Finding Your Angel Investor

As a rule, angel investors are wealthy people who like to bet on early-stage startups.

They offer first-round financing, bridging the gap between bootstrapping and institutional capital, with the hope that their high-risk seed money will return big rewards.

Numbering about 260,500 nationwide, according to Jeffrey Sohl, director of the Center for Venture Research at the University of New Hampshire, angels work on their own or by joining private networks that pool money, share expertise and divvy the due-diligence tasks.

The range of individual investments runs from $10,000 to $1 million, with deals typically between $25,000 and $100,000. Group or network ventures usually run $250,000 to $750,000 each.

Who are these angels?
Jeff Pulver could be the angel poster child. Trained as an accountant and bonds trader, he began investing in emerging Internet technologies more than a decade ago, notably as co-founder of Vonage, the VoIP phone service. "I have a history of getting involved early in such markets," says Pulver, who's also poised to reap the benefits of his early bet on Twitter — the social networking company has recently been valued at a staggering $1 billion as it hurtles toward a public offering.

He's first to admit that most of his hundred or more fliers never got off the ground. But like angels everywhere, Pulver knows that one or two seedlings can be all it takes to yield juicy fruit.

Most angels aren't fazed by businesses with negative cash flow. In fact, they expect it. They also can pull the trigger on investment decisions all on their lonesome. By contrast, venture capital firms and lenders must appease partners or shareholders before placing any bets.

If you believe your baby biz is prime for such funding, here's what you need to know to find an angel who might buy into your dream.

How to search for an angel
Your first stops should be the two best online listings of active angel individuals and networks in the U.S. and Canada: the Angel Capital Association, a professional alliance of 330 angel groups, and the Angel Capital Education Foundation, a nonprofit supported by the Ewing Marion Kauffman Foundation, which lists about 200 angel networks. For background data, average deal sizes and profiles of angel characteristics and demographics, head to the Center for Venture Research Web site.

When scanning, first check the regional breakdown. Often successful entrepreneurs or former executives themselves, angels make decisions based not only on a startup's need for cash but, more important, on how the angel's skills, experience and professional networks can help. That means they mostly stay close to home in order to make meetings convenient and resources count.

"I always describe angel investors as 'employees who give you money,'" says Chris Yeh, a serial angel since 2005. Among the companies Yeh has invested in is PBworks, a collaboration solutions provider in San Mateo, California, that he ended up joining as vice president of marketing. "My typical modus operandi is to be the first outside investor in an emerging startup. Once I'm invested, I help the entrepreneurs position themselves and raise their first institutional round."

Next, look at an angel's preferences and previous investments. Many specialize in specific sectors, while others are open to any good opportunity. You won't get far with a product that doesn't interest the angel.

How to pitch an angel
Once you've identified a likely individual or network, invest in some research. Work your contacts to learn what makes the angel tick. Why does he or she invest? How does the network operate? What kinds of investments have they made in the past, and what were the results?
 
The idea is to audition the potential fit so you don't waste time or resources (either yours or theirs). If it looks right, the next step is to get acquainted. "The best-case scenario is when two or three people have already spoken to an angel on your behalf before you contact them," says Connie Wright, Boston-based managing director at Accounting Management Solutions, an outsourcing service for small businesses.
 
Of course, that first meeting is all about defining your business for a potential investor, but it's equally about testing rapport. Angels are engaged partners, weighing in on decisions and operations, and you want to make sure you and the angel can work together. When you forge a bond, the angel will be more receptive when reviewing your business plan or will personally refer you to his or her network.
 
For instance, at the Angel Investor Forum in East Hartford, Connecticut, managing director Mary Anne Rooke says the group reviews submissions using Angelsoft, an evaluation software developed by well-known New York angel David Rose.
 
"When a member submits a business plan for review, Angelsoft notes the referring name and date," says Rooke. "If the referral is someone that members recognize, the submission will get a different view. If it comes totally unsolicited, it will be reviewed, but it won't get extra attention."

What your pitch should emphasize
The real skinny on what gets angels juiced, says veteran angel and former banker John O. Huston, is all about potential return. What that means, according to Huston, is that angels look for opportunities to make four times their investment within three years.

Sporting a long resume of structuring private companies, and now chair of the Angel Capital Association and founder of Ohio TechAngels, the second-largest angel fund in North America, Huston says it's rare for angels to hear entrepreneurs focus on their exit or rate of return — yet that's the key.

"If you want to make certain an angel reads a plan or pitch to the end, then one out of every 20 words — 5 percent of the plan — ought to talk about reward, not risk," says Huston. "Entrepreneurs are always convinced they've identified all the risks and how their team will manage them, but they're too silent about rewards. And it's always about risk-reward."

The biggest mistake
The most frequent pitfall is the inflated way entrepreneurs value their companies. Newbies, of course, are always convinced that their brainchild will become the ultimate commercial widget. So their business valuation — that is, the process that calculates the economic value of an owner's interest — is set way too high.

"If you are asking an angel to invest, say, $250,000, in exchange for 10 percent ownership of the company, that means you think the company will be worth $2.5 million after the investment, or $2.25 million before the investment," says Angelsoft's David Rose, who has invested in more than 70 early-stage technology companies. "But angels have looked at many startups like yours, and know [the company's] not worth more than, say, $500,000, so they're therefore likely to not even engage you in a discussion."

Worse, says Rose, is if you've already raised money from friends and family at the higher valuation. You've now put yourself in a real bind, where you may never attract professional investors.

Be honest and up front about your business
If you do head out to find an angel, the smart approach is to be honest and realistic, whether you're describing valuations, risk-rewards or your company's competitive set.

Don't forget: Angels are investors who typically have started and sold companies themselves. They've truly been there and done that.

Joanna L. Krotz writes about small-business marketing and management issues. She is the co-author of the "Microsoft Small Business Kit" and runs Muse2Muse Productions, a New York City-based custom publisher.