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of furthering the capital-raising process.
However, “garbage in, garbage out” is the watchword in data entry.
With each inaccurate entry”the wrong state, the wrong name, inaccurate in-
vestment criteria, or simply spelling something incorrectly”the database™s
effectiveness is diminished. Without absolute accuracy in the information en-
tered into the database, all is for naught.
It is also important to understand that if you go it alone, data entry is a
never-ending, time-consuming process. Keeping a database updated is easi-
est when maintenance is done regularly, even daily, even if it means updating
file information from someone immediately following a telephone conversa-
tion. Getting the information at that time eliminates having to have other

EXHIBIT 10.1 Setup of a Computerized Relational Database

Managing the database development budget
Networking considerations
Installing a backup system
Data entry
”Initial input, maintenance, and updates
Decide on export formats
Create relational queries and templates
Design database to fit specific criteria
”Fields, records, files
Select your database application

Source: International Capital Resources
218 RESOURCES FOR ENTREPRENEURS RAISING CAPITAL


people do it, or having to write the information in longhand and then enter-
ing it into the database. It should become a daily routine, but it takes time,
discipline, accuracy, and patience. Waiting, say, until the end of the month
makes for a weekend-consuming task.
The question arises about when a company keeping track of such infor-
mation should switch to a computerized system. The answer, we suggest,
comes when the company is spending more time doing things manually than
it is in making contacts to sell its offering”the real reasons this endeavor
was started in the first place. Another signal comes when the company has
had to hire people to manually keep up with the influx of information.


BACKUP
Another cautionary note seems worth sounding: the possibility of losing an
entire database of information. It happens, although rarely. A database needs
to be backed up, a feat accomplished with relatively little effort. If the system
does crash, eliminating everything, the information can always be restored
from the backup.
For safety™s sake, the user can simply copy the entire file over to another
area of the hard disk, although this is not the best way to back up such valu-
able information. If the disk crashes, the user loses both the backup and the
master file. The safest way is to copy the data onto floppy disks or tape, stor-
ing these copies off-site. Fire, a natural disaster of some sort, and even a
break-in are all good reasons to keep copies of a back-up disk or tape at
home. Even if someone burglarizes the office and makes off with the com-
puter, the backup tape is safe. A computer can be replaced by the insurance
company, plugged in, and the information restored by tape. Barely skipping
a beat, the company™s capital-raising campaign is back in operation.


COST

Finally, in going it alone, one has to consider the expense of setting up a re-
lational database. First comes the expense of the software, the application
program itself, costing a few hundred dollars. Cost continues to decrease for
database software and Pentium-based computer hardware. Additional hard-
ware”a good printer is necessary”would add several hundred dollars. Still,
with any word processing, a printer becomes essential. A basic printer entails
minimal cost and is fast enough for a small operation.
But those are just opening costs.
Another expense involves training, depending on how computer literate
219
Building Your Own Database of Angel Investors


the user is to begin with. Windows is very user friendly; going from square
one should not take too much time. The tasks are repetitive, which speeds
the learning curve.
Help from a consultant, however, is a different matter; at an average rate
of $100 an hour, the user had better be able to catch on quickly The same
rate usually applies for a phone call to a consultant sitting at home or for an
on-site visit.
For the database to be up and running and the project customized, 15
hours seems reasonable. There is hardly any point in slaving over something
that does not quite work for you. It makes little sense to spend time and
money, only to come up with something that could have been pulled off the
shelf.
The most expensive component, however, will be data entry, that ongo-
ing, tiresome task we discussed at length earlier. Data entry is not a one time
expense. In time, it could very well dwarf all other expenses combined.
When support is necessary, a temporary employment agency can supply a
competent data-entry person for $16 per hour.
Earlier we presented different ways of securing financial resources: by
renting them, that is, renting the names from other databases; by growing
them, that is, getting the names of people you know, then asking them for the
names of people they know; or by buying them, that is, using an alternative
financial resource to obtain new investors for your venture. In this chapter
we have plotted the task the individual faces in attempting to engineer a pro-
prietary relational database, specifically for meeting the venture™s financial
goals. Most likely, entrepreneurs successful at raising capital from private in-
vestors use all three strategies to some degree.
PART
Four
Understanding the Angel
Investment Process
11
CHAPTER

The Venture Investing Process


INTRODUCTION

Private equity investing is a process that falls victim to popular myths that
venture investment returns are the result of luck, managerial experience,
landmark technology, or inside information; but make no mistake, successful
angels and venture capitalists have an underlying process that winners fol-
low. The elements of the process are not only intertwined but also recursive.
That is, the aspects of this investment process, though discrete (as described
in this chapter) nevertheless weave themselves around each other. A sequence
is perceivable, though, again, intertwined. In a word, paradoxically, every-
thing happens at once over an extended period.
Entrepreneurs raising capital must recognize that this investment process
is used by investors to better manage the risk inherent in early-stage, private
equity investing. While on the surface it may appear that the successful in-
vestor has nonchalantly hit a home run, what is neither seen nor appreciated
is the amount of time, effort, and, of course, financial and emotional re-
sources that have been poured into each of these aspects of the investment
process. The investors do so to protect themselves as best they can from the
pitfalls associated with long-term, highly illiquid investments requiring ac-
tive involvement to build a sustainable company that consequently ensures a
payoff for the investors.
To navigate this investment process, the entrepreneurs will be called
upon display interpersonal skills and diplomatic and political dexterity.
Understanding their role during each activity will help them to achieve their
financial goal.
The phases of the investment process that we will discuss here include
deal generation or creating and identifying a flow of attractive investment
opportunities; navigating due diligence through screening, investigating,
evaluating, and analyzing the venture™s merits; ascribing value to the ven-
ture to determine equity share for investors; structuring the deal and terms



223
224 UNDERSTANDING THE ANGEL INVESTMENT PROCESS


of investment; monitoring the investment and defining participation and as-
sistance levels postinvestment, and identifying and managing exit to harvest
returns.
Underscoring the investment process are risk management and hedging
strategies unique to the early-stage, private equity transaction. We will also
discuss how entrepreneurs can expect investors to assess the risk in their deal
and the tools investors will use to reduce that risk, whenever possible.


GENERATING DEAL FLOW
Historically, private equity investors, particularly angels, found their deals
using such informal means as referral from family and personal contacts
(e.g., friends, associates, and so on) or referrals from professional service
providers (e.g., attorney, accountant, or investment advisers); or they may
have received an unsolicited contact from a nonfamily representative of a
company seeking financing. If this were true today, and these channels were
the only means available, entrepreneurs would be limited to investor devel-
opment approaches, such as networking with friends, family, associates, and
colleagues of wealthy individuals; and cultivating referral sources among ad-
visers to the wealthy, such as financial advisers, investment bankers, doctors,
securities attorneys, accountants, tax advisers, certified appraisers, entre-
preneurial finance consultants, commercial bankers, and preferred SBA
lenders. In addition, entrepreneurs would rely on cold calling leads they gen-
erate as investment prospects to pitch their deal, an approach our research
suggests may be successful less than 10 percent of the time. And desperate
entrepreneurs also might be tempted to place classified advertisements solic-
iting capital, an error that could lead to sanctions and penalties.
However, based on our research, we find that investors today are shift-
ing from informal to more formal deal flow development. And the reason for
this is clear. In our earlier chapter titled “A Strategy That Works,” we refer to
the concept of the funnel, suggesting that entrepreneurs need a pool of in-
vestor prospects, perhaps three to four times as many potential investors be-
lieved to be necessary in order to complete their financing round. Similarly,
investors need to generate significant deal flow, more so than is possible
through informal means, to discover the few promising ventures that merit
capital investment. Herein lies the opportunity for entrepreneurs seeking in-
vestors”each of whom cherishes privacy”to understand the channels used
by investors to find their deals, and understand pathways best designed to
identify and locate those qualified investors ready to invest.
The more formal strategies that investors use to generate deal flow we
discussed earlier. These include listing in directories, printed and software-
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The Venture Investing Process


based; participating in venture forums; joining venture capital clubs; partic-
ipating in online and offline investor networks; participating in an advisory
capacity for incubators; and becoming involved in public relations“based
approaches, for example, publishing articles on angel investing, contributing
to research studies, and offering interviews for business articles on venture
capital.
A review of the major directories, such as Pratt™s and Galante™s, will sur-
face institutional and a few smaller groups of private investors, for example
“store-front” venture capital firms. Also, investors join associations and then
become listed in regional association directories, like the one from The New
England Venture Capital Association.
Most directories are available in software form, easing the search for in-
vestors whose investment criteria fit the entrepreneurs™ deals.
Venture forums provide entrepreneurs the opportunity to meet in-
vestors, whether they present their company, exhibit, or just attend in the au-
dience, taking advantage of networking opportunities offered by the
organizers. Even if companies are not selected to present, investors are some-
times involved in screening committee roles and are accessible that way.
Venture capital clubs host monthly meetings. While some are closed to
members only, others open their doors to nonpresenting entrepreneurs. Since
these meetings usually center around breakfast, lunch, or dinner, opportuni-
ties arise to strike up conversations and initiate relationships with regularly
participating active investors. Of course, this same strategy can be used at in-
vestment conferences that private and institutional investors might attend for
professional development reasons to hone their skills, an important quality
of many sophisticated investors. (The great Spanish cellist Pablo Casals was
once asked why he continued to practice hour after hour, day after day, even
after he had long been acknowledged as the world™s greatest. His answer:
“So I can get better.”). Certain perceptive investors feel likewise; they too
want to “get better” at what they do.
Becoming active in online and offline investor networks means listing
your deal to gain exposure. Most online matching services are passive; that
is, they list your deal, leaving it up to the investor to contact you. Such is not
the case with offline networks, which conduct searches to find investors who
fit your deal parameters and actively contact them for you in order to deter-
mine their level of interest in the deal.
A number of investors have elected to volunteer for advisory boards of
incubators. This is an efficient way for investors to find early-stage deals in
industries of interest and geographically close to home, an effort to minimize
travel. The incubator provides extensive resources that to some degree re-
duce risks in company development. This fact is borne out in research show-
ing that incubated companies have better survival rates than nonincubated
226 UNDERSTANDING THE ANGEL INVESTMENT PROCESS


ventures. The investor may get involved as a mentor, adviser, or board mem-
ber. Incubator directors recognize the importance of capital for companies
under their wings, and when they think they feel they have found a fit, will
make the proper introductions.
On occasion, we have located investors for our research and for ICR™s
database through articles published by the investors, or locate them after
having heard them interviewed, or noticed their being mentioned in an arti-
cle or research study on angel or venture investing. Whether having pub-
lished an article or speaking at a meeting, a number of investors realize that
deal flow benefits sometimes outweighs their need for privacy, and they will
put themselves out there. An online search done periodically for recently
published articles and books on angel capital, venture capital, and early-
stage or private equity investing offer the best method of finding article-
based leads.
Last, but important, is an entrepreneur™s source of investors, ironically,
collected from other entrepreneurs. Why would other entrepreneurs pass
along an investor referral to you? Simple. It may be that the investor is no
longer willing to put any more money into that other entrepreneur™s deal; or
the investor may have rejected the deal but, in doing so, disclosed investment
parameters closer to your deal than their own.


DUE DILIGENCE

As a direct result of losses endured in the private, IPO, and public market fol-
lowing the dot-com and technology bubble burst, investors have become
more skeptical of entrepreneurs™ enthusiastic claims. An important implica-
tion is that investors have returned to basics, and due diligence again forms
a vital aspect of the investment-mating process. Detailed investigation has re-
turned front and center”elaborate and painstakingly thorough due diligence
means entrepreneurs can expect full legal and financial audits, assessment of
market potential, background and reference checks on founders and entre-
preneurs involved, interviews with former superiors, peers, subordinates,

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