Friends, Angels, and Venture Capital Sources
^ Friends and Family } Angels
} Venture Capital ^ What They Look For ^ Valuation
^ Angel Networks and Entrepreneurial Forums
Investors in your small business can take many forms. Generally, investors want a return on their investment, and seek to help guarantee that return by having some say in how the company is managed. This may be informal with some friendly advice, or a complicated agreement and ownership structure with a venture capitalist. Regardless of the arrangement, these sources can provide the financial backing you need to be a success.
Friends and family are the most common source for early seed financing. At the outset of your business, they are making an investment in you as much as in your company.
You may need funds prior to actually incorporating your business, in which case the investment may take the form of borrowing from friends or family. In that case, you will need a simple promissory note to evidence the borrowing. You may want to include a provision in the note that the principal (and possibly the interest) can be converted into equity in your company at the option of the lender. You will probably not know the terms of investment yet, so you may wish to state that the conversion rate would be some percentage—for example, 80%—of the price the company will offer to new investors once it is organized and ready to legally raise capital.
Friends and family investors can be a mixed blessing. If you think it would be best to take out family and friends as early as possible to eliminate future problems, then you can merely pay back the promissory note when you have raised sufficient capital in your company. It is far cleaner for tax purposes if you organize the entity you are going to use and then have the new entity be the borrower rather than you personally. A variation on this theme would be to pay the notes back and give the lender a small equity kicker (shares of stock or membership units) in appreciation for their early support.
Angel investors are high net worth individuals who invest in emerging companies. Like celestial angels, they can be tricky to find. Typically, they tend
To invest in companies in their own geographic area and will conduct varying degrees of due diligence on the company.
There are numerous angel clubs or gatherings around the country. These groups meet monthly, sometimes weekly, to hear presentations of emerging companies. In the meetings, the companies make their pitch in a twenty - to thirty-minute presentation with a few minutes for questions and answers afterwards. If any of the angel investors are interested, they follow up with the companies individually. In the height of the tech boom, some of the angel groups formed investment clubs that would review emerging companies and then invest as a group, usually through an investment partnership.
There are different kinds of angel investors. Target those that fit your current needs.
F Figure 7.1: ANGEL INVESTORS
A sampling of the types of angel investors follows.
• Retirement Investor. This type of investor comes from senior management of a larger company and may be looking to contribute to the new company at the same level. They may be using their early retirement or pension funds to invest.
• Value Added Investor. These are seed investors who generally remain in the background but are very active when problems arise. They tend to invest in the $250,000 range.
• Professional Angels. These investors come from the traditional profes - sions—lawyers, doctors, and accountants. Normally, they rely on the due diligence (investigation) of other parties for their investments, and tend to invest in companies that have a product or service in their professional arena. They generally do not get very involved with the business.
• Manager Investors. These investors may be available because of corporate downsizing. They are interested in contributing to the active management of the company with their skills. In effect, their investment is like buying back their last job. If you are short on the management side, these investors are valuable.
• Entrepreneurial Investors. This category is the classic angel investor who are successful entrepreneurs and want to reinvest those profits in a variety of companies. They tend to be the largest and most active of the groups of angels.
• Socially Responsible Investors. The socially conscious investor tends to be a nurturing investor whose values align with those of the company to create a melding of values. This type of investor may use screens to evaluate his or her investment. For example, they may have a screen for environmentally friendly products and services.
• Family Investors. This type of investor represents a family unit that makes selective investments. Usually, there is one person representing the family who negotiates the investment on behalf of the group. (Family - type investors are common in the Asian community.)
• Barter-Based Investor. Many start-up companies need equipment and services that they will have to purchase in the marketplace from the capital they raise. You may be able to barter for the necessary equipment by exchanging equity for the goods or services. This arrangement works particularly well where you are designing an application to run on a device like a Nokia cell phone or a PalmPilot. An investment by the manufacturer of the target device could be a natural fit as barter investor.