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by Carrie Levine, HBS Working Knowledge
Even angels need some convincing.
Although the early-stage investors known as angels may be willing to take a risk on a fledgling company, they still need to see a strong product, a documented need for the product in the marketplace and a competent team to see the project through, angels and entrepreneurs said during a panel discussion on "Case Studies in Angel Funding."
Angel investor Malik Khan (HBS MBA '82), a former vice-president for Motorola who has founded start-up companies himself, said he studies every investment opportunity for certain consistent features. "The stage [of a company] I like best is way before the product is even firmly defined," Khan said.
As an angel investor, you know the runway you're going to provide is only so longthree or six or nine months. The question is, is it long enough? | |
Malik Khan |
Khan said he examines each infant venture to see if the market for its product is big enough to forgive a few initial blunders in the company's business plan, whether the product solves a serious problem for potential buyers, and to determine the experience of the team.
The business plan, he said, is secondary and sure to change. "It's going to be somewhere different by the time they come out with the product," he said.
Christopher Herot is the chairman and CEO of MessageMachines, one of Khan's investments. The company developed an advanced messaging platform for wireless cross-device alerts and notifications. Herot stressed that Khan's understanding of, and background in, the wireless industry was essential in convincing him to jump onboard when MessageMachines was still a new concept.
"It's really important to find people who understand your industry," Herot said, later adding, "Most of the people we took money from, we knew."
Khan's specialized knowledge and contacts helped him decide to take an educated risk. "My due diligence really involved sitting down with the people building the wireless infrastructures and saying, 'Is this an idea whose time has come?' If I didn't have the ability to pick up the phone and make those calls and feel comfortable, I wouldn't have invested in the first place," Khan said.
Panel members concurred that knowledgeable angels with good reputations in their industries can help a start-up company obtain venture capital when the company is ready for growth, simply by attaching their good names to the venture.
"The angel people that you talk to usually know the industry. They tend to understand it more intimately" than venture capitalists, Bitpipe, Inc., CEO Jay Habegger said.
And angel money has helped get many a company to its first round of venture capital financing, panel Moderator Robert J. Robinson, an associate professor at Harvard Business School, said. Robinson cited Alexander Graham Bell and Henry Ford as examples of early businessmen who were helped by angel seed money.
"If it weren't for angels, those companies that present themselves to venture capitalists looking for their $30 million...round of funding would never have gotten there in the first place," Robinson said.
Herot added that until the company is ready to absorb a large sum of money and grow quickly, venture capitalists are rarely willing to invest.
"Until you're ready to absorb that $4 to $5 million in venture capital, it's really a lot of free lunches and interesting conversation," he said dryly. Angels, on the other hand, typically make smaller investments in a larger number of companies, Robinson said.
Kevin Tolly, president and chief executive officer of the Tolly Group and Tolly Research, said part of the reason he chose to invest early on in Bitpipe, Inc., is because its method of distributing in-depth technology information for enterprise IT professsionals tied in with the core business of The Tolly Group. Tolly's firm provides testing, analysis, and consulting for the networking industry.
Tolly said his ten years of experience as an enduser of technology helped him see the value in Bitpipe's pitch when Habegger came calling. "When I met with Jay and he explained the business model, I understood it perfectly," he said, adding that the best deal for an investor is when "investors can also use the product, and benefit not just from the investment."
Investors aren't the only ones who should be choosy about their affiliations
Angels and entrepreneurs agreed that new company executives should be careful about who they take money fromand what they promise to do in return. Both Habegger and Herot said they tried to draw from a list of potential investors who had connections either with their target industry, or personal connections with a founder of the company.
"I think it's important to choose your angels carefully," Herot cautioned. Habegger agreed, saying he would advise other entrepreneurs to do more research than he dideven though, he said, he got lucky in his angels.
Tolly said Bitpipe's "luck" also has to do with Habegger's efforts to keep in touch with his investors, and let them know how the company is doing by sending out a monthly summary.
"Because of that, we have a very happy set of investors. You are going to have to slice off some chunk of your time, whether it's [sending] a monthly letter to your investors, or whatever" to keep investors up-to-date, Tolly said.
All four panelists said they spent little time haggling over terms and valuations, but stressed the importance of having experienced lawyers involved in the process, so existing agreements aren't challenged by later investors. Valuations, they said, have been more difficult to arrive at since the economy began slowing.
"I think we're getting a lot more questions about how we're going to make money" in recent rounds of financing, Herot said. "I think it's an okay climate if you have a viable business model. I'd hate to be out there with two guys and a concept trying to raise money."
Khan agreed. "As an angel investor, you know the runway you're going to provide is only so longthree or six or nine months. The question is, is it long enough?" Khan asked, adding that a tighter venture capital market may be forcing angels to pour more of their resources into maintaining the viability of existing investments, rather than helping new ones.
But in the end, Habegger and Herot agreed, even if new entrepreneurs can't raise all the money they want, it's important to work with what they can get. "We wanted $2 or $3 million. In the end, we got $150,000. Guess what? We made it work," Habegger said.
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