As you may have read in my last post, I believe entrepreneurs should write business plans – for themselves and for investors.  You’ve probably also noticed that business plans come in several flavors.  Let me describe them and explain how, as an investor, I suggest that entrepreneurs use business plans.

Too often you read about investors who suggest to entrepreneurs that business plans are unimportant and they never read them.  I think this is poor advice for entrepreneurs, because business plans are not just written for investors.  Writing business plans forces entrepreneurs to think through and then describe in writing all aspects of their business.

In my last post, I poked fun at Eric Ries and Steven Blank for an article posted by the New York Times suggesting that “lean startups” are a fresh new approach, which is likened to bootstrapping. I pointed out that we outside of Silicon Valley have been bootstrapping our startup ventures for decades because venture capital is not nearly as available anywhere in the world than it is in Silicon Valley.

In all of my travels, I explain to audiences that there are only two places in the world for entrepreneurs starting companies and seeking capital – (1) Silicon Valley … and (2) everyplace else.  Except for those in the Bay Area, almost all the rest of us live and work in fly-over (or fly-around) states and countries.  The innovation in Silicon Valley is amazing and the sources of capital to support startup based on this innovation has been quite robust.  But, sometimes our friends in the Valley need to get out more…and see how the rest of us start and fund companies.

A summary report from the interns that carried Bill Payne's bags while in New Zealand

Ann and I have truly enjoyed our five month visit to beautiful New Zealand.  Lovely country and really friendly Kiwis – what a wonderful place!

I think tech transfer (TT) out of publicly-funded research organizations is really, really hard to do.    Here are a series of bullet points expressing my point of view on TT:

My friend, Brad Feld, is a prolific angel and venture capital investor.  More importantly, he is really smart and a genuinely right-minded proponent of entrepreneurs.  Brad wrote an insightful article on June 2nd for Business Insider entitled After More Than 75 Angel Investments, Here's What I've Learned.  This is must reading for all angel investors and entrepreneurs seeking angel capital.

I was a solo angel investor from 1980 until 2000 and made a significant fraction of my 52 angel investments during that period.  Solo angel investing is just plain hard work.  I found that, as a solo angel, it was difficult to complete adequate due diligence and very time-consuming to provide sufficient mentoring to portfolio companies.  Furthermore, soliciting financial investment from other accredited investors was limited to those in my personal network.

Dean Greg Whittred (UABS) interviewed Bill to discuss angel investing and the environment for entrepreneurs seeking capital in New Zealand

As has been reported in an earlier post, angels with a diversified portfolio of invested companies should expect to earn about 25% IRR over a decade or so of angel investing.  A frequent question from new investors is: “but what is your return on time invested in portfolio companies?”

A frequent question from entrepreneurs is “how much ownership do angels expect to purchase with their investment in my start-up venture?”

In the last post, I described the two most important characteristics of a fundable deal, that is, the entrepreneur/management team and the scalability of the business model.  So what are the additional features that can make or break an entrepreneur’s business plan?

The two most important attributes of a fundable deal for angels is the quality of the entrepreneur and management team and the scalability of the venture.

In an earlier post, I addressed the issue Is a Respectable ROI an Achievable Metric for Angels? and concluded that, under certain conditions, reasonable returns could be achieved from an angel’s portfolio.  My conclusions were based on a study by Professor Rob Wiltbank at Willamette University (near Portland, OR) Returns to Angels in Groups.  Please allow me to elaborate on my earlier work to provide an example of what might be expected from such a portfolio.

Over the past couple of decades, angels have consistently chosen to invest in software deals, more frequently than ventures in other sectors.  Software companies generally scale quickly and produce high gross margins.  When coupled with a great management team and a significant head start, software companies can produce wonderful returns for entrepreneurs and investors alike.

In his recent blog Don't Take Angel Investments From VCs, Bill Burnham cautions entrepreneurs not to include venture capitalists among investors in an angel round.  His premise is that these same VCs may choose to offer the entrepreneurs an onerous term sheet (low valuation, etc.) at the point the entrepreneur need to raise more capital.  If the entrepreneur chooses to ignore this “low ball” offer, the VCs may then attempt to dissuade other investors from making an offer.  Burnham’s logic is sound – it is possible that a VC could choose this strategy for taking control of the company.

Bill Payne has the perfect retirement job. The United States angel investor remains active in his first passion, business, while also having time for fishing and golf. An advocate for angel investing, Mr Payne speaks to business reporter Neal Wallace.

Derek Sivers points out a critical issue to startup companies:  Intellectual Property has LITTLE OR NO VALUE without execution by the entrepreneur and management team.  Here is his blog:

Professional investors, angels and venture capitalists alike, often stipulate that companies in which they invest establish a second class of stock (preferred, in addition to ordinary or common shares) and that the investors then purchase preferred securities.  What are the advantages to investors of preferred shares?

Angel investors are important capital sources for entrepreneurs, providing cash as debt, some of which may be converted later into equity, or more commonly to purchase equity interests in the company.  Seasoned angel investors favor funding seed and startup companies by purchasing preferred shares, rather than simply owning common (ordinary) shares or convertible debt (see: Angels: Convertible Debt Is Seldom the Right Security for Startup Investments and When is Convertible Debt the Right Instrument for Angel Investments?)

It seems everywhere I travel I find another “center of excellence” in Biotechnology and Life Science.  R&D in these arenas seems to grow and flourish.  Those with a focus on commercializing this science are then quite disappointed when angels express low enthusiasm for their particular projects.  Let me explain why.

Bill Payne, a prolific US investor who has set up four Angel investment networks, is in New Zealand for five months to offer his expertise as the BNZ University of Auckland, business school entreprener in residence.

The Australian Association of Angel Investors (AAAI) held their 3rd annual meeting in Adelaide last week.  Attendance was over 125, showing a steady increase over the past three years.  The messages of interest were consistent with what we are learning around the world.

To provide members with a broad selection of opportunities to invest in quality start-up ventures, angel groups encourage and are prepared to manage rather high deal flow.  Here are typical deal flow statistics for angel groups:

I read a blog post by Bill Burnham this week entitled Don't Take Angel Investment from VCs.  He gave the following example to make his point (my paraphrase):  An angel/VC that invested in the angel round tried to pre-empt the Series A fundraising in a company with a low-ball term sheet.  The entrepreneur thought he could do better and politely told the angel/VC “thanks, but I’d like to test the market”.  The response was swift and furious.  The angel/VC told the entrepreneur he had to accept the offer or the angel/VC wouldn’t invest in the Series A round  -  dramatically reducing the chance of raising money because other VCs would assume that the angel/VC wasn’t investing was because there was something wrong with the company.

 Back in the ‘70s, David Birch of MIT startled the world by reporting that US government data showed the predominance of new jobs in the US were created by startup companies.  Most mainstream economists scoffed at these results, since “everybody” knows that big companies create new jobs.

In my last post, I confessed that a decade ago I was skeptical about the value of national organizations of angels and angel groups, but I was wrong.   Despite my doubts, I participated as a member of the organization committee of the Angel Capital Association in the US.  Since then I have been engaged with AANZ (New Zealand), AAAI (Australia), BBAN (UK), NAO (Canada) and EBAN (Europe).  

In recent posts, I have described the growing US capital gap between typical angel and VCs round size.  US angels generally invest in rounds of $200K and $1 million, while VCs have moved from rounds of $2-3 million in the ‘90s to rounds of $7-8 million today.  This gap is quite troubling for entrepreneurs seeking investment between $1 and $5 million and for us angels who provide seed capital for their startups.

In an earlier post, I reported that angels in some US groups are investing in more angel-only deals, that is, startups for which less than $1 million in funding will provide sufficient runway to achieve positive cash flow.  Angels are electing to seek out and invest is such deals because venture capital in the range of $1 to $5 million is less available than in the past.  As I pointed out earlier, the world of venture capital in the US is changing rapidly – and not for the better.  VCs are funding fewer deals with a higher fraction as later stage deals.   US VCs are investing larger sums in total in each venture and waiting longer, hoping for larger exits.

I have been suggesting for some time that the US VC model is, indeed, broken.

In my last post, I described the trend among angel groups in the US to fund more angel-only deals, primarily because of the changing world of US venture capital.  I did so without really describing the characteristics of angel-only deals.

Because the US is a large country with huge demographic variety, venture capital has thrived in a few regions and is virtually unavailable elsewhere.  Venture capitalists prefer not to travel to portfolio companies, investing instead close to home.  Consequently, while angel groups in a few regions do a high percentage of their deals with VCs, most angel groups seek and fund deals that will not require subsequent VC funding – “angel-only deals.”

In my last post, I concluded that convertible debt securities are seldom appropriate for angel investments.  My primary conclusion was that using convertible debt was likely to substantially reduce the ROI of “smash hits,” those 7% of angel investment that provide 75% of our ROI.

Just after the Internet bubble burst in 2001, many of us angels were “crammed down” unmercifully by subsequent investors in our portfolio companies.  These new investors were funding our companies at valuation far below the pricing we had agreed to earlier, resulting in substantial dilution to our ownership.  To avoid these “cram downs”, some angels began investing in startups using debt instruments that convert to equity at the same time and under the same terms as subsequent investors, with a small discount in pricing, based on the greater risk in our earlier investment.  While there are some advantages to using convertible debt for early stage investments by angels, I dislike these instruments and seldom use them.

Until the mid-‘90s, the quality and consistency of term sheets offered by angels to entrepreneurs varied considerably.  Some were sophisticated while most were not – as if written on the back of an envelope.  Angels and entrepreneurs did other deals with only a hand-shake - no term sheet at all!

I’ve been asked for thirty years if due diligence on angel deals really pays off.  Are we angels better served spending substantial time with entrepreneurs before investing or should we simply to throw darts at a list of deals to pick companies in which we invest?  Frankly, I didn’t have a quantitative answer until November 2007.

Bill Payne, Entrepreneur in Residence at The Kaufman Foundation, says that most start-ups fail due to a lack of execution.

 I’ve been funding startups as an angel investor since 1980 without having a good answer to this question.  Early stage VCs seem to earn over 20% IRR (annual internal rate of return), so my thought has been that angels should earn even more.  After all, we generally invest earlier with more risk than do seed VCs.  My own portfolio has done well, but one cannot base any conclusions on one lucky chap.

Wait a minute. Before describing why I think It’s a GREAT Time to be an Angel!, let’s level the playing field. Just what is an angel investor? Wealthy investors have been providing funding and advice to new entrepreneurs for thousands of years. In 1983, Professor Bill Wetzel at the University of New Hampshire recognized the analogy between “Broadway angels” – those who funded new plays in New York City – and “business angels” – those who fund and bring business savvy to new business ventures, hence the term “angel investors” (or business angels in some regions of the world).