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Top Entrepreneur and Angel Investor To-Dos when Joining Together for a Winning Relationship in Early Stage Technology Ventures
Dave Litwiller This article details high leverage activities at the time of angel investment. It considers the entrepreneur, value-adding angel investor and jointly, addressing undertakings before and after investment that increase the likelihood of forming a mutually beneficial long-term partnership in early stage technology ventures. Emphasis is placed on actions beyond common rule-based checklists for investors and entrepreneurs at this stage, to highlight preferred practices pre- and post-investment which help qualify and most contribute to success of the relationship and investment.
First Impression, Near Term Roadmap, and Responsiveness. Much of the impression and visceral comfort about the entrepreneur that the angel will base his investment decision on is established in the first minutes of the first meeting. Come out of the gate strong. Deliver a practiced, concise pitch that has been well reviewed and tested. During the first meeting with the angel, lay out the roadmap for the business for the next two to four months.1 This is the time window when investment discussions and negotiations typically take place. Meet those operational, technical and market development milestones. Moreover, hit a few more that you hadn’t promised over that time frame. Near-term predictability, tangible execution progress, and up-side all form the proof points to help build investor confidence to bring an early stage investment across the finish line. During the second meeting with the angel, show that you are prepared, and have answers to everything that was identified for follow-up detail or explanation at the first meeting. You’re exhibiting to the angel that you’re a good listener, you are fast and responsive, and that you have a compatible communication style. Undivided Attention at Term Sheet Time. Turn off all sources of interruption and distraction when negotiating and evaluating a term sheet. Take time during the process to reflect and get advice. There are many terms that are necessary to protect investors in a term sheet and subsequent shareholder agreement. Many of the elements of traditional venture capital term sheets and shareholder agreements are coming into those of angel investors. These mechanisms are necessarily complex and have significant ramifications for founder and early employees’ entitlements to the ultimate proceeds from the business. Model the distribution of proceeds under a range of liquidity scenarios. Pay attention especially to what would happen in an early or modest valuation exit. With later round financiers typically expecting at least as good terms as earlier round investors, the terms of an early angel round often have significant influence over flexibility accessing downstream financing, and ongoing operating agility with the business. Shareholder and debt holder agreements have much more inertia than many other corporate matters. Care and calm consideration are essential at term sheet time for a good entrepreneur outcome. In addition to undivided attention, this is not the time for inexperienced legal advice, if cheap or the most readily accessible. Investment negotiations, term sheets and shareholder agreement drafting and review are instances to pay up for seasoned legal counsel. The best lawyers for these purposes have typically advised on dozens of past such agreements, and seen the life cycle ramifications of a multitude of terms and
“Mastering the VC Game”, Jeff Bussgang, Portfolio, 2010
© David J. Litwiller, 2011
negotiating postures. Most of all, the right counsellors have a reputation for business savvy in addition to legal savvy in term sheets, shareholder agreements, new venture governance, and venture finance. Explicit Liquidity Scenario Planning. Discussing and reaching a clear and shared sense with an incoming investor of the likely time frame to exit, and a plausible range of liquidity scenarios for the business, helps make sure that people are able to reach alignment with a pervasive force that will influence the ongoing governance and management of the business. Over time, liquidity ideas will nearly always evolve. Even so, the best way to assess if a group of people are likely to be able to stay in sync about exit objectives is to unambiguously reach agreement about an acceptable range of plausible outcomes prior to the onset of the relationship based on initial conditions. Competition for the Deal, with Valuation Pragmatism. The valuation should signal confidence and opportunity tempered for stage of development. Best from a valuation perspective is to show a functioning prototype and customer traction prior to seeking angel investment, extraordinary people working in the business, and a large target market with a sustainable edge and a scalable model. Doing so brings the best chances for competitive angel interest to drive not only valuation but also flexibility with investment terms. At the same time, there is a caution. A high valuation may be pleasing to the entrepreneur for the validation it provides, and minimized dilution at the time of early stage outside investment. An ideal but rare scenario even exists in which the angel who best knows the space, has the most vibrant network to add value, and has a particularly favourable bias toward the entrepreneur, is willing to invest based on the highest valuation. But, such conditions are exceptional with competing time demands for the entrepreneur when fundraising. Usually, excessively high valuation carries outsized risk for increased dilution and loss of control for the founder and early investors if there is turbulence down the line. Reduced future access to capital can result. A more moderate valuation typically provides access to a wider range of investors and investor representatives to participate in the build-out and governance of the company, and less need for draconian investment terms. A more modest valuation increases the odds of finding the right investor chemistry and complementary skills. Often, when it comes to early stage business valuation, a little less at the start ends up yielding more for the entrepreneur at the exit. Willing to Share, and Even to Step Aside. The entrepreneur needs to be willing to share decision authority with an incoming investor, especially on transformative issues. The entrepreneur also must demonstrate self awareness of strengths and weaknesses, be willing to bring on help in his weaker areas, and if conditions call for it in the future, to step aside. The obligations to shareholders and stakeholders beyond the founder may come to demand it with outside investment, even if such a future inflection seems a remote possibility at present. Reverse Due Diligence. Do as much due diligence on a prospective angel as he does on you. Get to know the investor to understand and test out how involved he intends to be, the value he can add beyond cash, the buzz that surrounds him based on his track record, and, his rate of investment in other firms at the moment. Check references. With the right investor, cash is only part of the contribution. The larger value comes from: guidance at major transition points; personal network to originate deals and ecosystem relationships; testimonial impact of his investment; and, leadership in syndication and follow-on financing. Explore particularly to understand the double or even triple bottom line he may have for his investment in terms of learning, networking, giving back to the community, and capturing more entrepreneurialism in his business life. Especially if an angel invests or intends to invest with a view toward taking an executive role with the business, rather than holding the line at being solely an investor, an even greater level of care than other major hiring decision needs to be taken because of the complexity of extrication should the employment arrangement not work out.
© David J. Litwiller, 2011
Time, Guidance, Sounding Board and Networking. The advice and counsel that an angel provides to the entrepreneur can be as much about the person as it is the business, given the multi-faceted challenges of leading a high growth technology business. It takes time to do this well and regular candid contact through ups and downs. An angel typically adds the most value when he helps de-risk or accelerate the development of the market, technology, and operational execution in areas where the entrepreneur and senior management team may not be as strong. An experienced sense to pick up on the likely soft spots in the entrepreneur’s strategic and financial model, in order to tighten them up, activates the value of an investment greatly compared with learning things the slow, hard way. Angel time availability to help out most at turning points or moments of turmoil for the business is paramount to add value. Angel value add is also high when syndicating an investment round, by the lead angel bringing the right group of other angels together for the deal rather than the operating management having to take time out to do so. Furthermore, helping management to scenario plan for some of the more likely pivots the business may encounter enhances the confidence and agility to take new headings when conditions call for doing so. As companies mature, angel ability to source interest and competition for M&A exits also generates significant returns compared to most other effort investments during the company’s development. Over time, the quality of an angel investor’s deal flow will be determined by how well he helps build companies through personal networking to facilitate partnerships, key hires, and follow-on financing. The reputation for doing so well brings better entrepreneurs and ideas to the angel in the future. Capital Reserve. The ability to keep up ownership percentages in winning portfolio companies during subsequent financing rounds enables the angel to realize the full value of his investment. As well, the advantages in speed, control and conservation of management time from being able to provide additional financing through an inside round frequently have a strong bearing on success to get the business through near-term turbulence, rather than having to access outside financing to power through minor setbacks. IP Management and Protection. Survival and later stage funding success statistics both correlate significantly with early IP protection measures. The risk of IP ownership and infringement claims rise disproportionately for those early stage companies that go on to much greater scale. At the same time, it is often difficult to retroactively apply effective IP protection measures covering earlier groundbreaking work. With a strong disproportion of angel investor returns concentrated in a minority of hyper-successful investments, sufficient funding and attention needs to be paid to IP protection from an early stage in order to maximize outcomes. A strong IP portfolio also provides greater monetization flexibility for investee businesses, enhancing liquidity options. Particularly at the present time with the popularity of lean start-up models, a blending often occurs of employees’ personal resources with those of the company absent a clear mandate for company ownership and control of IP. Angel investors are usually well served to encourage management to have distinct company ownership and repository of important IP, including items such as source code and design files, configuration management, invention notebooks and disclosures, invention assignment agreements, confidentiality agreements, and employment agreements, as well as supplier, customer, and partner relationship information.
Both Entrepreneur and Angel
Rapport and Mentorship. The mentor-mentee role at the start between investor and investee gives way quickly to mutual mentorship as a good relationship develops. The capacity to evolve to peerage needs to be evident during the investment qualification process based on mutual respect, communicating clearly, listening, sufficient similarity in personality traits, and a track record on each side to be persuasive to the
© David J. Litwiller, 2011
other. At the same time, more robust strategies and execution come from enough relevant diversity to expand the range of thinking from the combination of minds beyond what either would have come up with alone. The idea for the business will morph. To thrive throughout, a great interpersonal dynamic needs to be the bedrock for the entrepreneur and an involved angel. The big six dimensions of personality variation between people can be a helpful framework for investor and entrepreneur to assess fit, rapport and likelihood to achieve mutual mentorship. This can be done through a gauged degree of similarity and diversity in:2 • • • Openness to experience, including curiosity, novelty seeking, interest in cultures and aesthetics, individualism and liberalism Conscientiousness, as evidenced by self-control, trustworthiness, and focus on long-term goals willpower, reliability, consistency,
Extraversion, being friendly, gregarious, talkative, funny, expressive, assertive, active, excitement seeking, and socially self-confident, or even more pronounced forms of power displays and dominance Agreeableness, such as warmth, kindness, empathy, compliance, and modesty Emotional stability in the form of adaptability, equanimity, maturity, stress resistance, optimism, calmness, and speed rebounding from setbacks Intelligence
• • •
These trait profiles will tend to come out over the course of a sufficiently wide ranging discussion about the prospects for the business. Throughout the dialog, both should be on the lookout for compatibility and catalysis of thinking styles, ways of working, enthusiasm for the business, and a shared view of the future. A quick test to make sure that joint enthusiasm isn’t overlooking major latent disparities is to scenario plan for how the business, entrepreneur and investor would respond under the conditions of a threatening setback. Consideration of prospective events and reactions are illuminating for this purpose such as slower ramping revenue than planned, weaker margins, development milestone push-outs, departure of a key manager, or need for significant additional downstream financing that is well beyond current plans. Such internal investigations about personality and style should be augmented with external discovery from colleagues each has worked with in the past. More extreme behaviours can go undetected during initial interactions which are evident to those who have logged more time and under a greater range of demanding circumstances with the entrepreneur and angel. All said, exploring interpersonal chemistry beyond cursory impressions, and under both challenging and fulfilling scenarios, will help to assess the compatibility of people and opportunity.
About the Author
David J. Litwiller is a senior executive in high technology, based in Waterloo, Ontario. His background is in wireless devices, precision electro-mechanics, semiconductors, electro-optics, MEMS, biotech instrumentation, and enterprise software. He serves as an advisor for various private corporations in matters of strategy, technology, operations, and business development. Mr. Litwiller is the author of “Rapid Advance - Mergers & Acquisitions, Partnerships, Restructurings, Turnarounds and Divestitures in High Technology”. http://www.amazon.com/Rapid-Advance-Acquisitions-PartnershipsRestructurings/dp/1439200874/ref=sr_1_1?ie=UTF8&s=books&qid=1287516364&sr=1-1.
“Spent” Geoffrey Miller, Viking, USA, 2009
© David J. Litwiller, 2011
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