What's the difference between a venture capitalist and an angel investor? Not much anymore. Just try finding an old-fashioned angel

What will it take to persuade Hans Severiens to invest in your start-up? Ask him, and he'll issue a litany of demands--a business plan, well-defined milestones, a significant equity stake, and usually a board seat--rigid enough to make any entrepreneur want to leap into the arms of the nearest angel investor. Except that Severiens is an angel investor. Or what passes for one these days, when it's harder and harder to separate the angels from the venture capitalists. "There really isn't much difference," confesses Severiens, who belongs to the Band of Angels, one of Silicon Valley's better-known angel-investor groups. "We're all trying to make sensible investments, and we're exercising some due caution."

Nonchalant as he sounds, Severiens is emblematic of a surprising turnabout: not long ago angel investors were viewed as start-up saviors, quietly stepping in to fill the gap where venture capitalists feared to tread. Angels were defined by how distinct they were from the venture types: eager to make smaller investments, they were willing to wait longer for a payback and were fully expecting to play an active mentoring role along the way. Largely consisting of retired entrepreneurs looking to invest their accumulated wisdom and wealth--in that order--the angels clung to their discreet and inefficient operating style. You found angels less by trying than by hoping: through a chance meeting or a remote contact or plain happenstance. They wanted it that way.

Not anymore. In the wake of a raging bull market, many venture-capital funds have grown too big to even consider any investment below $1 million, leaving a much wider field for the angels. Meanwhile, a sizzling market for cashing out has enabled a broader range of wanna-bes to act on their angelic impulses. At least 10% of CEOs on this year's Inc. 500, a ranking of the country's fastest-growing companies, actually consider themselves to be angels. "There's a lot of money in the hands of young people who are technically competent and not afraid to invest," observes Severiens. Investing their cash also lends them cachet. Calling yourself an angel puts you in the orbit of such celebrated winged ones as Microsoft cofounder Paul Allen. It conjures images of the heavenly returns earned by the angels who backed Amazon.com, the on-line book retailer that was one of last year's hottest initial public offerings.

The angel community's newfound notoriety has come as a by-product of its growth: it's estimated that in 1996, 250,000 angels invested upwards of $20 billion annually; in comparison, roughly 600 venture firms put in half that amount. These days angel investors are about as publicity shy as the average Geraldo guest. Competing for the best deals, some resort to making cold calls. "They're hard to say no to," says Dale Van Aken, chief executive of Syncro Technology Corp., a $5.8-million software developer based in Langhorne, Pa. "They're saying, 'Here's my name, and I want to give you money."

Not that angels are all working their way through the yellow pages. Still, chances are that if your accountant doesn't know an angel, your lawyer will. If neither pans out, flip open the Wall Street Journal--where you'll find ads for matchmakers who specialize in linking entrepreneurs with angels--or do a search on the Internet, where even the government maintains a site, ACE-Net, aimed at pairing fund-loving entrepreneurs with well-heeled angels.

Dave Berkus, former CEO of an Inc. 500 company, says that the angel network he created, Los Angeles-based Berkus Technology Ventures, sees more and more deals that have been sent by venture capitalists. "I consider myself a seed venture capitalist," says Berkus. "But angel is a good description, too."

That very overlap makes angel a less-than-helpful label for those seeking to raise money. Like the budding venture capitalists of the 1960s, angels have discovered that pooling resources and sharing due diligence make for greater efficiency. Brand-name groups like the Band of Angels have helped legitimize angels as a breed. And harden them. "Nine times out of 10, entrepreneurs are too greedy," says Thomas Barr, who has invested in seven ventures while serving as CEO of HydroLogic Inc., a fast-growing environmental-services business in Asheville, N.C. "They want to keep too much. That turns off an investor more than anything else."

It's that sort of attitude that earned venture capitalists their unaffectionate nickname: vulture capitalists. Angels aren't there yet, but they are bringing new sophistication to every aspect of the deals they do, meaning that the wisest entrepreneurs are learning to perform some serious due diligence of their own. "We think of the classic angel as patient money," says Jeffrey Sohl, director of the Center for Venture Research at the University of New Hampshire, "but some of these investors are looking for a quick turnaround and will destroy the business to get the money out." With so much at stake, it's worth learning the new realities of angel investing.

Angels Who Fall from the Sky May Crush You

CEO Dale Van Aken would be happy not to hear from an angel again anytime soon. "I'm busy," he tells the angels who call him out of the blue. "I'm trying to grow a company. This is a distraction. Go away."

His response--however bluntly expressed--is more appropriate than ever. The attention surrounding angel financing has attracted some less-than-reputable figures. Some of them aren't angels at all, as Barney Adams knows. Adams, founder and CEO of Adams Golf, a $35-million maker of golf clubs in Plano, Tex., says that he's taken regular calls from would-be investors claiming to represent foreign angels and wealthy-but-reticent families. Asking for cash up front to cover fees, they'll offer to raise angel money for Adams, should his company meet certain requirements. Curious, Adams once played along with some "angels" who requested $50,000 up front, but he held off on sending the check. Suspicious of the forms the angels asked him to fill out, he played along by making a counteroffer: I'll double your fee, he said, if you send me the investors' check first. Not surprisingly, the investors refused, but they offered to reduce the $50,000 to $5,000. It was the last time he heard from them.

Adams also hears from investors who like to think of themselves as angels. One such big shot offered to advance Adams a considerable sum just as he was headed to an important trade show. The local businessman, whom Adams knew only slightly, encouraged the founder to go, relax, and call him to hash out the details when he returned. Counting on the money, Adams charged the trip on a credit card, only to discover when he got back that his would-be benefactor wouldn't return his calls. The lesson: perfect angels rarely fall from the sky. They materialize through long-standing relationships.

In fact, 90 days after that fiasco, Adams hooked up with a former coworker and fellow entrepreneur who wanted to invest more than $250,000, an offer he felt confident accepting. Sure, a shared history helps. But not everyone is lucky enough to have sat behind a future angel in grade school. The key is to recruit investors who understand your industry well, so they won't panic during a seasonal slump.

When Dennis Harmon, CEO of Synchronicity Inc., a Marlborough, Mass., company that builds software for the semiconductor industry, launched a private placement in early 1996, he and his three cofounders listed 124 people they believed would make ideal angels. They stuck to former coworkers who had money; industry executives and salespeople who knew the founders' work history and could presumably meet the net-asset requirements; past customers; and members of their network who would bring additional resources, such as advisers and more investors. Then they called each candidate. Those who didn't flinch at the $25,000 minimum got a 12-page executive summary and a letter outlining the investment process. Of the 24 new investors, more than half have their roots in the semiconductor industry, giving the company lots of helpful connections. One, a former boss of Harmon's who is now a senior vice-president at a large software company, has introduced Synchronicity to a customer with whom Harmon hopes to forge a strategic alliance. "He has a vested interest in hooking us up with the right people," says Harmon. Another angel introduced the founders to bankers and venture capitalists.

What Looks Like a Halo at First Could Be a Noose--Intended for You

Understandably, Joseph Freedman jumped at the opportunity to accept funding from three local entrepreneurs for Amicus Legal Staffing Inc., the company he had founded in 1991. "I was hoping for coaching and mentoring," says Freedman, who was looking for money to expand in 1993. Active company builders, as opposed to retired CEOs, could better relate to his problems. As it turned out, they were far too busy. "Their business took off when mine did," he says.

Working angels are a relatively new phenomenon, partly spawned by a proliferation of IPO-enriched CEOs. Pressed for time, such angels are often inexperienced investors with less tolerance for risk than even they realize.

Freedman, a law student who probably should have known better, forked over a 65% equity stake in exchange for $150,000. For the angels, it turned out to be "a hell of an investment," as Freedman points out. Last year, when the $11-million company was scooped up by AccuStaff, a $2-billion staffing company, their stake was valued at about $13 million, according to Freedman. He doesn't begrudge his angels their hefty return. He actually learned more by doing things himself, he says. But back then, their lack of involvement irked him. "It was frustrating," he says. "I really needed more than money."

Of course, more-experienced entrepreneurs might yearn for an angel who exudes aloofness. What's crucial is to surmise ahead of time whether the kind of angel you've attracted is going to be gratified by providing the help you need. Van Aken was working with three partners to launch his second software venture when there appeared before him an angel offering wisdom (she professed industry knowledge), riches (she invested an amount he would have expected from three angels), and discretion (she promised to forswear second-guessing). But before long, Van Aken says, "her advisory role shifted from a silent investor to a day-to-day role. And that included creating mini-alliances with other partners." Her meddling was not the sole reason Van Aken ultimately hightailed it out of the venture, but he says it did set into motion a series of "political problems" that put him on that course.

Van Aken advises entrepreneurs to contact other companies in which their prospective angels have invested. He also suggests that entrepreneurs and angels set guidelines that clarify each other's roles. "People have needs that aren't necessarily financial," he says. "She wanted a place to play and mess around and have a social setting."

For the most part, angels don't suddenly "turn into devils," as entrepreneur Mike Watts claims. But their motivation for investing needs to be scouted out ahead of time. If it's not, it will likely reveal itself just when it can do the most damage. When Watts and his father, Gerald, founded Professional Resources, a software-programming company in Merriam, Kans., they made a deal with the only investor who would give them money: the certified public accountant of the younger Watts's former secretary. But the terms should have signaled a clue about the angel's reason for participating. Not that the younger Watts was looking that carefully. "I always had this image of an angel with a halo," he admits.

The angel put in $20,000 and guaranteed a line of credit of up to $75,000, using himself as the bank, according to Watts. He received a 35% stake in the company and was paid a consulting fee, although he didn't provide any additional services, Watts says. The interest on the credit line--2 1/ 2% over prime--sounded reasonable. But the angel also got 20% interest on every draw against the credit line. The entrepreneurs understood the terms, but what they didn't expect was that the company would grow so quickly. As it did, Watts habitually tapped the expensive line of credit to make payroll, tossing the company into a "death spiral." Eventually, the pair turned to employees and friends, who pitched in $30,000 to buy out the angel's equity stake. They then took out a loan of $225,000 to pay off the line of credit. "We were trying to expand; he wanted to make sure we weren't spending too much money. We needed to hire; his goal was to make a lot of money," says Watts. Looking back, he issues a single cautionary sentence: "Make sure you have common goals."

It's Up to You to Harness Your Angel's Special Powers

When Robert Rogers Jr. set out last fall to scare up money for Chesapeake Center Inc., the health-care service provider he cofounded in 1985, he interviewed a dozen venture capitalists and angels. His first angel had been an almost-retired entrepreneur who offered $370,000 and plenty of advice. For his second round of financing, he chose an angel who not only offered $3.5 million but also signed a written commitment to help Rogers meet specific milestones.

It's tricky placing restraints on someone who is offering to give you money. But Rogers's contract spells out exactly how and when the angel will help him with such tasks as negotiating bank loans, checking out candidates for acquisition, and recruiting senior managers.

It's incumbent upon entrepreneurs to institute a formal communication system, especially given the average angel's bulging portfolio. David Spitzman, an angel investor based in Newport, R.I., wants to receive financial statements on at least a quarterly basis, supplemented by a phone conversation every couple of months. He's most irritated, he says, when he suspects he's being placated. "Inconsistency makes me nervous," he says. Pearl Holforty, CEO of Liberty BIDCO Investment Corp., an investment firm based in Farmington Hills, Mich., goes a step further in making life easier for her angels: three times a year, she invites them to a get-together where they can mingle with representatives of a company she thinks might interest them.

Such care and feeding can pay off in unexpected ways, as Joe Boldan knows. Boldan, CEO of Ex Officio, a $12-million travel-apparel company in Seattle, came to a sobering awareness late on Christmas Eve of 1996: sales weren't picking up fast enough to enable him to make payroll. The call went out: chief financial officer Bob Carroll got on the horn with Varro Smith, an angel with whom the company had a long-standing relationship. Smith, confident that he was hearing the truth--he'd always been kept in the loop--wrote a check for $125,000 to cover the pay of Ex Officio's 30 employees.

That kind of 11th-hour rescue could come from only one type of investor. Distinctions may blur, but one fundamental difference remains: because they are investing someone else's money, venture capitalists aren't much equipped for decisive, much less heroic, measures. Angels, no matter how much they've evolved, are still free to act on their feelings. "It's a great company," says Smith. "They have integrity." That's about as far as he goes--or needs to go--in explaining his decision to bail Ex Officio out. "He understood what we were going through, and he agreed to do it on the spot," says Boldan. "That's a real angel."

Stephanie Gruner is a staff writer at Inc.