Angel Investors: Be Careful What You Ask For

The pros and cons of this last resort form of financing.

You wouldn’t come to an angel investor if you could get money somewhere else.”

This was one of many blunt and provocative statements that emerged from a panel of “angel investors” that took place at Xavier University on March 3. Kevin Pollard, President of GlobalSolve Management Services, added to his comment by noting that “we are high-risk investors.”

Finding financial backers that will consider supporting long-shot enterprises that more traditional sources, such as banks and venture capitalists, won’t touch may sound like an entrepreneur’s dream. But this kind of investment comes with a price.

“You will have a different company structure at the end of the investment process than you had at the b eginning of the process,” warned Mark Graffagnini of Graffagnini Law Corporation and a frequent advisor to angel investors. “You have to be willing to share your idea and your business with the investors.”

Pollard and Graffagnini, along with fellow panelists Dann Schwartz and James Griffith, are members of the NO/LA Angel Network. Founded in February 2014, the network now includes close to 100 like-minded individuals who are interested in high-risk, early stage investing.

According to Pollard, the Network consummates a deal every two to three days – yet less than 3% of applicants are funded. Deals do not involve the entire network, just a certain number of its members for whom a specific pitch is appealing enough to convince sinking some capital into.
This distinguishes the Network from angel funds, where a collective of investors pools resources and makes group decisions; and from individual angel investors, who operate independently.

An Arduous Process

The Angel Network has a formal application process, which begins with their website, Applicants are screened for certain criteria, like how their proposal is different from others in the marketplace and potential for growth. Those who pass the first hurdle may then be asked to present to the Network.

All the panelists emphasized the rigor of the presentation.

“I’m looking for a 10% to 20% annual rate of return over the term of the investment,” said Schwartz, who describes himself as a “serial entrepreneur”. “I want to know, where are you going to get your sales? What is your competitive advantage in the field? And the figures you present better be real.”

“What makes you unique, different or valuable?” asked Griffith, founder of CARE Inc. “I want to be sure you are committed to making money. I want to get back twenty times what I invested, because I figure you also have about a 50-50 chance of going out of business.”

Documentation is essential: all the necessary legal documents. Market analysis. Financial analysis. Intellectual property protection, like a patent, or at least a clear indication that you can get one. Your business structure and your management team – this last point was strongly emphasized by several panelists.

“I want to know where are you going to get your sales? What is your competitive advantage in the field? And the figures you present better be real.”
 -Dann Schwartz

“Your first hires have to be your best hires,” observed Pollard, since your initial team is the one that must convert an idea into a successful business. In reviewing potential investments, he focuses very strongly on the ability of the management team to execute the concept.

“If you have an A-Team of management and a B-level model, I will make money,” was his summary.

Applicants must also be willing to relinquish some level of control over the business.  “We are looking to help mitigate your risks, not micro-manage your business,” said Schwartz, but he also added a willingness to adapt, to consider advice and respond to contingencies, was essential in order to attract his investment.

Angel investors will usually try to get a sense of who the individual is as well as looking at the idea. Background checks will be conducted, probing questions will be asked. A personal comfort level must be established for the investors. As Griffith put it, “We want to know that in a jam, you will default to your values, not what is expedient.”

Finally – and this is a frequent deal-breaker for many potential recipients of angel investments – you must have an exit strategy.

“We don’t realize our return until you sell your company,” explained Griffith. Thus entrepreneurs who want to maintain long-term control over their enterprise are almost automatically disqualified, as angel investors typically want out of their investments in three to five years.

Your Risks and Your Rewards

Partnering with angel investors is a high-stakes game for both sides. While the investors are funding business ventures that are inherently high risk, entrepreneurs are accepting parameters (such as the mandate to sell) that may not align with their larger objectives.

That said, there are obvious rewards for a budding business person, and they start with the application itself. Several panelists pointed out that simply going through the process of preparing and delivering the presentation to the Angel Network will improve the applicant’s overall business plan, strengthen the business model and improve its chances of success.

Further, angel investors don’t simply write checks. “We bring more than just money to the table,” said Griffith. “We bring contacts, expertise, experience. We’ve seen just about every scenario you’re going to see. We may not know the best solution, but we know what is not the best solution.”

Angel investors are not looking for financial control of the companies they support; usually no more than 20% of the business is owned by the investors. “If you go beyond that, the entrepreneur becomes an employee,” was Pollard’s perspective. Thus the potential rate of financial return for the business owner is also very high.

“We bring contacts, expertise, experience.
We’ve seen just about every scenario you’re going to see. We may not know the best solution, but we know what is not the best solution.”
 -James Griffith

The Tax Credit Curveball

Like many investment models, the Angel Network approach includes accessing investor tax credits. And like many Louisiana tax credits, angel investor credits took a hit in the recent state legislative session and face an uncertain future.

According to Robert Wollfarth, a Baker Donelson attorney with considerable expertise in business startups and related tax and economic incentives, angel investor credits were part of Act 125, which reduced a wide variety of business tax credits by roughly twenty percent. Wollfarth also reported that pure dollar amounts were capped on an annual basis and per project basis.

On the plus side, the sunset date for these credits was pushed back by two years, to July 2017.

“We got less, but we got it for longer,” acknowledged Wollfarth, who added that it was difficult to predict the full impacts of the angel investor credits this soon. He also pointed out that all the candidates for governor have pledged to call a special legislative session to examine the state’s budget problems early next year, and that virtually all existing credits are likely to be reviewed at that time. This adds to the uncertainty of projecting any impacts.

“It could be mostly a perception issue,” he observed. “The state has been on an amazing trajectory, rated as up and coming for business and economic development by multiple sources. Changing the game like this puts a damper on it, and has the potential to discourage new growth.”

Wollfarth did suggest that some businesses and their investors may take a more aggressive approach to seeking the angel incentives. This makes sense considering the overall aggressive nature of angel investing. Further, given the scale of investments made by the NO/LA Angel Network, it is fair to question whether the loss of roughly half a million dollars’ worth of incentives over the course of a year will be deeply impactful.

As the NO/LA Angel Network enters its second year, it is moving into community outreach, with the Xavier panel being one example.  One-on-one mentoring and advice sessions are available, initially through Propeller, and Network members are even willing to sign non-disclosure agreements prior to providing such sessions.

Partnering with angel investors is not for the faint of heart or narrow of vision. This is the big leagues – investments typically range from $100,000 to $2 million – and all involved are expected to bring their “A game” every day.

Yet for those who are accepted into the game (and accept the rules of the game), long-shot ideas quickly get high levels of resources to support them. While angel investors are demanding, they are very focused on results, for themselves and for their partners.

Said Pollard near the end of the Xavier panel, “We want to see everyone succeed.”