Startable – Healy Jones’ & Prasad Thammineni’s Blog

Ah, angel investors. With a name like that, you’d think angel investors would be everything venture capitalists are not – warm, forgiving, easy going, free flowing with their cash… I’m sure there are some angel investors who have those qualities. However, most of the angels I’ve interacted with have been smart business people looking to generate significant returns – not so different from venture capitalists. As your startup searches for funding you will likely be introduced to angel investors. Here are a few things you ought to think about while you interact with angels:

• Friends and family can be angels… but you’d better treat them right. Make sure your f&f realize that the investment is risky; clearly tell them they could easily lose their entire investment. It’s probably a bad idea to let them invest their entire life savings. Make it clear that the investment will not be liquid, so they will not be able to ask for the return of their money at a specific time. Make sure they know that their investment could be diluted to no value by future financing rounds. Don’t make the mistake of relying on a handshake or legal investment documents downloaded off the internet. Hire an experienced lawyer and make sure everything is clearly explained to your f&f.
• Don’t confuse smart business person with experienced investor. Just because someone has made money somewhere else does not make them an experienced angel investor. Ask them how many other angel investments they have made. Do some diligence on them if they are going to have any sort of an advisory/board/active role in the business – if they’ve invested in other startups talk to those CEOs/founders. Again, hire an experienced lawyer. 
• Don’t confuse smart business person with someone who automatically knows everything about the industry you are attacking. Success in the automobile dealership industry does not translate into knowledge in the Web 2.0 space. If you need industry advice and you are not going to get it from your angel investors it makes sense to create an advisory board with people with the right experience. A smart angel investor will probably ask for that anyways. This leads to the next point:
• Establish their role in the business. Board member or whatever, just make sure you won’t have to spend 30 minutes on the phone with them before every strategic decision if you don’t want their advice. Aligned your expectations of their role with theirs.
• Understand their exit/return expectations and make sure they align with yours. Angels can be great because they might be very content with a $10 million exit that would be considered a failure at a large venture capital firm. This assumes you’ve found an angel who would be content with such an exit. Other angels really want to go big. Figure this out, then ask yourself the next question:
• Get a legitimate feel for the amount of capital you need to get to cash flow breakeven or exit. Ask how much money the angel has to invest and make sure it is clear how the rest of the company’s growth will be financed. If it is clear that you will need venture capital or additional funding down the road establish this expectation ahead of time. Find out if the angel investor will continue to invest in the business in future financing rounds. If you are expectign to raise venture funding in the future, you are a bit like Goldilocks – you want your angel investors to invest just the right amount in future funding rounds: enough to reasonably defend their position but not so much that they crowd out venture investors or don’t allow the VC to get their desired ownership position. Several years ago I was with a VC who was unable to invest in a startup because the original angel investors exercised their “blocking right.” The angels were not happy with the dilution they were going to recieve in the financing round, and decided it was better for them to have a big piece of a small pie over a small piece of a large pie. This may or may not have been the best financial decision for the angel investors, but it really screwed the management team. Set expectations early on the capital required and make sure the angels will do what you think is right for the company.
• If you need VC later structure the deal right. Actually, just make sure you structure the deal correctly. Hire and experienced lawyer.

This post is getting pretty long, so I’ll stop there… however, if others have good suggestions I’ll add them in. 

Angel investors can be very valuable to the growth of your startup. Just make sure you AND they know what you are getting into together.