Are Investors Being Unreasonable?

Take a look at this article from the August 20th Milwaukee Journal Sentinel.  It seems to me this may be a sign of the economic times.  Or, of course, it's possible that Jason Weaver (who I know - and I think Sway is a neat company) is a bit frustrated about the "rules" dictated by the current investment environment.

Now, in some ways, I'm in agreement with Jason.  If the comment about "do enough things to us" is a reflection on potential investors who he thinks don't understand his business or can't help him, he should never do business with them.

Who the entrepreneur takes money from (see this post) is always more important than the terms.   So to the extent that he sees that the quality of the investor and his/her connections and abilities is really what the early stage company is buying, the more Jason and I would agree.

If a company is seeking "angel capital" it almost always wants people who can and will be helpful beyond writing a check.  This, in our group, has included providing industry knowledgeable directors, or connections to other groups, or other types of expertise the company wants.

But what about his comment about "ridiculous terms?"  The biggest single failure of terms set by angels is the opposite, historically, of what Jason calls "ridiculous."  The problem has been that too-high valuations and too generous terms have spawned painful down rounds that squash the entrepreneur and his early investors. 

New money, usually VC money, comes in and crams down those early investors and takes substantial shares from the entrepreneur.  This happens more often as the "second round" exceeds the amount early investors can raise, is often a somewhat unexpected round, and usually is associated with missed milestones.  At the same time the company is running low on cash.  This is a confluence of bad events.

Ask any of us who've experienced significant down rounds based on some or all of these things, and one begins to understand the cautionary nature of deal structures.  So in today's environment, caution is the watchword.  No one wants to begin a relationship with a company that is contentious, especially when the investor has no requirement to invest. 

In the case of Sway, it sounds like they are doing ok without investment right now.  And that's an important point.  If the entrepreneur can bootstrap the business, it will always be worth more to the entrepreneur as well as future investors, if any.  It provides more freedom for the entrepreneur.  And more choices.  (People I know are tired of hearing this, but we did bootstrap RTMS, Inc. up to $10MM in revenue.  It gave me a lot more freedom.  Some would argue it also didn't force me to make hard choices that caught up to us later, but that's a story for another time.)  So, I'm a big proponent of bootstrapping and the benefit it provides to entrepreneurs.

So, one of my questions for Jason is really if investors terms are "ridiculous," or even if they're not, shouldn't bootstrapping provide a much superior outcome for the company than equity investment? 

Another thing for the Halos to think about is the inherent difference between VCs and Angels.  VCs have an absolute need to find companies to invest in, and to do it on a schedule.  This is fundamental to their business model.  And it is unarguably what has driven valuation bubbles in the past.   Because they only get to raise a new fund if their latest results are good, they are pretty gun shy on terms right now.  And who can blame someone for trying to keep his job? 

Angels, on the other hand, largely do this for the enjoyment of working with entrepreneurs, socializing with each other, and generally being engaged in the community.  They play for their own money, not the money of investors, so they don't have time pressures or minimum investing requirements.  Many I know will actively seek deals to work on that are run by fun, engaging people who are eager to grow the business and know what they're doing.  The best seem to have a propensity to ask for help.  Here's an example: Flex BioMedical, run by Sal Braico.  Here's a guy (sorry Sal, don't mean to sign you up for more work!) who could give the talk about how to lead an angel negotiation with style and grace.  And a good outcome. 

On valuations, if an angel-backed company can get to the goal line without future rounds of funding, the question of current value is much more manageable. When there is the prospect of future rounds, sometimes evidenced by misses in the past, deal structures become more caution-driven.

So, I don't quite see how Jason's thought about "If they turn enough of us down or do enough things to us, eventually they're going to run out of people to do the work," fits.  If these are funded companies in his group, are they unhappy with the terms they took?  Or is it really the "turn down" part that's the issue?

Just by sheer volume, every would be investor passes on 95% of what comes by.  Our group sees 250+ opportunities a year, many quite good.  We pass on a lot of stuff that we like.  We just don't have the capacity to do more.  We try to provide fast feedback to everyone we talk to, and we try and talk to most everyone who contacts us (at our website). 

So, perhaps a positive use of these group meetings would be to discuss how people did get funded (ask Sal to speak for one!) and what the current requirements seem to be. 

Real angels, as I've mentioned, don't have to invest in anything, and all of us see lots of opportunities from people we know and trust.  Most won't struggle much with difficult situations pre-investment.

I hope perhaps a dialog might get started around these topics that will help everyone - entrepreneurs and angels - come together for their mutual benefit - and satisfaction.

Comments

[Jason Weaver]

Tim,

Thanks for the post. I wanted to take a moment to reply to your comments regarding yesterday's article. I appreciate the time you took to address my comments.

For one, I admire Angels. Most Angels are entrepreneurs who have been through their own start-ups and have succeeded (such as yourself). On the opposite side, several VCs have partners who have studied at Wharton, but many have never really ever have run their own company. I personally, prefer angels for the precise reasons you have listed. VCs have their place in the life of a company, but typically at much later stages. Investing in people is a better bet long term, in my opinion.

I'd like to personally address your comment on "ridiculous valuations". I agree with what you have stated about higher valuations on an initial round may hurt additional rounds. However, there is absolutely no question that both angels and VCs have taken advantage of the current economic climate to obtain more favorable terms. The fact that it has been more difficult to get money makes it easier for the people who have it to fund companies at very aggressive terms. I have personally seen my fellow Halo CEOs receive term sheets for 100% debt financing giving away 50% of their company on the first round. These terms were very unlikely a couple years ago. It's simply about supply and demand. I believe you would agree.

The Golden Angels have become a “power angel investing group" that makes it easier for 50+ angels to come together for one investment to obtain more aggressive investment terms without the need to run your investments through a fund. Individually, most angels wouldn’t have the opportunity to change existing valuations, demand preferred stock, etc. Make no mistake about it; if I were looking to make private equity investments, Golden Angels would make perfect sense. Well done.

In the Mid-west, I found the valuation discussion to be very unusual. Most investors couldn’t tell me why my company shouldn’t be valued as high as it is with any substantial facts. All they were trying to do was negotiate better terms even though I had a proven business model with growing profit. My conversations with investors in California were seldom around our current valuation. Valuations are a tricky thing, I personally believe Ning and Facebook are overvalued.

You were personally invited to our Halo Summit in July, but never replied to the offer to attend. Maybe you missed the email? I would have enjoyed having you and more angels around. We are hosting another one in Milwaukee in October. I hope to see you and the other angels there for some more opportunities to continue the discussion.

Respectfully,

Jason Weaver

[Tim Keane]

Jason, thanks. I think yet another consideration might be found at: http://www.ecommercetimes.com/story/Rough-Times-for-Angels-QA-With-MarketStar-Chairman-Alan-E-Hall-67852.html. Worth a look. Angels also are cash limited and are trying to fund their current investments - we've had several unexpected rounds this year as we try and keep our companies going. In some ways offering to invest in new deals is an act of faith.