And here is how you should approach Angel investors

Why are Angels important?

Angels provide a surprising amount of money to the local startup ecosystem. Angel Capital Association noted in a 2016 report that angel investors provide about $24 billion per year to seed and startup entrepreneurs in the US.

The impact of Angels cannot be overstated. To provide perspective, the Center for Venture Research noted in 2011 that Angels provide first-time capital to over 20,000 companies per year in the US while VCs invest their first capital in less than 1000 new companies per year.

What should I know about Angels and VCs?

Too many people treat Angels and VCs as similar source of capitals without realizing important distinctions in what, how and why they invest.

In sum, Angels are different from VCs because of 3 main things:

No fund mandate so they are not time-pressured to liquidate
Strategic interest: Lower IRR requirements
Strategic Interest: Alignment with industry

Disclaimer: It is important to note there are a wide variety of Angels, from professional Angels (rarer for SEA), to corporate executive Angels, to High-Net-Worth Individuals looking to broaden their exposure to early-stage companies.

As such, though many of these arguments are broadly applicable, they are not exclusively applicable to all Angels.

VCs and Angels have different incentives

Bill Payne, a renowned US Angel, noted in his2011 Definitive Angel Guidethat VCs are more likely to crush your company.

Venture funds must produce venture returns for their LPs. Especially given that VCs have to return their investment to LPs within a specific time-frame (typically 10 years from the day the fund is created), there is an additional pressure for the investment to be wildly profitable, and fast.

In order to achieve this, at least one or two of their investments must provide huge returns of the magnitude of 30 times or greater return on a given start-up investment in order to counteract the fund’s bad investments.

This means a US$3 million return for a US$100,000 investment.

Let’s do some brief math: Assuming the VC invests at a US$500,000 valuation, and that there is later stage dilution to account for, reducing their stake from 25 per cent to 15 per cent, this means that the startup must be valued at at least US$100m before the end of the fund life. If the fund invests in the second year, the startup has about 8 years to be making high tens to hundreds of millions of dollars of revenue to justify a US$100m valuation.

As Bill Payne notes, to do this, VCs encourage their startups to swing for the fences. They push founders to spend big and take big, calculated risks if it has the potential to turn that startup into a unicorn.

Also Read: Taking Echelon Asia Summit 2019 to a new level with 13 more exhibitors!

On the other hand, Angels often have multiple motivations, both financial and altruistic. Some feel that angel investing is a form of giving back to their community or in appreciation to those who mentored them earlier in their careers. All Angels view return on investment (ROI) as important, but in many ways, view ROI as a metric of success in angel investing. Since most Angels only invest a small fraction of their net worth, a high ROI is not critical to their goals and futures.

Angels have more strategic interests

As such, some Angels may be happier with relatively modest returns for their investment, especially if there are particular strategic angles to the company, such as an overlap with their professional lives.

Bill Payne wrote that he enjoyed working with entrepreneurs and feel that angel investing is a part-time activity that he could pursue into his 80s; one way for him to stay engaged in the business community after years of full-time involvement.

As Angels do not have a fund mandate, they are less time-pressured to find returns for their investment. This allows them to explore non-venture investment opportunities that may be highly lucrative only in the long-run. These opportunities may or may not be in the traditional industry space, and may also encompass disruptive technologies or business model with long maturity times. Typically, opportunities like distributorships, service companies, and manufacturing are examples of what Angels may look at over VCs.

As a result of the lower pressure for venture returns, Angels would also be far more likely to accept private-equity type exit situations and mechanisms, including buy-back clauses, dividend repayments or exits to private equity firms (which tend to come with a lower multiple relative to tech company acquisitions).

Industry Alignment

Industry Alignment is perhaps the most significant way that Angels differ from VCs. If you are, for example, an electronics office supplies e-commerce company, having a chief procurement officer of a large company would represent an industry-aligned Angel.

Alignment in the industry provides the following advantages:

Understanding problems within the industry and whether the issue solved is one that is needed to be solved.
A higher perceived tolerance for risk
Strategic Alignment: An Angel may be able to further their own interests in the industry with their involvement in the startup scene
Relevant support: As Angels are likely to invest in a smaller range of startups than VC (even accounting for the larger VC staff), Angels are far more likely to be more hands-on and provide much-needed help.

Talking to Angels may be easier. Given an Angel’s understanding of the industry, not only would the Angel be aware of the opportunity that the startup is tackling, the Angel would have a far certain position of the nature and status of the company, as they would be aware of what the startup is doing well, or not well, and can price in their risk accordingly, thus having a higher perceived tolerance for risk.

Their background and informational advantage give the Angel a better ability to invest. With the certainty and knowledge, the Angel would generally be able to move faster and with more certainty that a VC, who would typically have to rely on experts (even potentially Angels to provide the guidance to invest). As VCs tend to invest in a much wider range of industries, they tend to not have the relevant expertise to quickly determine interest in a business model, particularly a unique or niche approach.

Also Read: This Echelon Asia Summit 2019 ticket giveaway might bring you closer to your next funding round

It is advisable when looking for Angels to find one that can bring more than money to the table. Entrepreneurs should pick only ‘smart money’ to invest in their company, meaning, investors who can bring value other than their money.

Talking to Angels can be harder

Just like in any profession, VCs can be sophisticated and unsophisticated. However, as Angels may not spend as much time ‘in market’, it is more common to hear about bad investment terms from Angels.

If this happens, it is frequently because an Angel doesn’t know market-standard terms and/or doesn’t understand how non-market terms hurt everyone involved.

Further, as Angels are not as financially motivated, they may not be sensitive to valuation and its implications. I’ve seen how Angels have bumped up a company’s valuation to 100x Revenue, at relatively low growth rates. Entrepreneurs get enthused by the support the early investors get and are understandably upset when confronted with the fact that VCs are not willing to support such a high valuation.

This, however, creates a valley of death scenario as VCs are not able to justify the valuation to invest, and the startup has run out of angels willing to invest in the company.

It goes without saying, but it becomes important to be financially aware when dealing with investors and to understand what is actually beneficial and not beneficial for you. A great beginner resource to rely on is ‘Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist’ by Brad Feld and Jason Mendelson, of the Foundry Group, a renowned US VC.

Reaching out to Angels requires a different strategy

Angels tend to be more private and harder to find because they don’t want to be inundated by founders seeking money.

As mentioned, there are a variety of Angels, and understanding their motivations for investing is important. AsEntrepreneur Magazine notes, for most Angels, start-up investing is a hobby that must be balanced with the rest of their obligations.

If they are too high-profile in public, they would likely be constantly bombarded by founders seeking money. Although some Angels will actively blog, Tweet or create an AngelList profile, these tend to be the most active angel investors.

On top of the fact that many Angels are not active online (especially in Asia, where many of them are high net-worth executives or made their money in the non-tech sector), the majority of Angels enjoy their privacy and therefore won’t be easily found online.

In some regions of the world, personal security is an additional factor that encourages Angels to invest quietly. such places, Angels become a potential target for crime if the public is aware of their wealth.

Also Read: In democracy, social media is the fruit of the poisoned tree

A great resource to rely on in SEA are local Angel groups like BANSEA, Angel Central, ANGIN, and the Bangkok Venture Club.

There are important distinctions with Angels and VCs, particularly on the types of companies they invest in, what arguments may work better for them to invest, and the type of financial structures that work best for them. With that being said, welcome to 2019. Opportunities are out there. Go out and find that Angel, VC or startup that can kick off your foray into the entrepreneurship scene.

—

Photo by DESIGNECOLOGIST on Unsplash

The post Confusing Angels with VCs is a common startup mistake appeared first on e27.