Angels

Early-stage ventures are a risky investment and valuation is more difficult to determine when comparing to a listed stock.

The upside, however, is very attractive. As a simple example, an early-stage venture bought at a valuation of $1 million that lists or is sold through a trade sale with a PE ratio of 10 with $10 million in profits provides a 100 times return to the angel investor who backed the venture. An investment of $100,000 would return well over $50 million after tax and expenses. Angel investors, as we all know, are interested in helping young companies generate these kinds of returns for their investment.

What's changing is that people with the ability to invest in early-stage investments are beginning to realise that there are ways to reduce risk and to generate real returns. Angels groups are being started based on new models that consider the reduction of risk paramount. This book in itself is part of the change that is occurring. For the first time we are discussing the importance of entrepreneurs, investors and mentors operating as a single team with a single goal. It's one of the many small changes that will shape angel investing over the next decade.

Why angels don't invest in all ventures

When an investor makes their first $100,000 investment in an early-stage venture and lose their money they are not happy. Of the many outcomes, one is the loss of this investor's confidence to invest again. The investor is taken out of the market with some of the following comments:

1.    I did not realise it would become a family business with no opportunity for an exit

2.    They kept coming back and asking for more money

3.    I worked with the entrepreneur but they did not listen

4.    My spouse will kill me if I do it again

5.    The venture did not succeed

Investors are often people you meet in everyday life. They may invest in many deals or may only invest in one. They like to think they know what they are talking about and they often do. In general, the experiences of a first time angel investor are limited and although they may offer some great experience to the team, they may also make mistakes as we all do.

If an investor invests the same $100,000 and wins they are very easily ready to invest again. Securing an angel investment for your venture is very much a privilege and a huge responsibility.

Growth of Angels Groups

Angels groups formed in Australia have taken these issues and addressed them in an unusual way. Typically angels groups have formed by investors with a formal structure and a mandate to invest a minimum amount every year to maintain membership. This has worked in the past; however, many such groups fail within a few years. The model does work and certainly it enhances the early-stage investment environment.

In Australia, groups have formed, through the Angels Institute, without the mandate to invest. Members of these angels groups include mentors who are unable to invest funds directly. By not insisting on investment, groups are formed by people who want to assist early-stage ventures. Further, without the mandate to invest, the group is less likely to invest in a venture that has not yet proven that it is investor ready. This like-minded approach creates a social group with a real interest in getting together. Bringing in mentors has proven to be extremely important because these members are critical in researching, nurturing and supporting the ventures both before and after investment. Both mentors and investors "invest" time and/or money to secure an equity position in the ventures they eventually back.  Mentors may also be compensated through the investment where appropriate.

This approach has proven to be appealing to those involved in the early-stage investment community. Mentors are very pleased to be rubbing shoulders with investors, knowing that their likelihood of being supported is enhanced. Investors equally value the fact that they have mentors capable of reducing some of the risk in the investment. As a team the group can improve the outcomes of their investments significantly.

An additional benefit to this structure results from the potential need for follow-on investment. Angel groups are generally limited to investments under $1 million. Many opportunities will require second level funding beyond this limit. The good news here is that as a group they have the increased attention of venture capital and private equity players. It is possible for the group to pre-arrange the second round, subject to performance, before the angels invest.

Venture capital and private equity firms find this attractive. Not only do they receive access to quality deal-flow, but they also generate a potential investment that are better prepared and that require less maintenance by their busy investment managers.

Are funds available?

It's not now and never will be easy to raise funds for a venture. This is not because the money is not available, but because becoming investor ready is a complex and difficult process. Too many entrepreneurs believe they are investor ready when they are not. If you are truly investor ready, you will find the funds required to take your company where it needs to go.