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Introduction 223
Generating Deal Flow 224
Due Diligence 226
Business Valuation 228
Negotiating and Structuring the Deal 230
Risk as a Driving Force behind Deal Structure 231
Definition of Negotiation 233
Elements in Structuring the Private Placement 234
Overview of Deal Terms and Provisions 235
Overseeing and Advising Postinvestment 238
Harvesting Returns: Realistic Exit Strategies 240

CHAPTER 12
Preparing for Due Diligence 245
Introduction 245
Prescreening 246
Management 247
Business Opportunity 249
Industry 250
Products or Services 251
Market, Sales, and Distribution 251
Competition 252
Research and Development 253
Production 254
Intangibles 254
Legal Due Diligence 255
Financial Due Diligence 259
Questions About Projections 259
Questions About Capital Requirements 260
Questions on Assets in the Pro Forma Balance Sheet 261
Questions About Liabilities 262
Questions on Shareholders™ Equity 263
Questions for the Income Statement 264
Questions for the Cash Flow Statement 265
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Questions for the Use of Proceeds 265
Questions on Financial Assumptions 266
Lists for Reference Checks 266

CHAPTER 13
Valuation of the Early-Stage Company 269
Introduction 269
Pricing as Good Judgment, Not Formulae 270
Risk 271
Negotiating Valuation 273
Sweat Equity 275
The “Living Dead” 276
Strategies for Circumventing Negotiation Roadblocks 277
Fundamentals of Valuing Start-Up Ventures 278
Macroeconomic Forces in Valuation 279
Risk Profile of the Investor 280
Company-Specific Risk 281
Investor Involvement 283
Correlating Rate of Return with Time to Liquidity 284
Multiples 284
Discounting Projections 286
Valuation Methodology Used in Early-Stage,
Private Equity Transactions 287
Dilution 290
Truisms in the Valuation Process 292
Caveats for the Entrepreneur 294

APPENDIX A
How to Write and Present an Investor-Oriented Business Plan 297
The Target Audience 297
Introduction to the Business Plan 300
What Does Your Business Plan Need to Contain? 300
Creating a Business Plan 300
Executive Summary 301
Mission or Charter 302
Description of the Business 302
Ownership Structure and Equity 303
Description of the Product/Service 304
The Market 305
Description of Industry and Trends 307
Marketing Strategy 309
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Marketing Plan 310
Sales Plan 312
Operations, Research and Development
Strategies, and Plans 313
Management, Organization, Personnel, and
Information Systems 316
Objectives and Milestones 318
Financial Projections 320
Supporting Documents 323
Preparation and Delivery of Your Presentation 331
Preparing an Effective Presentation 331

APPENDIX B
Legal Primer on Securities Law Issues for Nonlawyers 335
Contents 335
Foreword 337
Overview 337
Private Offerings”The First Step 344
Public Offerings 345
Disclosure Documents 349
Integration Rules: Timing 350
Restricted Securities and Trading 350
The Internet 352
Federal/State 353
The ™40 Act 354
The Usual 355
Sales”“Agents” (California) 355

Suggested Reading List 357
Glossary 361
About the Authors 367
Index 369
Preface


he number one concern of start-up entrepreneurs and growing small busi-
T ness owners and managers is how to finance their venture. When the per-
sonal financial resources of the entrepreneur are exhausted, when the
tradition of going to family and friends for “cradle equity” has been thor-
oughly “worked,” and when incurring personal debt from a bank for a loan
is no longer a viable option, then raising private capital can be one of the
toughest challenges for many entrepreneurs. Whether you have an as-yet-un-
proven, visionary start-up or already own a small, established company hun-
gry for expansion capital, access to capital on the right terms is critical to
your success.
Available for financing are an array of alternative capital resources, but
the problems center on which are most appropriate for you and where do
you find them. While economic conditions during the previous four years
have had an impact on capital availability and increased competition among
entrepreneurs for that capital, alternative, nontraditional capital resources
are out there.
For some companies”those possessing the right mix of attributes”
money will be available; yet for many, understanding where to look, how to
present, and how much money is needed comprise just a few of the questions
for which business owners are ill-prepared to answer. How do you uncover
the dozens of alternative ways to finance your company and prepare for rais-
ing capital?
How to identify qualified, hard-to-find private investors who prize their
privacy is a case in point. Also, how do you motivate them to read your busi-
ness plan, to meet with you, and how do you interest them in your venture
and your deal? Sometimes asking the less obvious questions is most useful
(e.g., when should you not seek angel capital?). Are your current money
sources structured most advantageously for you? Have you overpaid? Has
your company grown and have you recognized the changing needs of your
business? Are you prepared for your company™s capital requirements in the
next phase of growth?
Capital is the single most important ingredient in getting a venture off
the ground. But finding it can be a challenge”particularly if you are running
out of funding options. Suppose your venture is too small for institutional


xv
xvi PREFACE


players. What do you do once you™ve exhausted your personal financial re-
sources? Where do you go after the banks, the leasing companies, the ven-
ture capital firms have turned you down? Which financing sources are worth
exploring and which are not (e.g., conventional lenders, institutional venture
capitalists, or business angels?).
The fledgling entrepreneur has long turned to a wealthy uncle or well-
heeled friends to provide that cradle equity for the early growth of a promis-
ing business. However, it™s always been hard for companies to know where
to turn to find unrelated investors, and similarly difficult for willing risk tak-
ers to find new ventures in which to invest. As a primary source of capital for
early-stage and growing companies, the angel capital segment of the investor
market is a vital source for today™s entrepreneur. But much like the capital
they provide, these private equity and debt investors remain true to their
name”private. Yet, what we are seeing is the majority of venture capitalists
evolving out of early-stage and investing in later-stage, larger deals, thus cre-
ating a huge vacuum that business angels have moved in to fill.
Private investors, or business angels, are a primary source of financing
for many early-stage deals. However, most small business people have lim-
ited knowledge about the angel equity market, business angels, the private
equity investment process, and how deals get done. Also, few formal mecha-
nisms exist for bringing angel investors and entrepreneurs together. The strict
regulations imposed on offerings, together with the incomplete understand-
ing by entrepreneurs of the complexities of the equity financing process, cre-
ate the need for the groundbreaking research on what works in Angel
Capital.
Also, what type of information do investors expect, and how do you ef-
fectively present that information? What are private, not institutional, in-
vestors looking for? What documentation is needed, and how do you craft
your presentation to investors? International Capital Resources™ proprietary
research in building the largest database of business angel investors in the
United States provides valuable insights into the motivations, preferences,
and expectations of the selective private equity investor.
Angel Capital is about the manner in which successful entrepreneurs
must go about the business of raising capital, the efficient manner of know-
ing where they are, where they are going, what they are doing, and how they
are doing it.
This book describes a model of the funding process uniquely suited to
the private placement transaction. A model of this process is the only way to
consciously manage the increasingly demanding, exhausting process of effi-
ciently and effectively raising money.
Angel Capital is about the careful planning entrepreneurs must do in
xvii
Preface


order to ensure the success of the capitalization and financial transaction
process. This book offers the expertise of the people who have created the
largest network of private investors in the country and by the firm that is rec-
ognized as the leading expert on accessing and cultivating relationships with
angel investors.
In addition, the book is about the secretive, highly specialized segment
of the investor market that is a major source of funding for entrepreneurial
ventures. It provides intelligence on a segment of high-net-worth investors
specially interested in financing earlier-stage, developmental-stage, and ex-
pansion-stage ventures.
Angel Capital covers a lot of ground. Part 1, “The Challenge and the
Solutions,” focuses on how entrepreneurs are creatively addressing the chal-
lenge of practicing capitalism in the face of a significant capital gap. We sug-
gest how they should structure their search for capital as they confront an
“inefficient” market, and provide a proven strategy for taking control of the
capital-raising program.
Part 2, “Understanding the Angel Investor,” explores angel investors”
who they are and where they can be found. In addition, we present an
overview of alternative sources of capital. A comparison is made between
angel investors and the institutional investor community, correcting the mis-
conception that the institutional community is the primary source of funding
for early-stage deals. Then, from scores of presentations and interviews, we
turn to what private investors look for in a deal”their criteria and their ex-
pectations. We explain who the private investors are and how they relate to
others in the capital market.
In addition, we present the results from a major new study of 60 angel
investors designed and conducted by the authors for this text. This study will
further clarify, in the investors™ own words, what they seek in early-stage pri-
vate equity transactions. This information will help entrepreneurs work
more effectively with investors in selling illiquid “story” securities. Investors
also share their wisdom in candid insights regarding the venture process and,
in particular, about valuation and due diligence. These are critical topics for
entrepreneurs as they try to understand the more cynical view of investors
following the “dot-bomb” fiasco, as well as the public equity stock market
meltdown, resulting in losses in their portfolios.
We also reproduce here our pioneering typology on the primary angel in-
vestor “types,” acknowledged by many researchers and educators to be the
major contribution to the angel investor literature. And we show how entre-
preneurs can use this information to better position themselves with investor
prospects in presenting and selling their deals.
Part 3, “Resources for Entrepreneurs Raising Capital,” deals with a set
xviii PREFACE


of tools entrepreneurs will find invaluable in the search for investors. We
provide a comprehensive historical introduction to alternative funding re-
sources, particularly those related to angel investors, notorious for prizing
their privacy. These resources and tools”past and present”will help entre-
preneurs deal with the formidable tasks they face. We share our own re-
sources and that of others on new directions emerging as sources of investors
and capital. Next, we have assembled one of the most current and compre-
hensive directories of alternative capital resources in the United States. Using
our unique classification system, you, the entrepreneur, will be able to locate
the full range of directories, software, incubators, finance conferences, in-
vestor meetings, venture forums, venture capital clubs, offline and online
networks, and financial intermediaries. As you proceed thorough the financ-
ing process”from planning and developing documentation through presen-
tation, investor introductions, and professional counsel”you may need to
keep track of all the investors and others who can help you, a daunting task
in itself, especially because the funding venture never ends. It just changes
form from one type of financing to another. For this reason, we discuss set-
ting up your own investor database.
Part 4, “Understanding the Angel Investment Process,” describes the
new capital-raising reality facing entrepreneurs now and for the foreseeable
future. Investors have altered their investment approach, responding to
losses they incurred, placing new emphasis on risk assessment, hedging, and
co-investment strategies. Also, we will help entrepreneurs to appreciate the
investors™ “return to basics,” as well as their renewed vigor in attending to

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