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Reprinted from Under30CEO. See the original article here.
By Rishi Anand
The Internet is saturated with articles on ‘how to pitch your idea’; ‘how to draft and implement your pitch to perfection’ ad nauseam, but there are simply not enough articles and resources out there on how a relatively inexperienced entrepreneur should deal with hard hitting investors when meeting them to raise external investment for their business.
As an established entrepreneur and angel investor network that has featured thousands of investment proposals to genuine, high caliber angel investors (follow link to view our database of investors) that have included investors from the UK Sunday Times Richlist, one of the former Founders of Skype, and even one of the former directors of Morgan Stanley, we have been in a unique position to see both sides of the funding equation between entrepreneurs seeking investment capital for their business and the angel investors that are looking to invest in these high risk ventures. In fact, entrepreneurs that know how to negotiate in the right way, ensures that:
You will receive better terms – in terms of % equity you will continue to own in your company vs. the investment capital you raise.
You will not lose a potential deal because you have failed to value what a business angel investor can actually bring to your company (know-how, experience, network of contacts), and…
You will be able to walk away from the deal (if need be) as getting the right answers to the right questions from an investor will empower you to walk away if it is not right for you. It is wise to always ‘go with your gut’ in these situations but it is important to remain impartial during negotiations and to ask the right kinds of questions that may well uncover red-flags and most importantly not put-off a potential investor.
So you have a full business plan with financials. You are armed with industry stats and have made your investment pitch to an investor. Now what?
Fact #1: Your Investment Summary is NOT your Executive Summary
Angel investors are highly successful business people that have a lot of money behind them which is why they are able to afford to invest in high risk; high reward non-traditional investment propositions (YOU!). As a result of this, they will get approached daily by pie-in-the-sky entrepreneurs and time wasters that just want to talk about their ideas but not really make any of the sacrifices that are necessary to build a truly profitable business. So when you are invited to deliver your investment pitch to an angel investor it will be important to stand out from the crowd by knowing your business plan inside out (including the financial section), having a great presentation that may include PowerPoint slides with graphics demonstrating your key points of your investment pitch and by having a well-written one page ‘investment summary’ (which is NOT your executive summary) prepared especially for the angel investor you are pitching to, ready to be handed out straight after your initial pitch or preferably handed out after the Q&A session when your meeting has ended which will act as a refresher.
The decision to invest will never be made during your initial pitch BUT the decision NOT to invest could be so it is vital that you articulate yourself and speak in a language that a potential investor finds reassuring and knowing your business plan inside out will help with building your credibility in the meeting.
Handing out a fully bounded business plan after your investment pitch, when an investor has not asked for a copy, will likely cause the investor to just flick through it and archive it somewhere in his office. A half page or one page investment summary on the other hand will formalise and add credibility to your investment pitch and will increase the chances of an investor perusing the key points of your pitch at their own leisure time. In case you would like to find out how to write the perfect investment summary or would like to know the real differences between an executive summary and an investment summary please follow this link.
Fact #2: Angel Investment does NOT happen overnight
Receiving investor interest and pitching to them successfully is hoop #1. The process of actually signing contracts and receiving angel investment will most probably be hoop #4 or #5 and can take many months to complete as experienced angel investors will not draft contracts and send funds over without first seeking out their own legal advice or guidance at key points during negotiations from their own network of advisors. So remaining patient, strategic and prepared to answer all types of questions during this time will be the best strategy moving forward.
Fact #3: Angel Investment is not just about Money
Angel Investment is a value proposition for both sides and the past experience as well as the success rate of the potential investor should be recognised and valued correctly by an entrepreneur.
Recognising the value that an Investor can bring to your business is an important consideration as an angel investment into your business is not just about the money and the potential savings you will make by not paying interest on the capital you have raised. Think: receiving an angel investment from one of the founders of Skype and the value and experience that they could bring to your start-up. It would be fair in this example to say that the value brought to your enterprise could end up being worth 10 times more than the value of the investment capital itself. So in this scenario, you would be more receptive to receiving less investment and potentially giving away more equity in return for having them join your business as the value of their contribution to your business long term would be worth more than the actual investment amount you are seeking to raise. Valuing an Angel Investor’s possible future contribution to your business will rely on your own due diligence in combination with your intuition and we will address this issue further in the Q&A section below.
Things to do & questions to ask Investors during negotiations…
To start with, it is good practice to ask a potential investor to sign a Non-Disclosure Agreement (or NDA) before revealing any sensitive facts about your business, and asking for an NDA to be signed can do no real harm to both parties.
There is a modern school of thought that debates whether or not an NDA is a legally enforceable agreement or not, however, the fact remains that when an entrepreneur insists that a potential investor sign the agreement before entering talks, it sends out some very clear positive signals, namely:
– That you are serious about your idea or business.
– That you have made it clear, and in writing, that you are now entering talks in areas that you feel are confidential and that you (in no uncertain terms) do not want the information that is discussed from this point forward (or documents that you subsequently disclose) passed on without your express written permission.
– And, in the case that a potential investor simply states that they do not wish to sign the NDA (for whatever reason) then this will be a clear indication that you should be on-guard and perhaps less co-operative with the quantity of information you are asked to provide. The usual reason for an angel investor refusing to sign an NDA is that they are already working in areas that conflict with your business; and that would be your first red flag that should seriously make you think twice on the amount of information that you are willing to disclose.
Once the ‘Non-Disclosure Agreement’ is signed (or not signed) this will be a good time to value the contribution that the investor could make to your company by considering questions like:
1) Has the Investor worked in your industry sector and if so what is his/her experience level within it?
2) What resources does the business angel investor already employ that you may be able to leverage? Example: access to office property, access to experienced sales staff, existing know-how in your industry, trade suppliers, or even existing distribution networks to wholesalers and suppliers that your product could piggy bank of? Is there some way to leverage this as part of the angel investment package (example, one or two years free rent on office space)?
3) What companies has the investor invested in to date? What companies does the investor privately own? It may be worth considering carrying out credit checks on these public companies at a later date to provide you with valuable insight on how this investor manages his/her own businesses.
4) From the Investor’s past angel investments, how many of them are similar to your business and industry sector and how well are they doing? Also how many past business angel investment successes has this investor had?
5) From point 4 above, if the investor has had past successes in his angel investments, ask what qualities the entrepreneur had that first attracted the investor to invest in him/her. This can provide you with a candid view on the types of qualities the investor will be looking for in you (!)
6) Has the angel investor exited from any of his/her past business investments? If so, what were the results and how much of it was as a direct result of this investor? Would the Investor be comfortable with you contacting the entrepreneur(s) involved in that business? If not, why not?
7) If you do retrieve the entrepreneur’s contact details from point 6 above, call him/her and ask what level of support the entrepreneur received during their time together and was it valuable? Contacting an entrepreneur that has exited and is no longer involved with the investor will yield far more honest and upfront commentary over someone that is still currently involved with the investor for fear of conflicts of interest.
8 ) How many business investments (NOT traditional investments such as stocks, bonds, property investments etc) has the investor made in the past? This is a revealing question as most experienced business investors will know exactly what they want from you and your business from day 1, whereas, less experienced business investors will be far more hot/cold during your meetings and may tend to make commitments verbally that are later broken when they have consulted with their own network of friends and advisors. This does not happen all of the time, but more often than not, a less experienced investor may seem friendly and agree to a whole host of terms verbally in a meeting and then on the eleventh hour almost schizophrenically change all of the terms they have verbally agreed to. Expecting this may provide you with more leeway and understanding if this happens.
9) Always be on the look-out for the ‘good cop, bad cop’ routine played by an investor and his advisor. Most important of all, if negotiations are later fully delegated to an investor’s advisor it is best where possible and funds allowing, to have your people talk to his/her people, as it can be quite an exhausting experience trying to negotiate key points and terms with an advisor that does not have the final say on key decisions. Even if the investor states that the advisor has full power to negotiate on his/her behalf ultimately they will not as it is not their money at stake.
10) What payback period is the business angel investor realistically looking at for his/her investment in you? What is the investor’s expected timescales for an exit of his investment? Is the investor looking for a short term, medium term or longer-term return on his/her investment?
11) Is the investor willing to be on the board of directors of your company? This can indicate the amount of involvement that the investor is willing to provide over his/her angel investment.
12) Will a Lawyer/Solicitor be drafting the legal documents for the angel investment and deal structure in your company? If so, will you retain your own counsel whilst these documents are drafted? Also, it is not unheard of for an angel investor to take the stance that he will not be using corporate lawyers to draft agreements, as if an investor chose to invest in 8 – 10 companies the total legal bill could turn out to be well over £50,000.00 assuming a lean estimation of £5K per company which is low! Whatever the situation for the investor, an entrepreneur should always pay for legal advice before signing any contract so that all terms are fully understood and you enter into any agreements with your eyes wide open.
13) In terms of deal structure, if an Investor is purchasing equity, what type of shares will the Investor be purchasing (common shares or preferred shares) and have you spoken with your accountant or tax advisor in terms of the potential tax benefits and downfalls to the different types of structures an investor may propose? Always do check if there are any warrants or share options attached, or would the investor instead wish to assume responsibility for some kind of debt in your company? If so, do ask your lawyer to check whether the debt will be classed as subordinate debt or convertible debt.
14) And finally, Net Worth of the investor – though you may never reasonably know what the exact net worth of your potential investor is, it is important to understand that an investor should have at least 7 – 10 times more in liquidity over the amount that they are going to be investing in you. So if you are seeking an Investment of £50,000, the angel investor should have around £500,000 of liquid assets (shares, positions in gold, cash etc) that are easily convertible to cash over the short term whilst also being able to service their own debts.
The reason why the question of net worth is important is because an investor that you choose to partner with must always provide strength to your business relationship, and this strength cannot come from someone who is constant fear of losing their investment if the venture fails or does not make money in the first quarter. This is not a question of wealth but affordability and as a result, it is important that as much due diligence is carried out beforehand to ensure that the investor can actually afford to invest in your company and potentially be a good bedfellow with you.
The following points above are only considerations and by no means exhaustive but should set out a good foundation to the types of questions you should consider finding out over the course of your ensuing negotiations with an investor.
Entrepreneurs must always remember that even though it appears difficult to raise angel investment now, making a wrong choice with the wrong investor today will almost certainly be impossible to separate from tomorrow so you owe it to your ‘future-self’ to ask as many questions as you can today.
UPDATE TO ARTICLE: We have received emails from entrepreneurs that are looking for a list of questions that angel investors will ask and a good list of questions can be seen here: Angel investor Due Diligence. Ensure that you have answers to these questions before meeting an Investor. Again, the above link is not exhaustive, but it is a good start when preparing to meet an Investor for the first time.
Rishi Anand: Founder and Managing Director of VentureGiant.com. Find Angel Investors at Venture Giant. If you are a Tech Start-up or Small business looking to take your businesses to the next level, Venture Giant connects entrepreneurs & SMEs to Angel investors that are seeking to invest and provide angel investment to start-ups and established businesses.
The opinions expressed here are entirely of the author’s and as a result the author cannot take any responsibility for the results or consequences of any attempt to use or adopt any of the information presented in this guide. Whether you are successful in raising investment from an angel investor or not, it is always important to seek independent advice from professionals before consummating any type of angel investment deal.
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