Thoughts from the west out east, and vice versa

The theme of the event I spoke at last week was angel investing – east meets west. It was an interesting format. About 250 people from 15 or so New England angel groups were represented there, as well as speakers from “out west.”

One thing that I heard repeatedly today from the better angel groups (east and west) is that every single deal that is presented to their group is sponsored by one of their members. That member introduces the deal before the pitch. I got to see 3 “quick pitch” deals today and they were all high in quality. They were effectively introduced by the sponsor angel. If the deals weren’t good, that angel would look bad for bringing the deal to the group. Social pressure was at work naturally and effectively because of this simple rule. No screening committees, application fees, etc. Just go impress a member angel. We should be able to learn from these best practices in Colorado, but we haven’t. Both Kieretsu and CTEK require applications, payment of fees, and artificial screening processes. Just make them get to and impress an active angel who is a respected member of the group. Much cheaper, no fees required, and good dealflow. If they can’t find and impress just one angel enough to get there, there’s a 99% chance they shouldn’t be there anyway. I continue to hope we see this sort of model adopted with Colorado’s angel groups. It’s certainly the way many of the very high quality angel deals get done outside of those groups already.

I especially enjoyed the presentation today by Luis Villalobos who founded the Tech Coast Angels (California) and is now a managing partner at Angel Venture Partners. Luis has directly invested in about 60 companies as an angel, so he has quite a bit of experience. So I listened very carefully.

Luis said that “The role of angels is to transform promising opportunities into terrific investments.” He continued on to say “Rarely will angels find a funding-ready deal.”

I’m an entrepreneur too, and at first I found that a bit offensive. As I thought about it, I realized that he’s of course correct. Experienced, extremely high quality entrepreneurs have plenty of funding available to them already. Strong entrepreneurs with current traction and measurable success in their businesses do too – they can pick their angels or VCs, assuming it’s a deal an angel would be interested in anyway. So really what remains are companies that don’t have great progress yet and/or are run by less experienced entrepreneurs. And as we know, they’re not going to have it exactly right.

So, Luis concludes, it’s the job of the angel investor to help the company to tweak (in the best case) their plans appropriately. That is the magic, and that is why the only angel investor who is worth a crap is one who has experience not just investing, but in building companies that work.

On another topic, Luis warned angels not to use “milestones” too aggressively in deal structures. He says that the team will manage toward the milestones, right or wrong, because that’s where the incentives are. And as we also know, most startups start out doing stuff that is wrong. It logically follows that the milestones are probably wrong too, even when written by the “all knowing” investor. Guess what, the investors are probably wrong too. The smart ones just realize that over-managing with specific up-front long term milestones are likely to lead the entrepreneurs down the wrong “planned” path.

Luis was also suggesting a new way of thinking about angel deals. Rather than committing to participation in a round at a particular pre-money valuation as is commonly done, he was talking about about the benefits of offering to buy something specific and immutable such as “25% of the company for $500k.” Luis was explaining situations in which angels could commit $250k in capital at a 1.5M pre-money valuation, only to have no real argument for stopping the company from raising significantly more money, and effectively being “committed” to participating with an over-funded company and taking front-end quasi-dilution. In deals I’ve been around, there is usually an upper limit to how much money is being raised in the term sheet, which prevents this sort of thing, so I’m not sure I agree that there is a real problem. To be fair, I don’t think Luis does either – I think he was just wondering aloud why seed round angel terms sheets aren’t more straightforward. Seems to be a theme lately.

Good stuff.

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