New Venture Lab: Equipping Christian Entrepreneurs

Angel investors are wealthy individuals that make individual venture investments in start-up companies.  They typically invest $25,000 to $250,000 and often are the intial venture funding source prior to a larger institutional round of $1 - 5 million or more.

But not all angles are saviors, as this article from Forbes.com points out, so the entrepreneur needs to beware when taking on an angel investor:

Your young business is poised for promising growth--if only you could get an infusion of cash. So what’s the best funding source for your early-stage business?

You could tap friends and family members. But then, they tend to have little experience, offer too much unsolicited advice and create complications at family events. This leads to nothing but trouble.

At the other extreme are venture capitalists--professional money managers who place many bets on nascent companies hoping that one or two will hit it big. VCs offer funding, expertise and a valuable network of resources to help businesses grow. The problem: VCs typically demand a fair amount of control and ownership, in the form of a board seat, voting rights and senior securities that would get paid off first in the event of liquidation. (The logic for entrepreneurs: Owning a smaller percent of a bigger company is better than a larger percent of a smaller one.)

A third alternative for cash-hungry companies are "angel" investors. These high-net-worth individuals (or groups of them) dabble in small businesses but would rather play golf than get their hands dirty in day-to-day operations. Generally, angels bring more business expertise to bear than friends and family members do but don't demand the same draconian terms as VCs. According to the Angel Capital Education Foundation, there are now 265 angel groups in the U.S. (up 67% since 1999), which include some 10,000 individual investors.

None of which means companies touched by angels will be blessed with financial success. Consider data from a year-long study released this month by the Ewing Marion Kauffman Foundation and the ACEF, which looked at investments made and returns captured by 539 angels between 1990 and 2007. While overall returns averaged 2.6 times the initial investment within 3.5 years, only 48% of the deals returned more than the original investment. In other words, 52% of all angels lose money on their investments. (As for start-ups that initially ran on angel capital but later accepted VC money, the returns on the winners were higher--but so were the number of losses.)

Before you align with an angel, ask yourself: Does this guy have just one success to his name, or a few impressive launches I can emulate? Is he 100% committed to my success, or am I just a nice distraction from his ballooning handicap? Is his experience relevant to my business? And if it is, to what degree is he dedicated to helping get my company off the ground? Ask those questions and you'll find that not all angels are saviors.

I recently came across a very interesting and advanced piece of software developed by a professor at a leading university. The professor mentioned that he had taken the advice of some angel advisers and had already entered into an agreement with a large public company under which he signed away the exclusive rights to the technology with no revenue guarantee and no non-performance termination clauses. In effect, he had given away the distribution rights for the product and had no recourse. Predictable result: The software got subsumed into the organization and never made it to market.

While the software had some real market potential, the professor made a critical error by partnering with an angel investor who didn't understand the market conditions and underestimated the capital and resources needed to build the company. Despite his best intentions, the angel didn’t have the experience to look at all dimensions, such as which products should be built and which should be licensed. Entrepreneurs need to look at all the dynamics involved. In the professor's case, entering into a deal with a behemoth was a good thing; structuring it the way he did was devastating.

Frequently we see angel-funded companies sell off intellectual property rights for very small amounts, severely limiting the upside potential of the companies. We have seen others create complicated (and costly) legal structures for no sound financial reason. The mistakes go on and on.

Bottom line on angels: Take their money--but only if they bring other strategic benefits to the table. In the end, entrepreneurs need investors who offer more than just deep pockets.

By Lou Volpe, Forbes.com