Q&A Series 1 on Angel Investing: Angels Who Contribute More Than Cash

  1. What are some of the best practices for scouting out a strong private company to invest?
    1. Act with an entrepreneur’s mindset not just an investor’s mindset. Private equity is about investing in businesses not stocks. Hence, it’s critical for investors to understand industries, subsectors, specific businesses and management teams. Ultimately, they are assessing a management teams’ ability to build a company that succeeds in a competitive marketplace with a business model that generates attractive returns. While an investor always wants to invest at the lowest price, in private investing the deal structure and management team are more important than valuation and, I would argue, even the company’s initial product or service.
    2. Be an information (and insight junky). The lack of private company information requires investors to do their own research to understand industry trends, regulatory dynamics and competitive issues. It’s very helpful to meet with as many people as possible, evaluate every company you can in the relevant business segment and develop relationships throughout the industry. This gives you context and perspective to evaluate investments and management teams.
    3. Take your time. It’s invaluable to meet a management team, hear their story and over the next few months to see how they execute against their plan. It’s even better to know an executive or a team for a number of years hopefully through another company with which you were involved. The most successful investors that I know have typically known the CEOs of their portfolio companies for years and in prior investments.
    4. Build a great network. Finding a great private company entails getting connected with the best entrepreneurs, the best ideas and the best companies. Furthermore, investors need experts to help evaluate business strategies, products and services and management teams. Hence, it’s essential to build a broad and deep network of industry players to optimize your deal flow, assist in due diligence and then help with recruiting, business development and capital raising.
  2. What are some particular warning signs to proceed with caution — or not at all?
    1. Often the warning signs are subtle. You will need to trust your gut. Investing in private companies is risky and investors rarely have full or even accurate information. Private equity investors are principally betting on the capability, drive and ethics of the management team to build a great company and thereby drive attractive investor returns. In some cases, the investors don’t have a long term relationship with the management team and hence they need to rely on their background checking, references and intuition in assessing the team.
    2. Ensure the company is properly capitalized with a strong, committed investor group. Private companies are often capital starved and will complete financings that don’t build in sufficient time for raising the next round nor contingencies for budget overruns. Investors should take the time to get to know the other investors, their investment strategy, capital reserves, etc. It is also essential to pressure test financial projections with varying assumptions to ensure the capital raising is sufficient to achieve the milestones and timeline required to raise the next round of capital. Or better yet, investors should seek to create a financing plan to get to cash flow breakeven in order to reduce or eliminate the follow on financing risk.
  3. Is the high-tech sector, for example, especially prone to private companies that are more sizzle than steak? What other sectors, if any, may be especially risky?

    Early stage or very high growth companies across all industries are valued almost entirely on their future expected revenues and earnings. That is sizzle. The steak is what they have today in product or service, IP, customers, revenues and earnings but the investors are being asked to pay for the future potential in all of these metrics. In the high tech and especially internet world, sizzle is the main meal as VCs and investors are all trying to find a “unicorn” to lift them into the rarified air of the great success stories. It’s instructive to remember that some 75+% returns in the venture capital industry have come from a very small group of companies such as Microsoft, Apple, Google, Facebook, Amazon. Sizzle rarely pays off.

    Another sector where this sizzle phenomenon is rampant is in biotechnology. Investors can rarely understand the science to its required depth and biotech CEOs are notoriously talented story tellers. Admittedly, we have just come through a biotech bull market where tremendous value was created and, in cases like Gilead Sciences, the sizzle turned into steak.

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