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Angel Investing for Everyman

R.HoffmanREID HOFFMAN, chairman and co-founder of LinkedIn Corp. Bloomberg News

Investors in very early stage companies, known as Angels, have been glamorized and idolized by everyone from Hollywood to the blogosphere. They have become the new American Dream – modest wealth turned into fame and fortune by a single smart investment. Think Groupon, Facebook, Pandora, Twitter and LinkedIn — Angels invested a relatively modest sum of, let’s say, $500,000 only to watch it grow zeros in front of the decimal point.

A dream come true for the lucky Angel with access, opportunity, connections and a modest war chest of discretionary capital. With 20/20 hindsight, those investments were no-brainers – revolutionary platforms with hundreds of millions of community members/subscribers all frothing to contribute and share free content or offer deals on thing you buy every day at huge discounts. The lucky Angel investors are now household names, greatly in demand for quotes, insights into their investment philosophy, and enticed to join the Boards of the next great startup. They truly were visionary at the most fragile and sensitive time in the startup company’s life and were rewarded handsomely for that insight and for taking the extraordinary risk. Without Angels, we might not have companies like Apple Computer, Google, or Ciena – all Angel funded at their inception.

Before you reach for your checkbook; a few sobering realities. First, there is no guaranteed, exclusive, first right of refusal process granting any one early stage investor the ability to be the first money in the door. Most, if not all, early stage companies typically have existing investors before the ink is dry on the napkin detailing their invention, concept or proprietary idea.

The founder (and any co-founders) and their respective aunts, cousins and rich uncles typically have already put in personal money at the inception of the company – whether in hard cash or as payment for services rendered (sweat equity). They also likely have tapped into their friends and family circle for convertible debt or equity capital and a pre-money valuation has often already been established. So, unless you have been working side-by-side with the founding entrepreneur, you aren’t coming in at dirt-cheap, pre-smart money valuations. Furthermore, unless you are a savvy financial wizard or have personal experience in early stage investing, you really don’t have the ability or skill set required to do the requisite due diligence needed to ensure yourself that there really is a viable business underneath all that entrepreneurial enthusiasm.

In short, those Angels that were the early money into Facebook, Groupon, Linkedin, etc. weren’t just lucky investors who happen to make a smart (lucky) bet – they are all very savvy business people with lots of discretionary cash and the time and skill required to investigate, test, model, analyze and negotiate a great deal. They draw upon their own expert networks of friends and colleagues to validate the business model, confirm their market research and get the best advice available. They surround themselves with high-powered lawyers and advisors who know how to drive a great deal at the right price/valuation. 

P.TheilPeter Thiel, Angel Investor behind PayPal & Facebook

From the entrepreneur’s point of view, picking the right Angel to be the first ‘outside’ money in becomes less a function of the actual investment amount than the ‘star power’ that the Angel brings to the table. The right Angel investor/Board Member/Advisor can be the key that enables success since they bring a heavy dose of instant credibility to the newco; eg., ‘if he is investing in this company then I’m following him in since he is smart, knows this space and wouldn’t waste time on a losing proposition – he will make it work’. The Big Name Angel can also be the key to raising the more significant levels of capital needed to see the dream through to conclusion – the money that typically comes from VC’s, big institutions, strategic investors, etc. whose analysts and bankers will climb all over the business plans and projections with a fine tooth comb. From the viewpoint of the public, the Angel funded blockbuster deal was all magic and vision – the reality is that most of the high profile Angel success stories were the product of opportunistic timing, unparalleled access to the best ideas, lots of hard work in diligence and negotiations – all with an uncertain future outcome and lots of hurdles to overcome on the path to the Billion+ dollar valuation.

While all of us would love to be the fortunate Angel with the wisdom, foresight and courage to ‘bet the ranch’ on an idea with no revenue, no staff and no real product, the majority of smart investors still prefer to approach ‘Angel-like’ investments confident in knowing that there is more than just an idea and an enthusiastic entrepreneur supporting their investment. They want comfort that the deal has been vetted, that valuations are reasonable, that risk has been minimized to the greatest degree possible, that terms and conditions surrounding their investment are governed by SEC/FINRA regulations which protect their rights under law, that the sponsoring broker or selling agent has a track record of success and a team of talented resources to help the company with strategy, organization, talent-sourcing and execution.

AAPLApple stock is up 40x within the past 10 years -- imagine getting in at the ground floor of that one!

They also don’t want to take the whole investment or be the first and only one investing capital in the company. They get comfort from knowing that other smart, high net worth individuals have looked at the opportunity and liked it enough to put in money.   They are prepared to trade off a 1000:1 or 10,000:1 return (with a reciprocal chance of success!) for a more reasonable, but still extremely lucrative return resulting from a more prudent and rational approach to Angel investing. By choosing this approach, the risks are mitigated, the investment levels are smaller/manageable and the due diligence, execution/growth management, and value creation time, skills, etc. are performed by professionals – not by a single lonely angel! Angel investing is risky enough without attempting to go the course alone. All that said, Angel or Angel-like investing can be the most exciting, stimulating, rewarding (both financially and psychically), and patriotic way that high net worth individuals can deploy their discretionary investment capital.

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