Wednesday, May 19, 2010

Angel Investment Criteria

I’m planning on going to a Tech Coast Angels mixer tomorrow and the topic for me is whether there is angel funding out there for startups that don’t meet classic VC models.  If there are, then who are they, what are the criteria, what does it typically look like?

By way of background for the question, there’s a great post by Bob Aholt, a Pasadena Angel: An Angel Investor’s Thoughts on Valuation.  The example he uses is:

Investment    $500,000
Pre Money    $600,000
Post Money    $1,100,000

Founders    55%
Investors    45%

Sale Price    $5,000,000
Time    5 years

ROI    355%
Multiple    4.55x
IRR    35%
NPV @ 10%    $828,000

Admittedly that valuation and the resulting ownership causes me to wonder, but the most interesting aspect is that Bob is talking about investing in a much smaller exit, with no future investment planned.  Bob is heavily focused on ROI (and team/product).  But it seems like Bob would be a candidate.

But, this is not my experience with Angel groups.  For example, TCA’s evaluation criteria first bullet is:

A market opportunity sufficiently large to create a business that can grow to at least $50 million in annual revenues.

What if you believe you have a company that will be a profitable $10M company with obvious exits?  Can you raise $750K - $1M with no future investments planned?

My guess is that there’s potential with Bob individually, but not for TCA or Pasadena Angels collectively.  And I’m really wondering about that.  Do you need to get past the organizations to the individuals?

I’m a regular reader/listener of the Frank Peters Show that talks about Angel Investing.  In his recent post, Top 10 Ways to Win a Business Plan Competition, he says:

#4 I wanted to push this further down the list, but I just bristle at this: the revenue forecast. These are so detached from reality. My 4 plans get increasingly more incredible, ranging from $50M, $60M, $70M to $161M in year 5! This does not happen in the real world. Remember my day job, I'm past Chairman of the Tech Coast Angels and I see a lot of pitches with revenue forecasts. So get real. Your investors will be thrilled if you can get to $10M in some reasonable time frame. More likely, you'll be back for more money in less than 2 years, saying what everyone says: "it's taking longer than we thought". Investors won't believe your numbers anyway, so your over-sized hockey stick betrays your naiveté.

What’s funny about this is that the reason people put in these optimistic projections is to fit the investment criteria.  See investment criteria #1 from TCA.

And this also seems to contradict what Frank himself talks about on his show.  For example, Frank had Basil Peters, author of Early Exits, on his show back in March.  Basil tells us:

Exits are also happening much earlier than before. The largest number of exit transactions today are in the under $30-million valuation range. These exits are often completed when companies are only two or three years from startup.

I guess I’m wondering why early stage investment isn’t aiming at these kinds of investments?  Or maybe they are and I’m missing it because I’m going to TCA events?


Frank Peters said...

Contradicting myself? Wouldn't be the first time.
But Basil's point is we should be funding companies that can exit at $20-30M, so their revenue at that point might be less than $10M.
Are we following Basil's advice?

Tony Karrer said...

Frank - thanks for stopping by and for all the great things you do with your writing and podcasts. One nice thing is that I've heard from you and a couple other folks from TCA already as a result. So, it's definitely a responsive group!

hyip said...

I am too wondering that why early stage investment isn’t aiming at good kinds of investments.

Ken said...

Tony - Although your experience might be that angel groups are rigid regarding investment criteria, this is certainly not true in practice. It is always a SUBSET of the total membership which invests, and these members each have individual risk preferences and investment horizons. The challenge for an entrepreneur is to identify that subset and find champions within the group. Some angels only swing for the fence, while others are quite happy to rack up doubles with smaller investments.

Tony Karrer said...

Ken - thanks for chiming in on this. I have some input from some folks at TCA and Pasadena Angels. Still it's a bit on the fence as to whether "doubles" can get through the gatekeepers to even get in front of the members.

HYIP monitor said...

"I’m wondering why early stage investment isn’t aiming at these kinds of investments?"

I guess that after the emergence of AlgelList the early stage investments will be aiming mainly at this kind of investment. It's just the matter of time.