<<

. 28
( 62 .)



>>

on the industry average, and the amount of capital required in year num-
ber 2”coming from a public offering or other investors. Or else we™re
going to tap you if we can for another round.
153
Types of Private Investors


What also gets my attention is a business plan that includes in its
terms an action plan from someone who demonstrates that over the next
90 to 180 days, from the time the company receives the money, he or she
can enumerate what exactly has to be done to make this business go. The
more specific those kinds of milestones are, the more comfortable I am
in knowing that I can measure progress after I™ve made the investment
and calibrate how I should react; that is, whether I™ve made a mistake,
or whether I should put money in if I™m asked. This is a very good way
both to monitor the investment and to assess how management is doing
and what you can do to help them.
I favor a short time to liquidity. I don™t think of myself as a
long-term investor, but I turn out that way in many of these ventures. A
fax company that I helped start had a business plan that declared we
would go public and have $50 million in sales in five years. It™s got about
$10 million in sales and probably another three years till liquidity”now
that it™s been in business six years. That™s typical. And I™ve found that
there are good enough opportunities in the public stock market that pro-
vide liquidity with moderated risk.
If I™m going to have a long-term, definite ending in a private com-
pany, I™d better have some chance of liquidity along the way. I don™t nec-
essarily want to pull my money out, but the company needs to have a
plan for stages of investor returns. I™d like also, as a secondary criterion,
to have the possibility of a very high return. Maybe you think a 50-per-
cent-a-year return is high. To me, a very high return means it is an Apple
Computer in the making, or a medical device that everybody in the
world wants, or a solar energy company, alone among the whole indus-
try, that actually makes something everybody wants.
Also, I look for people who have done it before, hopefully very suc-
cessfully. This usually means that they are coming out of the same in-
dustry, maybe another company, and they™re just going into business
competing with the former employer. Or in some other way they have
been successful entrepreneurs and are working now in something very
closely related. And, finally, I look for some downside protection.
I™m quite willing to walk away from investments and lose all my
money, but I prefer that there™s some kind of second chance at getting
part of my money back or parlaying it into something else of value. I
think also that the fellow investors need to be able to contribute some-
thing besides money. Finally, the process ought to, on a whole, just be
fun if it works; otherwise, it becomes too painful to think about.
What most entrepreneurs sell is a story, and what most investors,
particularly the more sophisticated investors, want to buy is manage-
ment. When you™re out there selling to people who are investing $15,000,
154 UNDERSTANDING THE ANGEL INVESTOR


$20,000 at a crack”your friends and members of your family”the story
becomes a question of what they are buying. If you™re going to succeed
in raising the money for a larger, more sophisticated investment, and if
the company, in turn, is going to succeed, you™re going to have to show
the more sophisticated investors that you™ve got the management team
in place”or know how you™re going to get it in place”and also show
that the team has formulated a clear plan of action.
Management is the key to being able to deal with unexpected prob-
lems certain to arise. So if you are an entrepreneur with a great idea and
a great story but you don™t have the management expertise, get it. Even
if you give up a significant chunk of your company to get the right man-
agement in place, you™ll be way ahead for having done it. Qualified man-
agement is one of the most difficult parts of a business plan to evaluate
because resumes can all be made to look great. How do you evaluate
what someone can really do? I have found that I need to do a lot more
due diligence every time I review a potential investment. Having done it
several times, I have been surprised at instances of outright fraud, out-
right cover-up in which people were not revealing everything.
Personally, I™m a generalist. If it looks like it can make money, I™ll
take a look at it. For example, a potato chip plant in Colorado already
had an empty building where the company was going to set up its
plant, and it was already sourcing the chips from a Texas operation.
From a look at the business plan, from all the numbers, all it needed
was capital to get machinery in there and start producing, instead of
buying, the chips. The company was going to be making money in no
time. It was in the stores, a really ready-to-go operation. It already had
shelf space and name recognition in the area. But it wasn™t telling the
whole story.
So how do you uncover that? It™s a difficult thing from an investor™s
perspective. You have to be very careful. It™s very important for entre-
preneurs to reveal everything and to have integrity, or else you are build-
ing in your own doom. You™re not going to succeed by hiding things. It
all comes back to bite you. So make sure you tell a potential investor the
bad news first, and if they™re still interested after they hear the potential
difficulties, you™ve got someone that™s ready to go through the trials and
tribulations with you. But if you™re giving only this wonderful story
about the future, and the investor buys into that, what happens when the
first problem comes along? Now you™ve got problems beyond anything
you have anticipated.
I, by the way, have an entrepreneurial background myself; I haven™t
always been an investor. I remember someone explaining the difference
between institutional and private investing, a distinction sometimes dif-
155
Types of Private Investors


ficult for a private investor to remember: The private investor does not
have to invest! Sometimes the story is so attractive that you are lured
into it and say, “Wow, this is hot; this really has sizzle.” But you have
to have that management team to keep the bacon frying or the sizzle
fizzles.
Perhaps the greatest disservice that™s been done to entrepreneurs is
the saying that if you build a better mousetrap, the world will beat a
path to your door. It™s just not true! The shelves are lined with better
mousetraps. If you have the right management you can take an inferior
product, make it succeed, and make money. So don™t buy into a story
that just because you™ve got something unique and better than what™s al-
ready out there that you™re going to succeed. It takes a lot of hard work
and correct management decisions.
In terms of my own investments, as I said, I™m a generalist. Gener-
ally, $50,000 to $100,000, sometimes a little more per investment. I™ve
been a public investor and actually was a commodity trader for many
years, which led me to understand risk and decide that the risk involved
in investment in private companies made sense. In fact, it™s kind of the
same game. You expect to lose. You have to be willing to accept losses;
the wins just have to be big enough to compensate for them. So as a
commodity trader, I found that if I could be right 30 percent of the time
I could make a lot of money, because I cut my losses short and my win-
nings were big ones.


Deep-Pocket Investor #2
A good CEO without an exit strategy is much better than a poor
CEO with an exit strategy. If it™s a poor CEO, you know what
your exit strategy is; it™s called a Chapter 11 or a Chapter 7. So to
me the quality of a CEO is the most important thing.

When I look at a business plan, my interest is heavily weighted toward
the numbers. I look at projections going out only about three years, be-
cause after three years, I™ve never found a crystal ball that was clear
enough to mean anything. The other thing I™d look for in a business plan
is a reason to believe the numbers are good. I would expect a write-up
saying it™s a projection, but why should I believe this projection is solid?
I do not want just words; I do not want just numbers. I really think you
have to feel ownership of that business plan. You have to believe in it;
otherwise, you can™t sell it. When you ask for investor capital, you™re
asking the investor to buy your perception or your business plan.
Companies never go broke if they always have enough cash. Since
156 UNDERSTANDING THE ANGEL INVESTOR


the only time companies go broke is when they run out of cash, really
work on your cash projections, your cash flows. The size of the invest-
ment I typically look for is something in the $100,000 to $250,000 class.
So I would say I™m a smaller investor.
The enterprise should be projected in the black within 18 to 24
months, or have a reason why it™s not profitable within that time frame.
If our projections are good only for three years, we had better be in the
black 18 to 24 months out.
The president of the company should really consider that his invest-
ment in the company is a modest living and his real income should come
through stock options. If the president isn™t willing to live modestly as
he™s building the company and figure his payout comes at the end with
the stock offering, or stock options, I really question whether this is the
person to run the company. I™m not concerned as much with an exit
strategy as I am with the quality of the CEO. A good CEO without an
exit strategy is much better than a poor CEO with an exit strategy. If
it™s a poor CEO, you know what your exit strategy is; it™s called a
Chapter 11 or a Chapter 7. So to me the quality of a CEO is the most
important thing.
Also important is that the company be big enough to have an out-
side control board. I would not be interested in owning control of the
company, but the company has to have an outside control board. And I
will help in the area of actively recruiting board members, because my
firm belief is that if you have a board with experienced businessmen and
those members have all run businesses larger than this one, you have in-
creased your chances of success. And getting an outside control board,
gathering people who will truly participate, is not that much of a prob-
lem, and not that expensive either.
No single customer should represent more than 5 percent of your
volume. If you have a customer who represents 20 to 30 percent of your
volume, you no longer are making the business decisions; your cus-
tomers are.
In my investments the majority of the business assets are located
within two to three hours of my home. As an investor I want to go out
and be able to kick the side of the wall, or kick the desk, and find out
where the hell the investment is. I don™t want an investment a five-hour
plane ride away. You also want to go out and see what other people
think of the business, depending on what the business is and depending
on whom you™d ask.
Time frame? I™m comfortable with looking at a 10- to 12-year,
maybe a 15-year investment, as long as the projections forecast that we
can grow by internally generated cash flows. If you™re going to show
157
Types of Private Investors


rapid growth, you™re going to need additional rounds of investors, and
additional rounds of investors may demand more than the first group
did. May not, but, in turn, may.
I guess everything boils down to three important things: the quality
of the CEO, the feasibility of the projected balance sheet, and the
reasonableness of the business plan. The rest becomes second fiddle.
If you can get those three things in order, you should be able to get an
investment.


Deep-Pocket Investor #3
I™m not going to continue looking at a deal where I don™t feel very,
very comfortable with the people. That™s not only a feeling that
they™re straight, but also that they™re honest. And I gotta like them.
Otherwise, I™m not going to invest.

I™ll just make one comment up front: I™m a real expert in this business be-
cause in the 12 to 14 years that I™ve been in this aspect of the business, I
have personally made every investment mistake you can make. Or I™ve
witnessed the mistakes.
The trick in this business is to learn by doing business and to try not
to make the same mistake twice. But oftentimes we get caught up in the
entrepreneur™s and the founder™s enthusiasm. That™s as it should be.
That™s the kind of business this is”more art than science.
My particular background is eclectic: I™ve been on both the entre-
preneur side and the venture capital side. Last year I spent the better part
of the year working as the founder of a company and I was humbled by
that experience. So I certainly have empathy for people on that side.
One of the things that came out of that experience is a respect for
knowing the market. I see a lot of plans stating that the market is $5 mil-
lion, or it™s equal to the gross national product, or it™s this or it™s that. I
would urge you to concentrate on how you™re going to get to that mar-
ket, to zero in on what the served market is. And, like all of these things,
there are entries on both sides of the ledger. Certainly there is the focus:
You want to have a niche; you want to have a small market; but, at the
same time, that market has to be big enough.
Like any business plan, like any good entrepreneur, you can count
on shifts in your strategy once you get into the market. So I would urge
you to also understand the market and be comfortable with the fact
that it™s big enough to accommodate the necessary shifts in your strategy.
If you™re in a very small, very well-defined, limited market, you™re
not going to have the luxury of shifting your strategy, so you™d better
158 UNDERSTANDING THE ANGEL INVESTOR


have a concept for a product that is proprietary or has significant barri-
ers to entry.
As an investor in technology, nontechnology, and service companies,
and as a board member of seven small companies, I look for what is re-
ally different about the concept. Now that difference doesn™t necessarily
have to be proprietary technology. It can be the different distribution
strategy. It can be a different way to service an area that™s not now being
served well.
I spent most of my life in the corporate rat race, and I left it in my
late forties to start my company, not because I had a burning, compelling
desire to start a company, but because I™d been running a company in
Silicon Valley and, as you sometimes hear, the venture capitalist will ter-
minate a president when the moon gets into a certain position. I fell vic-
tim to one of those venture capitalists. I couldn™t get a job anywhere else
so I started a company.
I had been in the equipment leasing field for a lot of years, so I
started in that. I capitalized the company with $1,000 and went after a
market that all the big people in the equipment leasing field said was im-
possible to succeed in, and that was financing start-ups. They thought
my concept was that I would take incredible risks and go down the
tubes. They were wrong on both counts.
I wasn™t taking terrible risks. I wasn™t gambling on my ability to dis-
cern a good deal from a bad deal. What I was doing was structuring each
transaction as a professional financier might structure a real estate trans-
action. And so I mitigated risk, if you like, with available collateral. I
capitalized the company on $1,000 and in the first year, before my own
salary, we made about $17,000. So I paid myself a salary of about
$15,000”about a third of what I had been making before”so I could
show a profit of $2,000. I had this strong compulsion to show a profit.
And 14 years later, our pretax earnings were a million and a half,
and I sold it. And, since that time, I™ve been taking life a little easier, and
from time to time, I invest. I have looked at literally thousands of deals
because I focused on emerging-growth companies, start-ups in a wide
variety of fields, but primarily in high tech (though I had very little
high-tech background, it was primarily in electronics, and I never took
physics). And I™m still as green in technology as I was when I started.

<<

. 28
( 62 .)



>>