An Introduction to

ANGEL INVESTING

OUTLINE
Who are these Angels? Entrepreneur-friendly Communities Company Formation and Startup Funding Portfolio Strategy for Angel Investors Post-investment Relationship between Entrepreneurs and Angel Investors Why Angels are Joining Groups The Angel Investing Process The Power of Angel Investing Seminar

Angel Investors
(vs. private investors)

Invest money in seed, startup and early stage companies Invest time in entrepreneurs and their companies
Business acumen Mentoring and coaching Serve on boards Make business introductions

Who are these Angel Investors

Often successful, exited entrepreneurs or retired business persons active investors
Invest both time and money in companies

Accredited Investors - SEC definition Angels invest their own money (not money managers) Investing in local companies

Motivation:

Why Become an Angel Investor?

Helping entrepreneurs Stay engaged using skills and experiences to help build a business Giving back to community or university An active form of investing not just watching markets Return on Investment is the metric

How do Angels fit into Entrepreneur-friendly Communities

Entrepreneur-friendly Communities

VCs Funding Sources Grants Angels

Banks SBIRs

Service Providers
Mentors Coaches Role models

ENTREPRENEURS
Entrepreneurship Center
Bus Plans Education Networking

Colleges & Universities Companies Sources of Talented People

Technology Innovations Product Ideas

Labs

New Company Formation and Funding Sources for Startup Companies

Who are Funding Startup Companies

Friends, Family (and Fools) FFF Angel Investors Venture Capitalists Other
Government grants (SBIRs, etc.) State and local programs

 Friends, family & fools

Typical round: $10,000 Each investor: $ 2,000
Source: estimate

Not accredited Unsophisticated Investing in a friend Passive 1-2 lifetime investments ($100 to $5,000 each)

Angels
Typical round: $600,000 Each investor: $ 40,000
Source: Center for Venture Research

Accredited Expertise and personal money Active Investing in entrepreneur Portfolio of angel deals
Limited partnership Institutional money General Partners active Invest in company Large portfolio

Venture Capital
Typical round: $7,000,000 Each investor: $3,000,000
Source: PWC MoneyTree

Funding Seed and Startup Entrepreneurs

(typical year)

Startup companies Funded by FF&F Funded by Angels Funded by VCs

500,000 200,000 (est.) 35 - 50,000 < 500

Estimated that 90% of Outside Equity Capital in Seed/Startup Stage Companies is Sourced from Angels

An Angel Portfolio Strategy

An Angel Investing Strategy:

Portfolio Considerations
5-10% of net worth (asset allocation) 8-10 investments (risk diversification) High tech, low tech, no tech (your choice) Variety of involvements
Lead investor Board, advisor Passive

Most of ROI from 1 - 2 of 10 companies

Implications of this Strategy

Net Worth Requirements
(testing the SEC definition of an accredited investor)

Return on Investment implications

Definition:

Accredited Investor
Financial position of investor:
Net worth: $1 million, or Annual personal income: $200K, or Family income: $300K

Assumption:
Knowledgeable capable of due diligence Can afford to lose invested funds

Implications:
Giving up regulated disclosure

Implications:

Angel Investor Net Worth

Typical angel investment ~$25K 10 investments = $250,000 invested 100% reserves, another $250,000 10% of Net Worth ($500K/10% = $5 million) Therefore:
Minimum net worth for angels = $5 million SEC definition is 70 years old

Angel Expectations: 25%/yr

25 22.4 18.7
Historical 20 Year Returns for Alternative Assets

18.7 16.5 14.9 13.2

20
Returns 15 10 5 0
Seed Funds All Venture Hedg e Funds

Buyout s

S & P 500 NASDAQ

Source: Venture Economics, HFRI Equity Hedge Index

Implications:

Size of Each Opportunity

1-2 in 10 investments will produce almost all of the ROI for the portfolio These successes must yield 20-30X ROI
(Nonbelievers: Do the calculations!)

Andwe cannot pick the winners Therefore, all portfolio companies must demonstrate the opportunity for a 20-30X return on investment.

Integrating Exits into Portfolio Strategy

VCs exit in 3-5 years (assume 5) Angels invest earlier and expect to exit in 5-7 years (assume 7) A balanced angel portfolio contains ten companies. Consequently, angels should invest in 2-3 companies per year
Build to ten company portfolio gradually A portfolio of companies in all stages of development Good balance for investors time

Exit Strategies
12000
20X

10000
100X

8000
6000 4000
IPO M&A

2000
0

1999

2000

2001

2002

2002 Software Industry Equity Update

Economic Benefit from Angel Invested Entrepreneurs and their Companies

We have absolutely no data but

Consider the following:

Angels invest in 7-10% of all startup companies Angels only invest in companies that will scale
20 to 30 times growth in valuation in 5-7 years Employment created by these companies is high

David Birch (MIT) and others have demonstrated that high growth companies create all net new jobs in America. Angel-funded companies create lots of jobs

We have absolutely no data but

Consider the following:

Anecdotal data suggests Angel Investors and the Entrepreneurs in whom they invest enjoy some very successful exits. Exited entrepreneurs often become angels Angels often reinvest portfolio returns The wealth creation from angel investing is spawning an even greater number of companies.

Post-Investment Relationship

Angels invest time in portfolio companies

Angels bring expertise to portfolio
Business acumen Vertical expertise Financial experience Director service

Common roles
Advisor, Mentor, Coach, Director Except in emergency, not paid consultant

Portfolio Considerations
With many portfolio companies
Not active in all, pick roles suited to your skills Let other angels serve remainder of companies

As contribution fades, exit in favor of new directors, advisors Limit number of Boards to 3-5

Why Angels Join Groups

Growth in Angel Organizations

200 180 160 140 120 100 80 60 40 20 0 1996 1997 1998 1999 2000 2001 2002 2003
Data provided by Professor J. Sohl, University of New Hampshire

Solo Angels
Process is time-consuming
Deal sourcing Reading plans Due diligence

Due diligence is difficult

Finding vertical experience May require using outside experts

Legal support is expensive

Investing through Angel Orgs

Dividing the work eases the pain Variety of vertical experience available Standardized processes and term sheets Deal flow encouraged, entrepreneur-friendly Pick and choose the deals you like Great camaraderie among the like-minded

The Angel Investing Process

Summary:

Angel Investing Process

Pre-screening Screening Due diligence Investment presentation Follow-up discussions and meetings Closing

Deal Flow Statistics

Prescreening Screening Due Diligence Investment OVERALL 1 in 4 to Screening 1 in 3 to DD 1 in 3 to Inv. Meeting 1 in 2 raise money 1 in 72 who apply receive investment

Power of Angel Investing

Developed by Kauffman Delivered more than 30 times in the US Trained over 500 angel investors High ratings by participants
Knowledgeable speakers Important topics & content Relevant & beneficial information Well presented information 4.64/5.00 4.60/5.00 4.60/5.00 4.54/5.00

Seminar Content
Is angel investing right for you Where to find good deals Due diligence Structuring the deal Valuation The post-investment relationship

Seminar Format & Delivery

All day experience Networking opportunities Designed for 20-25 accredited investors Mix of learning methods
Lectures Panel discussions Case study exercise (valuation)

SUMMARY
Angels are making a difference
In job creation In wealth creation by providing equity capital and mentoring to entrepreneurs

Plan a portfolio strategy as you begin investing Join an angel organization

Good deal flow Robust processes Great camaraderie

This introduction to angel investing was developed by the Kauffman Foundation for the Angel Capital Association. It is designed as a recruiting tool for angel organizations and to introduce interested groups to the subject.
For more information on Kauffmans Angel Initiative, the Angel Capital Association, or the Power of Angel Investing seminar for new angel investors, contact: Marianne Hudson (800) 489-1447 mhudson@kauffman.org