Below are my notes from the MIT Enterprise Forum Session on “Ten Steps to Angel Financing”, led by Chris Hurley of Beacon Law Advisors.  I tapped these out on my Blackberry, so apologies for misspellings or omissions. The talk took place on March 6, 2008.

Ten steps to angel financing

1. Types of Angel
- “Love angel”– has relationship with founder. Can help get the bus moving– investors want to be last person in the deal not the first. (Angel deals are viral.)
-  ”Full time angel”: growing increasingly sophisticated.
- “Industry veteran with vertical expertise’– very valuable, especially if they can attest to your idea
- finance person
- “mentor capitalist”: closer to love money, valuable in managing board. Retiring baby boomers stay in the biz world.

2. Current trends
Improved communication techniques helping an imperfect market to become more efficient
- transaction costs dropping
- smaller opportunities becoming attractive
- angels getting more sophisticated as they do more deals, piggyback off each others due diligence.
- custom deals: S-corps, operating LLCs, “synthetic preferred”

3. Pros and cons of angels vs. VCs
Angels can be more flexible
- in size of investment.  VCs are headcount light and can’t look at too many deals or too small deals.
- in types of investments
- generally, angels have better ability to play small, play early, participate in nice deals

Angel deals. $250k-$1.5m

VCs: $150m+ funds have a hard time writing a check for less than $2.5m, with a plan that justifies that level of spending. All vcs say they focus on early stage, but are unlikely to fund someone who doesn’t have a track record of success. They’ll give a “soft no” keep in touch answers instead.

VCs need to swing for the fences and hit a home run or the economics don’t work. A $5-$50M exit just isn’t interesting. Angels can work with smaller deals where everyone makes money with a small exitt Angels invest their own money, VCs invest others. Angels can have more direct industry experience.

VC advantages: VCs have more resources and contacts at their disposal. Bigger checks, fewer cats to herd. VCs more likely to invest and help with fundraising in subsequent rounds.

4. Angels compared to VCs
Don’t think of Angels OR VCs.  Competition is good for moving along a deal. No impetus to move otherwise.

Angels and VCs frequently in the same deal if not now, then down the road.

Can create angel momentum to pressure VCs.

There is an art to approaching both and to make the deal palatable to both.
- Think beyond initial raise
- Custom deals are good, but don’t create roadblacks in subsequent financing

Take enough money– closing will be harder if you ask for too little money, and you’ll pay dearly if you fall a bit short. Better to ask for too much than too little.  Can structure deals so that not all of the money is up front but is milestone based.
Should you put the raise in the business plan?  Yes, but don’t put deal terms, esp with VCs. Be ready to explain why you need that much money and what milestones you reach with that investments.

When approaching an angel, you can give them more specific terms in a separate document to streamline things.

Too high a valuation may set up future down rounds that wash out the common and all past investors.

Q: What percentage of early stage deals are convertible note vs. priced round?
A: Perhaps 10% of deals. Convertible notes are appropriate from investors standpoint for bridge situations. Relatively short time period and you’re bridging to a quantifiable, material milestone. If convertible debt piece becomes too large relative to next round, this can discourage future investors who don’t want to share the round with cats and dogs.

Q: What about maturity date on convertible debt?
A: Typically 12 months– should be enough time to get the deal done. Investors will often be ok with extending the date if you keep in good communication.

Q: What is a warrant?
A: An option to purchase preferred stock for some period of time after the next round at a discount rate.

Q: How much do you pay yourself?
A: Shawn:  Too low is bad. Take the low end of the salary range for your position in your region and knock no more than 10-20% off that.

6. Strategic Investors
E.g. Company investing in your technologu
Pros: less valuation and terms sensitive. Can open distribution channels. Can increase credibility dramatically.
Cons: Strategic rationale can quickly change. May prohibit other opportunities. Financial deal can cloud commercial deal.  Long deal cycle.

7. Angel and venture capital protocol

Do:
Put confidentiality notice on business plan.
Be confident, passionate, commited.
Listen.
Be forthright and thorough about competition.
Bottoms up projections.
Clearly state assumptions.
Avoid common and easily avoidable mistakes, esp related to structural issues.
Many engineers can’t sell. Make sure you can answer who is going to build it and who is going to sell it. Make sure you have someone who knows how to sell giving the pitch. Rehease rehearse

Don’t:
Ask a VC or an angel for an NDA
Be stubborn, inflexible, combative
Say there is no competition or underestimate competition. This shows  insecurity and costs you credibility
Show lack of sophistication by taking an unreasonable position on structural issues.

8. How to access the fragmented angel community
There’s a danger in being too exposed. People like to feel they are in on something. Don’t start with a public angel pitch first– get your love money first.

Angels tend to hide and use gatekeepers. Work with lawyers accountants to assemble a hit list.

Stay organized. Don’t double or triple team. Assign responsibilities.

It usually takes multiple meetings to close. Don’t let let prospect get cold, but be respectful. Raising money us a different sale than a product sale.

If you have someone interested, don’t leave the meeting until you’ve set up the next one.

Have a game plan and try to stick to it.
- think whether it is smart to pitch VCs and angels at the same time.
- many limited partners in vcs are also in the angel community, pitching to vcs too early can poison the well with angels.
- schedule smart friendly folks for a dry run.

Time horizon
- funding generally takes between 3 and 6 months from first meetingg

9. How angels identify promising investments
- referral: who is recommending deal
- strong and experience of team
- sensible and well-thought out distribution and financing plan: get set of financial projections is key
_ size of opportunity and attractive exist scenarios
- hot marlet

10. Selling an opportunity to an Angel
Know technical sophistication level of angel and investing style
- do your homework and prepare

Be credible
- don’t overstate where you are in development, financing, customer traction
- sell yourself and your team. Admit holes.
- emphasize strengths, acknowledge weaknesses
- know your limits. Demonstrate that you know you don’t know it all.
- be thorough in analyzing competition
- good plan, financials

11. When is your company ready for angels?
Core team assembled
Beta product or compelling demo
Strong opportunity for growth/return

Investor materials
- business plan
- overview (1 page)
- executive summary (2-5 pages)
- financial projections
- ppt presentation
- product FAQ and Investment Deal Faq

Web site may be helpful
Board of directors and BOA may be helpful. BOD shows stronger validation. Investment is strongest.
Legal housekeeping in order.  Don’t wait until the money arrives to get the house in order.  Delays the deal, makes the management team look bad.