David Rose: What Angel Investors Look For in a Startup
Every year, angel investors invest more than $20 billion into U.S. startups. Recently angel investing has moved even further into the mainstream, spurred in part by the popularity of the hit TV show Shark Tank.
Yet details on the types of ventures angels fund and how they do so remain relatively unknown. To cast light on the subject, David Rose, founder of the New York Angels investing group and CEO of investment firm Gust, has written a book, Angel Investing, that was released this week. Inc. spoke with Rose about the role angel investors play in the startup world and how entrepreneurs can get investments.
At what stage should founders be trying to get angel investments?
David Rose: Today, given the reduced costs of starting a company, the bar has been raised an enormous amount. When it took $20 million to get a company started or even $2 million, the only way to start a company was to get the money first. But at this point, angels no longer fund ideas. If you just have an idea, don't even try. Now where does that first money come from to start a company? It comes from the entrepreneur. Because if you are not prepared to put in money to back your idea, there is not a chance in hell that anyone else is going to.
How much do you expect entrepreneurs to invest in their company at this stage?
David Rose: Now how much they put in, that’s a different story. Not everyone is Elon Musk. So what we as angel investors like to see is what we call "skin in the game." We want the entrepreneur to show us that they have something meaningful to risk backing the venture.
The first outside money is coming from people who are betting on the person--usually friends or family members. Then at that point the entrepreneur will use that money to actually develop something--some proof, some traction that you can actually create something that people want. This typically is where angels come in. We take the first outside bet on his or her ability to actually deliver a product into this market that people are willing to pay for.
So then what types of companies are you or other angels looking for? Is there a common thread you have found between successful investments?
David Rose: There are some businesses that are just not appropriate for this kind of funding. That's something very important that a lot of people don't get.
Can you break that down?
David Rose: Businesses that are heavily dependent on people doing something are not the kind of businesses that angels invest in. There are very, very few investors that you will find who will invest in a consulting business, a design agency, or a pool cleaning business--anything that has to scale with people.
Angels want to see how a business can get big really fast and do it economically. That’s why we invest so often in Internet-based businesses, whether it's a social network or a business-to-business platform, because you can scale much more easily with that technology behind you. Angels tend to invest in companies that have relatively low costs of entry because, remember, they aren't investing hundreds of millions of dollars, or tens of millions of dollars, or even a million dollars. The typical angel investment is about $25,000 per angel, per company. If you are trying to build a nuclear power plant that requires $2 million to build, even though that’s a good thing for society and it might be lucrative, angels simply can’t fund that. That’s not what we do.
What is the number one quality you look for in an entrepreneur when investing?
David Rose: The number one thing I look for is integrity. When you invest in a startup, everything is going to go wrong. Since we all know going in that is going to happen, we want to have the things that we can control to be absolutely rock solid. I can't control the customers or the market or what will happen with the product, but what I can control is if I trust the entrepreneur. Integrity by itself is not enough to get you funded, but a lack of perceived integrity is absolutely enough to not get you funded.
What do you think is the most important aspect of angel investing that a lot of entrepreneurs and hopeful angel investors don't understand?
David Rose: There is one big thing both sides typically misunderstand: how risky the overall business of angel investing is. No matter how great the company is, what the market is, or how cool the product is, the majority of companies fail. Obviously not a single entrepreneur starts a company saying that they are going to fail; every single one of them has the vision and the passion and the drive to say, 'My company is going to succeed.' And when an angel invests in a company--because it turns out that most angels were entrepreneurs themselves--they tend to get carried away too.