Two years ago, when I was raising capital for my new software company, Abuzz, I invited two potential investors to a presentation I was giving. They invited two other investors, one of whom, after asking questions about Abuzz's market focus, started to criticize our strategy. Rather than question what he, an uninvited guest, was doing asking questions in the first place, I let his negativism take over, and it turned the whole meeting sour.

My unfortunate experience suggests two lessons about securing money from "angels," private individuals most likely to fund companies in the very early stages. The first is that angels are idiosyncratic. Rather than dealing with institutions (as you'll do when your company gets big enough for you to go to venture capitalists), you're dealing with individuals and their whims. The second lesson is that you, the entrepreneur, can and must manage and master those whims. But you need to prepare.

More and more very young enterprises are turning to angels for initial rounds of financing. Based on my experience raising capital for two companies -- yes, I finally did raise $335,000 for Abuzz -- I've developed a checklist of dos and don'ts. I've divided the list into two parts: what you must do before making human (or should I say angelic?) contact, and how you should handle the angels once you do get in touch.

Before Making Contact...

  1. Write a Presentation and a Business Plan

    I suggest starting with a presentation that contains 10 to 15 slides and runs for no more than 20 minutes. In the course of your presentation, you should outline your product, your market, your management team, and the reason you think your product will sell. You should make the presentation before a few people you trust, get feedback, revise it, and give it again, this time taping it. When you view your taped version, make sure you are making a compelling case for your company.

    Only after you are satisfied that your presentation does make your case are you ready to write your business plan. Crafting such a plan is a fairly standard exercise. You can find tips in books, Web sites, and software programs. I recommend making an outline, using simple prose, and keeping your document to a maximum of 20 pages. Don't submit an 80-page plan!

  2. Identify Potential Investors

    Having developed a presentation and a plan, it's time to identify potential investors. One rule of thumb: Approach only those individuals who are less than two degrees of separation from you. Get references from people you know, but should those new acquaintances refer you to their contacts, you're on thin ice. Referrals from referrals rarely invest.

    Another tip: Stay local. You won't need to go beyond your geographic area to find pockets of people eager to invest. It is, however, a good idea to approach people you don't know (and who may not be in your locale) if you believe they have a unique understanding of your product.

  3. Create a Term Sheet and Specify a Valuation

    You're now ready to create a term sheet, a one-page outline of the investment opportunity your company affords. It should include a "valuation," your best estimate of what the company is worth. Determining valuation is tricky. I suggest that you not try to gouge your investors. Aim for a fair deal. If you think your company is worth, say, $3 million, and your investors offer $1 million to $2 million, go with the $2 million. From the beginning, you want investors always to feel as if they're making money. Even though they'll own more of your company with the lower valuation, during later financing rounds, your company's stock will be more likely to increase.

Even though some angels are sophisticated investors, it's a good idea to warn them about the risks involved. (Each state has its particular disclosure requirements. You should check with your attorney or CPA to make sure that you are in compliance.) At the very least, you'll save face, and in the unfortunate event that your venture fails, you'll still be able to have lunch with your angels.

Finally, structure the investment as common stock rather than preferred stock. While savvy investors often push for preferred stock, I'd recommend that the first money into a business -- the "seed" capital -- be in the form of common stock because it puts the investor on equal footing with the entrepreneur. If the company's valuation is fair, getting common stock shouldn't be too difficult.