Yesterday, I participating as a coach and panelist in a program put on by the Kauffman Foundation and The Colorado Office of Economic Development & International Trade (who comes up with these names?) called The Power of Angel Investing. The purpose was to educate various economic development professionals from across the state on angel investing – specifically how it works, what motivates angels, and how to help promote angel activity.
I thought Steve Mercil (note to Steve, if you blogged, I’d read it) did a great job running the seminar, with interesting slides that I generally agreed with and thought were well presented and articulated. As always some of the panelists said a few wacky things (this always happens when a room full of angel investors open their mouths). My favorite was “in general I won’t even consider a deal that doesn’t have rock solid IP protection.” Hey, to each his own.
The most interesting (to me) part of the seminar was when we split out the participants into groups of angel investors and entrepreneurs. The two groups had to try to hammer out a term sheet based on the information provided to them. We explained to the groups that they were not to get “hung up” on due diligence type issues in their negotiations. Just make some assumptions, and see how close you are. They had some financials (actuals and projections) as well as general statements about the industry, due diligence that had been performed, etc. These were real case studies, from real companies. And so there they sat, pitted against each other.
This was fun to to observe/coach. The entrepreneurs quickly valued the company using what they felt was a “standard” valuation using total revenues from year 5. These revenues were about 61M, so they quickly concluded that their company was probably worth about that. According to the case study, they’d been in business for two years, and appeared to be near break-even, although they’d never actually earned one red cent. They bought into their own hockey stick utopian view of the future. It was amazing to watch how quickly they fell right into the role of the confident entrepreneur. My advice to this team was to “go in with some humility.”
Meanwhile, the investors opened with a valuation of “2.5 to 3.5 million” (which, of course means 3.5M in any negotiation I’ve ever been in). They said they were bullish on the company, and felt they were offering a more than fair valuation.
When each party threw out their opening offer, there was clear tension, obviously. A shouting match ensued, with lots of laughter and clear hurt feelings. It was almost like it was real. I figured this one was over, the investors will get up and leave and make the company come back to them – if they’d even speak to them again.
After three rounds of negotiation and much coaching, they parties settled on a valuation of 3.67M and a board observer role for the preferred shareholders.
The real case study was presented, in which a valuation of $2.03M had been arrived at by the actual angel investors. The study then also revealed that the company was doing well, but did not grow nearly as much as the entrepreneurs had anticipated. The angels made about 3x on the deal – not much of a win, but not a loss either.
I learned a couple of things from watching this.
1) Convertible debt sure has it’s place. 😉
2) Entrepreneurs with no experience and no advisors sure look like morons in these types of negotiations. They were off by a factor of 30x from reality, where as people with the same background and experience looked at it from another point of view and were at the right order of magnitude. Hence:
3) Doing the kind of math an angel investor has to do is not hard. You just have to put yourself in their shoes for a second and (just for a second) don’t believe your own wild projections.
This was a fun and worthwhile event, and I’m glad to see these sorts of educational opportunities here in Colorado.