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Another is the business strategy risk. Could the market change and have an
impact on the acceptance of the service or product? Is there still growth
ahead for the company through its product and technology? Is there any-
thing brewing in the market that could affect the company, creating market
risk? Will the manufacturing and R&D work as planned or is there opera-
tions risk? And, importantly, what is the financial performance of the ven-
ture to date and how have the managers financially performed in other
ventures with which they have been involved? These are the risk characteris-
tics in the deal that investors sometimes use to reject an offering.
Finally, rarely will entrepreneurs find investors willing to make direct,
private investments to provide exorbitant salaries or back salaries, or to
pay off loans or other debts incurred by the venture. Investors are interested
in building mountains, not throwing money into a hole that has already
been dug.

Different types of direct participatory investors prefer different levels of in-
volvement in their portfolio companies. These levels of involvement fall
along a spectrum ranging from less active involvement to more active
(Exhibit 6.4). The private venture investor helps to build value. Most direct

• Angel“ • Informal • Part-time or • Investor-
seat on working consultant- full-time owner
board of directors investor manager-investor

Less active More active
Figure 6.4 Levels of Involvement in Direct, Private Investments
Source: International Capital Resources

investments require additional work beyond the money invested. This addi-
tional work often translates into being involved in some aspect of growing
the enterprise.
Also, the level of involvement can change dramatically”in either direc-
tion”depending on management™s performance and the risk to the investor™s
investment. Passive angels may settle for a seat on a working board of direc-
tors, or they may require detailed financial reports prepared periodically.
These persons are not looking for operating management responsibility.
Meanwhile, consultant-investors may provide consulting help on a tempo-
rary basis as it is needed and requested.
Manager-investors, a new breed of investor discussed in the next chap-
ter, provide support and industry knowledge, long-term commitment, and
deep pockets. As long as the chemistry is satisfactory, well-connected man-
ager-investors investing within a close geographical area typically expect an
operational role in the venture. Investor-owners, for their part, are buyers
concerned with control. While involvement may be a knee-jerk reaction to
the illiquidity of this type of investing, in most cases it may simply create
value through the use of the investors™ knowledge and contacts, or reflect a
sizable financial commitment. As Andrew Carnegie said, “If I™m going to put
all my eggs in one basket, I™m going to closely watch that basket.”
It is incumbent on entrepreneurs to ask themselves how much involve-
ment they are willing to accept from investors offering capital. Entrepreneurs
need to clarify in advance for themselves the degree of involvement they be-
lieve is palatable and so proactively seek investors for their venture whose
preferred level of involvement to monitor their portfolios conforms with the
entrepreneurs™ expectations. Your eagerness for the investors™ capital should
not blind you to all the things investors can bring to not only monitor the
deal but also add value. By using discretion in your choice of investors and
communicating clearly expectations on both sides about the level of involve-
What Do Private Investors Look for in a Deal?

ment before taking the investment, the entrepreneur goes a long way in pre-
cluding conflict. Remember, it is the quality of the investors that the entre-
preneur permits to play a part in his or her venture now”along with the
relationship that subsequently develops with them”that will be scrutinized
by the investors whom the entrepreneur seeks to bring in on future financing
rounds. Involving investors now who can add value can make easier the task
of bringing on board additional significant investors later.

While more passive investments expect profit derived solely from the efforts
of others (e.g., in mutual funds), direct investing in private, early-stage ven-
tures can entail significant involvement, contributing the investor™s added
value. In several ways, investors can help beyond their infusion of capital
(Exhibit 6.5).
Early-stage, active investors can help entrepreneurs of the companies in
which they invest, in a number of ways. First, the entrepreneur must recog-
nize that all direct investors offer the potential to provide more than money.
To seek only the capital and forget the capitalist is to miss the point. We look
at investor contributions as value-added, over and above their capital invest-
ment. Investors can help with identifying and facilitating alliances and strate-
gic relationships with more established corporations, using such vehicles as
technology transfer, joint venture, or original equipment manufacturers
Investors can assist with the equity offering by bringing in other in-
vestors or by supporting your presentations or discussions with new, pros-
pective investors. They can help with arranging other financing. Through
their extensive industry contact network, they can provide introductions
with potential customers, suppliers, or distributors. With their general man-

EXHIBIT 6.5 How Investors Add Value Beyond Capital

Alliances with larger corporate partners through technology exchange,
original equipment manufacturers, or other agreements
Assist with equity offerings, financing, joint venture, and acquisitions
Provide industry contacts with potential customers, vendors, and financing
Assist in strategy, financing, and recruiting issues
Bring right knowledge and functional experience to help you grow your business
Offer a multidisciplined external contact network

Source: International Capital Resources

agement and technical experience in multifunctional areas, they can assist in
strategy development, business planning, and recruitment of key talent for
the management team to help grow the business. But most of all, having al-
ready “been there” and successfully having done what the entrepreneurs are
trying to do, they will bring patience, calmness, and fortitude in the face of
the start-ups™ emotional “roller-coaster ride,” and be a sounding board for
ideas on how to cope with unexpected events.

Because private investor motivation is a driving force behind their invest-
ment criteria, it will pay entrepreneurs to attend to what prompts investors
to make their investment decisions.
One motivation in private investment is, of course, ROI, but it is only
one factor of many in the decision-making process. The decision of the pri-
vate investor to invest always turns on this fact: The private investor does not
have to invest. Therefore, unlike the institutional investor and the money
manager, the private investor market cannot be approached as some mono-
lithic block. Even Stonehenge is not a single giant slab of rock. Like
Stonehenge, the private market”despite all its shared elements”is com-
posed of separate entities, exhibiting a complex set of motivations that we
need to appreciate.
As Exhibit 6.6 indicates, one significant shared element ironically serves
to separate investors: Ninety percent of the millionaires worth between $1
million and $10 million are self-made. Having made it on their own accounts
in part for their idiosyncratic natures.
One way they can recapture their successful experience”typically in
their forties and fifties, after they have already “made it””is by investing in
new companies, making investments based on the acuteness of their analysis
and intuition. Scoring once again reinforces their self-image. Their judg-
ment, once again proven correct, sustains recognition in the investment and
entrepreneurial communities in which they live. This serves as an important
As mentioned earlier, angels come in many different forms; they are any-
thing but monolithic. So no single motivation or set of motivations can de-
scribe and sufficiently explain the different types of investors. Through our
interview research, we have identified a range of investor motivations, in-
cluding improvement of self-image and self-esteem through recognition of
involvement in the company and by selecting winning companies. Another is
alleviating concerns by helping others; for example, the investor who left a
career in commodities trading set up a cancer-related medical research fund
What Do Private Investors Look for in a Deal?

Improve self image, self-esteem, and recognition

Alleviate concerns”Help others

Obligation to give back

Get “first crack” at next high-rise stock prior to IPO

Habit, addicted to the high-risk “rush”

Fun and exciting, the “joy of giving.” “You never know how much
you know until a small company turns to you.”

ROI 30% minimum

Desire to take charge of the stock selection process more directly

Exhibit 6.6 Investor Motivation
Source: International Capital Resources

after the death of his wife to breast cancer. This praiseworthy feeling of obli-
gation, this urge to give back, characterizes many investors who inherit their
wealth. Getting a first crack at the next high-risk stock before IPO reflects
the angel™s understanding that the big money is made before the IPO. Some
investors, much like gamblers, develop a habit for this type of investing and
become addicted to the high-risk rush. This type of investing can be enjoy-
able and exciting, and the joy of giving is best characterized by what one in-
vestor confided: “You never know how much you know until a small
company turns to you for help.” Obviously, return of investment and ROI
are important motivators, and so is the desire to take charge of the stock se-
lection process more directly.
In their book Angel Investing, Osnabrugge and Robinson suggest that
business angels™ primary motivation for investment encompass (1) expecting
a high financial reward, (2) playing a role in the entrepreneurial process, (3)
feelings of fun and satisfaction in being involved in an entrepreneurial firm,

(4) creating a job for oneself, and possibly some income, and (5) gaining a
sense of social responsibility. To some extent we agree, but we have a differ-
ent research-based model of the set of forces at work that influence angel in-
vestment behavior. One study of returns on investment for angels showed 39
percent of investors reported a total loss of investment, partial loss, or only a
write-off or tax benefit as a result of a negative return. Nineteen percent of
angels in this survey reported break-even or nominal returns lower than had
been projected. Thirty percent reported returns of 50 percent or more, and
12 percent reported returns greater than 100 percent.
Internal rates of return were compounded annually over the term of the
hold; returns were cash on cash plus capital gains. A number of the investors
did report multiples of investment exceeding 20 times ROI. The greatest re-
turns occurred when the investments were in ventures at the seed, R&D, and
start-up stages of development. It is true that ROI is indeed important. But a
major consideration in calculating rate of return is how long the investment
is held before liquidating. For example, three times the investment over three
years yields a 44 percent return, whereas three times the investment over five
years yields a 38 percent return. As venture capitalist Lucien Ruby observes,
“Venture capital investors do not have to get their desired returns. In fact,
they usually do not. But they want to see the desired return as a possibility.”
So since financial returns are many times just a mirage or goal, what are the
nonfinancial returns that motivate investors to get involved in these higher-
risk deals?
A particularly fascinating component in the investor™s motivation may
involve the desire to alleviate misfortune. If the investor™s spouse or a child
has died from a disease, the investor may hope to be an instrument in re-
search for a cure. In fact, there are a plethora of nonfinancial returns sought
by high-net-worth investors who turn to high-risk/high-return private place-
ments. These include creating jobs in geographic areas of high unemploy-
ment, developing socially useful technology in medicine or energy,
contributing to urban revitalization, encouraging ventures founded by
women or minority entrepreneurs, or the more esoteric personal satisfaction
derived from assisting entrepreneurs to build successful ventures in a free en-
terprise economy.
Some investors are motivated by the passionate commitment of the en-
trepreneur. People committed to a venture can be persuasive; they have en-
thusiasm and solid entrepreneurial vision, especially when the venture is
close to their heart. Entrepreneurs with an ingratiating style, with the
investor™s concern at heart, and with a passion in their plea, become difficult
to shake. The only way to get rid of them, in fact, is to make a token in-
vestment or refer them to another investor who more likely will invest in
the venture.
What Do Private Investors Look for in a Deal?

Motivation also emanates from the feeling of obligation”noblesse
oblige”perhaps born of guilt about how a particular fortune was made in
the first place. David Rockefeller outdid his father™s campaign of giving away
dimes, begun in the first place to improve his deeply tarnished image. The
compulsion arises to outdo the previous generation, to give back what may
have been gained darkly”and then give still more.
What we mean by getting the first crack is being a part of the first round
of financing at what investors hope will be the next high-rise, private stock
leading to an IPO. Many people are familiar with the IPO market. Another
way of looking at the angel capital market is to see it as the pre-IPO market.
By the time a deal reaches the IPO stage, the big money has been soaked up
by the early players. The people attracted to this type of investing, those will-
ing to leave themselves subject to high risk, are those who want to play at
that level because this is when the return comes in, not when the stock hits
the street and is already being managed by a securities broker and the syndi-
cation broker dealers.
There is also a habit associated with this kind of investing, not unlike a


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