, with great risk hopefully comes great reward. Investing in an idea or early stage company is inherently very risky, but the amounts of such investments are often much less than later rounds of financing, and can yield incredible returns when the company is a home run. Angel investors are typically not your larger institutional investors, rather, angel investors are typically high net worth individuals who often have a relationship to the startup. However, a small but increasing group of angel investors now organize as angel networks or angel groups.
While attracting a seed investment from angel investors can be difficult, it certainly isn’t impossible. Knowing a bunch of rich people who believe in you certainly makes it easier to find angel investors to provide seed capital to your company, but not everybody has such relationships or access to these types of people. Often, luck plays the biggest part in finding an angel willing to invest in your company. As I’ve personally found luck to be pretty hard to control, its probably best to focus on the things you can actually do to help attract angel investors, some of which include:
1. Legally Organize Your Business
After deciding that you want to launch a new business, one of the first steps should be to legally organize your business to protect yourself from personal liability, among other things. I typically advocate doing so very early on in the process, but the decision of when to organize is really up to the entrepreneur. However, in terms of attracting angel investors, organizing your business is an absolute must. Few, if any investors of any type will invest in a business that has yet to be legally organized, and failing to do so really makes you look unprofessional and unprepared. Deciding on which type of business entity to organize as depends on the specific facts, circumstances, and goals of your business. Limited liability companies are quite popular for startups, however, not the best entity type for everybody. Involving an attorney in the business planning process is almost always best course of action, and often quite inexpensive for the peace of mind it provides.
2. Build Your Network Before You Need It
If you have the ability to meet the type of people that may become angel investors, do so now. Pitching your idea to somebody you know is typically much easier than doing so to a cold audience. Developing relationships is key in terms of attracting angel investors.
3. Protect Your Intellectual Property (if you have it)
If you have creative works, copyright them. If you’re an inventor, patent your inventions. At a minimum, most companies are seeking to create a brand, and that brand should be trademarked or protected in whichever method does so best. This process can take some time, and often involves work that should only be done by an intellectual property attorney. Start early in the process, and be ready to answer intellectual property questions to potential angel investors.
4. Build a Strong Management Team
An early stage company is often light on product, customers, or a proven track record. Quite often it is the people that make a startup interesting and worth betting on. Build a solid management team that angel investors will be willing to place a bet on. If your management team lacks industry experience, try to bring on industry experts to serve as advisers. Many industry experts are willing to serve as advisers, and providing small amounts of options, warrants, or other equity compensation can often be quite convincing.
5. Prepare a Professional Business Plan
Preparing a thorough, well-thought out business plan is an important part of the entrepreneurial process – it is an important step regardless of whether you are seeking outside investment. However, if you are seeking outside investment, the business plan becomes of much greater importance, and should be drafted to also appeal to your audience of outside investors. There are plenty of resources available online that will provide guidance in getting a professional business plan together. If you do not have experience in drafting business plans, you should spend the time to familiarize yourself with the process.
6. Build a Website and Look Professional
While not all businesses depend on the Internet or a website, in today’s business world, they should all have a website, as it makes you look more professional and serious about your business venture. Your website should be simple, clean, and convey to the investor that your company is more than an idea. You should also take time to create a social networking presence, as it can be an invaluable resource in finding customers and networking.
7. Know How You Will Make Money
Investments are made to create a return. Show investors how you are going to generate a return. Make sure to spend time creating quality proforma financial statements and a well thought out financial model. Be prepared to defend your assumptions, provide both best-case and worst-case scenarios, and seek plenty of feedback prior to pitching investors.
8. Have a Detailed Plan of How to Spend Their Money
Before an investor writes you a check, they will almost always want to know how their money is going to be spent, and typically with specificity. Be prepared to explain, in detail, how much money you will require in total, and know how you will spend this money in great detail. Expect push-back on your estimates, be prepared to defend your assumptions, and seek feedback from others before you’re ready to make your pitch.
9. If Possible, Have a Product or Customer
Having a prototype product prior to pitching investors can be difficult depending on the type of industry you are entering. However, having something tangible for investors to see can go a long way in demonstrating that you have made progress before approaching outside investors. If possible, it is also very valuable to have existing users and customers – they can help validate your venture, and show that your business is more than just an idea. While having products and/or customers may be difficult for many businesses prior to obtaining outside investment, they can go a long way in convincing investors to write you a check.
10. Invest in Your Venture
I understand that many entrepreneurs lack financial resources, which is the reason that they seek investment. However, you should invest what you can to demonstrate that you believe in the business, are serious about the venture, and are willing to place your own resources at risk. Investors will almost always ask how much you have invested in the business – make sure to be ready to answer the question, and demonstrate your commitment and belief in the business.
11. Be Reasonable About Valuation and Terms
This is very often an issue for entrepreneurs, as they are typically biased and overly optimistic in their business. Make sure that you are reasonable about how you value your company for investors. Understand basic valuation principles, cap tables, and what terms you are offering investors. You probably see the unlimited potential of your business to make you rich, but its likely that this is a best-case view that will take significant time, resources, and luck to achieve. Investors often see the opposite – they see the risks, challenges, and obstacles to getting a return on their investment. You need to be reasonable in how you value your company. Seek the input of others. Study how companies are valued. Make sure to talk with lawyers, accountants, and other advisers. In the end, just make sure that you’re valuation is reasonable and can be supported.
12. Be Honest and Transparent
Almost every early-stage business has its problems. No business is perfect, so don’t hide your issues. Investors will almost always discover issues, and if you have not been honest, forthright, and transparent with outside investors, they will lose trust in you, and it is unlikely that they will invest. Being transparent and pointing out your companies challenges shows that you’re realistic, trustworthy, and understand the realities facing your business. Instead of hiding issues from investors, identify them as challenges and spend time addressing how you will overcome them.