Here's the shortest, best advice on how to get start-up capital:find some rich angels
All right, so finding rich people isn't as simple as it sounds. But now that other sources of capital have practically dried up, these so-called angels have become an even more important font for entrepreneurs. The problem is, where do you find these heavenly beings and what kind of deal can you expect from them?
There's no shortcut for locating angels. It takes legwork and perseverance. And angel investments can be wildly disparate in structure. But there are some similarities, especially if you're dealing with "professional" angels -- wealthy individuals who have business experience. In contrast to rich uncles or other family backers, these investors will expect equity in exchange for their money, though some are happy with a smaller percentage than venture capital firms or other institutions would take. Angels are also apt to make their investment decisions quickly, without the extended getting-acquainted period required by investment firms.
There's a downside to those pleasing characteristics, however. Angels can be meddlesome, particularly if they haven't successfully made the transition from business manager to investor. What's more, a group of individuals doesn't have the prestige of a big-name institution. Angels may not be able to get you in the door of an investment bank once your company is ready for a private placement loan, for example, or an initial public offering.
But at their best, angels can provide exactly the incubator your company needs. To understand how angel investments happen, we took an inside look at a Chicago group's recent investment in ICOM Simulations Inc., an early-stage software company. It's too soon to tell if the company -- and the investment -- will be successful, but this investor group does have the most important trait you can find in such backers: prior angel experience. Here are some of the players who came together in the ICOM deal:
* The archangel. The hub of the group is William N. Weaver Jr., a partner in the Chicago law firm of Sachnoff & Weaver Ltd. The firm has a general commercial practice, but he began orchestrating angel investments as a sideline in the late 1960s when a client introduced him to a needy software company. Weaver usually invests in the deals he puts together. He doesn't collect a fee, but he is paid hourly for doing the legal work involved.
Weaver has a stable of 20 to 25 potential investors whom he's met through client work and, increasingly, through the angel deals he's engineered. The deals themselves often come to him through the same web of relationships. He first heard about ICOM, however, from a contact at a major accounting firm. After visiting the company, Weaver was interested but had some concerns. He thought that Tod Zipnick, ICOM's founder and chief executive officer, was naïve about how much equity investors could demand. He also thought Zipnick needed a strong, detail-oriented manager.
* The entrepreneur. By the time he met Weaver, Zipnick had been trying to raise upwards of $1.5 million for 10 months. He had presented his case to venture capitalists, hired someone who failed to find capital, and begun to seek out wealthy individuals to patch together his own group of angels.
What Weaver offered was speed. After he made several visits to ICOM, some with people who were better equipped to evaluate the technology, he told Zipnick he thought he could raise the cash. Because he can't be sure how many of his angels will invest, Weaver never guarantees how much money the entrepreneur will actually end up with.
Zipnick and his staff made a presentation to about 15 potential investors gathered by Weaver. ICOM is a developer of entertainment software, and its inventive computer games are dazzling, even to the technologically illiterate. The big question that investors had was whether enough consumers would buy the new optical disk players needed to run ICOM's fancy software.
* Angel #1. Howard Tullman was a key investor because he was one of the few with both technological expertise and business experience. A multimillionaire and founder of CCC Information Services Inc., he started his own venture capital firm, Eager Enterprises Inc., early last year.
His investment in ICOM is separate from Eager, though -- and personal. "No question -- it's a matter of putting some money back into the system that helped me," he explains. Of course, he also thinks ICOM's technology is excellent -- an assessment that Weaver and other angels relied on in making their decisions. Though Tullman now sits on ICOM's board, he downplays how much an angel can really contribute. "We don't add anything to the learning curve. We're just as stupid and ill informed as most people."
* Angel #2. For John Puth, angel investing in young companies like ICOM is unusual. Having run several large companies in leveraged buyouts, he's more comfortable investing in business opportunities in which he has some input. "I'm not a passive investor," he asserts. Still, the start-ups that Weaver brings to his attention allow Puth to broaden his portfolio.
ICOM's technology intrigued Puth, but what persuaded him of ICOM's bright prospects was its board of directors, which includes a senior vice-president of The Coca-Cola Co. and Frank Biondi, president and CEO of Viacom Inc. "I made the investment decision because Tod was able to attract this caliber of board member. Anyone could be fooled, but I doubt all of these very bright guys could be fooled," says Puth.
* The deal. Altogether, 17 of Weaver's angels invested, putting up nearly $1.3 million. For that and for the additional $600,000 that came in related deals, Zipnick gave up about 20% of ICOM's equity. A venture capital firm would have asked for 30% or more, says Weaver. The angels now hold preferred shares with no dividend so that ICOM's cash flow isn't strained.
Now Zipnick has the money to potentially turn his start-up into a commercially viable company. And he appears to have the other key ingredients, too. He finally persuaded an old friend, Dennis Defensor, to come on board as ICOM's president and chief operating officer a few months after Weaver's angels invested. And he claims that Weaver and Tullman, who now sit on ICOM's board, have already made valuable contributions. "Many investor groups don't care about the health and growth of a business," he says. "A good angel will understand the ups and downs and will stand by your side."
Where to look
It's not just lawyers who create angel groups. Accountants and stockbrokers are also often plugged into networks of wealthy individuals. There's no mystery to checking out these would-be archangels. Just be sure you
* Check the track record. Look at how many deals your money raiser has worked on versus how many he or she has actually closed. Make sure the deals are of recent vintage. Being out of the game even for a short time means an archangel might have lost touch with the valuations being assigned to companies or with his investor group.
* Ask for references. Talk to the people your archangel has raised money for in the past. Find out how long it took to get the money, how the angels behaved on the board, and how the angels have reacted when the company has had problems.
* Pay within reason. If you can, make the bulk of a money raiser's fee payable after he's actually pulled in the capital. While it is possible to find deals that call for 5% for the first million raised, 4% for the second million, and so on, Weaver says between 5% and 10% per million raised is reasonable.