Angel Calc Revisited

Do you know when your young business venture is "fit" to attract angel investor financing?

There are many theories and rules of thumb about how angels investors seek their ROI targets. To understand their motivations and ROI targets, let's look at how they work and the risks they face when writing a check:

Experienced Angels are the real Angels you want to work with. Most work in groups to share the heavy burden of due diligence research required to invest intelligently. To vet deals they try to include scientists, engineers and management experts in different industries and technologies. They ask a lot of questions and then more questions and then proof and supporting documentation. They generally do not move fast but cover their bases well. When they invest they will stay involved and help the management team with seasoned advice and working their contacts to help your business succeed. These are true ANGELS to entrepreneurs.

A High Risk Game
Research by the Kaufman Foundation (KF) shows that Experienced and committed angels' returns are on average quite attractive at 2.6 times their investment in 3.5 years. That, however, is balanced by the sobering fact that on average 52% of investments are a total loss and only 10-19% are a home run. Successful deals need on average 7 years to exit.

In my early days in this "bloody contact sport" my mentors cautioned me that a good rule of thumb was to consider a very early stage deal only if I could see a potential to earn 30 times my investment in about 5 years. Later on I tried to reconcile the KF statistics, my experience and the very demanding ROI target I was advised.  Eventually I modeled that all factors can be reconciled if one presumes that the probability of success of a well researched deal is only about 10-12%.

From experience I believe that it is a reasonable and not overly pessimistic expectation considering that the typical early stage business reflects most of these characteristics: Little or no sales, limited proof of market, may have lab tested technology, but little or no production, no proof of scalability, little or no delivery and distribution experience. Moreover, any of the following may apply:  a. in "some other garage" a similar or better mousetrap may be ready to come to market, b. the management team may have or may develop unforeseeable weaknesses (e.g. sociopathy leading to financial embezzlement, personality incompatibilities, office love affairs, divorces, loss of key talent due to death, accident, distraction, etc. - Over 35 years I experienced all of them as causes of aborted successful businesses); c. "effective" IP protection may prove difficult to obtain, may be revoked if prior art appears unexpectedly (see my posts on patents), inadequate funds to protect owned patents, exposure to Patent Trolls;  d. government regulations that may prevent or delay market acceptance, unforeseen vested interests that may create insurmountable barriers to market acceptance.

All considered the 10-12% probability may even be optimistic, but it appears to be what angels use implicitly if not explicitly.  To balance this somewhat dark view, we play this game  for the few successes that give us the satisfaction of helping turn dreams into reality, sometimes making a difference in the world and perhaps history while making a ton of money (in only 10% of cases)

So, with all this in mind, below is AngelCalc (copyright Marco Messina 2007-2013). Its intent is to help you test if your business has sufficiently high growth and profitability potential in an industry with sufficiently high exit valuations to satisfy the requirements of experienced Angels.  This is generally unlikely unless you have a unique IP component, market dominance potential, very rapid scalability. If your business cannot meet the angels' criteria, your funding efforts will be better put elsewhere. F&F (friends and family) may be an alternative at least until the criteria may be met.

A different analysis that comes to the same 30X ROI target is found in the section What do angels target for returns?  at page 3 of this KF paper

AngelCalc - Calculating with Angels
This model attempts to explain the finance-ability of a business based on angel investors' required returns.

The prime objective is not to set a valuation, although it can be used to back into or to validate a valuation that investors could live with. Primarily, it seeks to determine whether the relationship among the following factors allows a viable solution that meets investors criteria.

There are two paths each with its own factors:

P/E-Multiple Valuation (as for a public company):

1.  time horizon is 5 yrs, 
2.  future EBITA,
3.  future PE and market cap (from current comparables),
4.  investor's average returns and required return,
5.  the ASK needed to implement the plan
6.  The % equity to give up for the ASK

Revenues Multiples Valuation (most often for M&A sale of the company)

1.  Time horizon is 5 years
2.  Revenues in year 5
3.  Applicable multiplier for comparable companies sold
4.  investor's average returns and required return,
5.  the ASK needed to implement the plan
6.  The % equity to give up for the ASK

With both valuation methods the implied probability of success is 12% because it reconciles the return multiple identified by the Kaufman Foundation research (2.6 times return in 3.5 years) with the rule of thumb often quoted of "30 times the investment".  It can be adjusted to reflect the maturity (de-risking) of the company (e.g. VCs who invest at later stages often target 10X or 38% probability of success)

See input instructions above

Questons or comments? I'd love to hear from you, particulalry if you disagree.

Good luck. May you be so lucky to find a REAL ANGEL.

Marco Messina
The Angel Pitch Guy

Invention, Innovation and Entrepreneurship

Working with startups I have the good fortune of dealing regularly with highly motivated energetic and imaginative people who feel a drive to change their world. To some the world is the immediate vicinity, to others it is the whole globe, but in all cases they all see themselves destined to make a big difference. Most, not all, hope to be well compensated for their novel contribution and hard work. Even in this specialized group, however, invention, innovation and entrepreneurship are frequently confused. There are standard dictionary definitions of each readily available, but their frequent interplay complicates things. Let's look at how:

Invention (Inv)
An invention is an idea developed by a person, the inventor. To be recognized as such by the US PTO it requires 1. Novelty and 2.Non-obviousness to others skilled in the domain.  Note that there is no reference to usefulness, implementation, results, etc.

Innovation (Inn)
Is the process by which a useful outcome is obtained by a the implementation of either a new idea (an invention) or of an old idea in a new way or under new circumstances.  Note that invention is not  a requirement, but novelty of application, usefulness and most of all implementation are.

Entrepreneurship (Ent)
The activity of an entrepreneur: from its French root it implies starting something, particularly in business, taking risk for the outcome. Only initiative and risk taking a required, however common sense would also recommend a useful purpose that justifies the risk taking.  Neither invention nor innovation are required.  By this definition an entrepreneur could be one who opens a delicatessen selling the same products at the same prices and with the same level of service as the competition. So long as there is excess demand to be met the risk would be compensated by happy customers.  Growing from there would require innovation.

Most founders of startups I run into have some of all of the above. They are risk takers (Ent), they act (Ent) to achieve a useful purpose or meet a need (Inn, Ent) and they do so in a novel way (Inn) sometimes starting from a new idea (Inv), sometimes from a novel reshuffling of an old one (Inn)

With this in mind, some interesting businesses, inventions and entrepreneurs come to mind

Vannevar Bush
Bush in 1945 (yes '45) in an article "As We May Think" in The Atlantic Monthly conceptualized and defined the specifications of a personal information storage, retrieval and sharing machine, the Memex, remarkably similar to a today's  personal computing devices.  Note that he did so before the invention of transistors and ICs that made the digital age possible. Reading the referenced article, you may note that it all depended on photographic data compression.  Today's high density ICs still depend on the same principle, so Bush was correct in his extrapolation of the fundamental technology and only incomplete in the details of the ovolution. This example begs the question of how much do we recognize something as today's innovation only because of short memories.

Zappos
Zappos is frequently and justly touted as having developed a fanatic level of customer service. It is a correct assessment but only relative to on-line retailing. Anyone who dealt with Nordstrom in Seattle around 1970 (interestingly also a shoe retailer in its beginnings), would instantly recognize the same fanatic commitment to service that built their retailing empire. To wit a story reported by the Seattle papers of a sales clerk running out of Nordstrom to buy from a store next door something a customer wanted but not carried by Nordstrom. Without taking anything away from Zappos this example again begs the question of how much do we recognize something as today's innovation only because of short memories.

Cloud Computing
This new holly grail of the information age is a "whole new concept", invention and innovation only to those that began computing in the desktop PC age (the Computing Mesozoic).  Any remaining survivors, Homo Calculans, of the computing stone age (the Computing Paleozoic) will recall IBM's TSO (Time Sharing Option).  In its day a new concept, TSO promised, and largely delivered, ultra-flexible access to computing resources, centrally managed and backed up, capacity seemlessly reconfigured by the Wizards of Armonk to give us, Homo Calculans, ready access (through monitor-less teletype terminals) to the day's "Software Services" (SaS).  The services included pre-Visicalc/Supercalc/Lotus/Quattro/Excel simulation wonders and other similar wizardry.  Then the Federal Trade Commission mandated the end of SaS and a new age dawned. On the carcass of TSO Honeywell, CDC, Amdhal came to feed.  Eventually they succumbed to more nimble raptors: DEC, WANG, IBM-NASD, Prime, who in turn were hunted into extinction by the micro-raptors Apple, the CP/M herd, the Microsoft/Dell/Clones, IBM-PC/DOS and countless other breeds too small to note. And now the CellPhones and Pads are coming.  Few of the species were adaptable enough to come through the ages: IBM, HP and the endlessly adaptable software-jocks that live parasitic lives on any platform. In the end the logic at the foundation of TSO, like a dominant gene survived to see its day again.

We call all this evolution Innovation and Invention for good reason: in all its forms it is always novelty with purpose.  The  true constant, the DNA of it all, is in the entrepreneurs who have that special gene for taking risks with the purpose of doing something useful, to meet a need.  That will not change.

Marco Messina

Did you just say THAT to an angel?

One of my favourite Dale Carnegie quotes is: "If you want to gather honey, don't kick over the beehive."

Just like bees, angels have adverse responses to certain stimuli. Keeping those in mind will make getting to their honey far more likely.  Following are some examples of statements (S) often made by "honey seekers" and the mental responses (R) they are likely to stimulate in the angels.  Depending on the mood of the moment, the responses may or may not be verbalized. Often, in front of a large audience, the "honey seeker" is better off if the response is just a silent smile.

S   We have no competition
R  Either you have not researched it, haven't found it, or are so deluded to not recognize it...
R  If no one does it, perhaps it's because no one needs it

S   We have made very conservative projections
R  Sure.  So did the 1000's that came before you; and you are not even smart enough not to say it
R  If you are conservative you are no entrepreneur, buddy, you better go work for the Census surveys

S   We researched it so much, this is now a sure thing
R The only sure things are death and taxes.  We do not like sure things.

S   We are creating a market
R Excellent! This is an answer in search of a problem, that will be a real quixotic adventure
R Cool! If I wanted to create "futures" I'd be buying into a kindergarten or a primary school

S   Our solution will become the standard
R My goodness! We only have to stop the people who today are doing whatever by the current standard and force/train them to do it a new way. Along the way we only have to redesign all regulations, training programs, certifications, cajole all vested interests, etc. AND we make no money until it's done. Where is my checkbook.

S   If we get 1% of .... to buy our product we'll make millions
R Ah! Here comes the 1%er again.  If I could only have a dollar for only 1% of the 1%ers that presented plans I'd have the best performing fund at next years ACA Summit
R  Sure buddy, and we are going to do it all with viral marketing too

S   I am the only resource but I'll have key man insurance
R I like that!  So for an early exit all I have to do is to pray for trucks to hit you.  This is so new a strategy, we could write a white paper for HBR
R  We could optimize this plan by doubling the premium and make you open a branch office in Darfur

S   We are co-managers
R No way.  We want to know which throat to choke when things don't work.  Only one throat.
R So, we are supposed to pay two to make decisions that one should be able to do?

S   We only have to scale... 
R But of course! The difference between your local taco stand and McDonald's is only scale.  Same for mom's kitchen and Campbell Soup or my kids' tree-house and the Sears tower. It's only scale.

Lastly there are the responses that "seekers" give including an implied  "you dumb ass" commentary.  They are always a good bet for making angry bees out of angels:

you have to understand...

No buddy, I have the cash and do not have to do anything, you have to make me understand

everybody knows...  

Ah well, I must be the only idiot that doesn't.  I stand corrected.  Thank you so much for that clarification.

as I said before...  

Excuuuse us! We are either forgetful, slow or inattentive.  We'll do better next time... since you ain't getting any "honey" this time around.

Conclusion

Much has been written about human communications since Dale Carnegie wrote his masterpiece, little of substance has been added. It remains one of the best  manuals around: you might read it again with your angels in mind.

Marco Messina

Fishing for Angel Fish

The scarcest resource of entrepreneurs is not money, is time.  Money, when you can get it, is just a means to increase available time by hiring outsiders to do for you whatever you are smart enough to delegate and manage.  Conversely, all the money in the world will achieve nothing more than the going rate of interest in a bank account (3%) unless one puts it to work with time and energy. SO, NEVER WASTE  TIME.


One way I see many entrepreneurs wasting time is chasing funding from angel investors with propositions that do not come close to having any chance of success.  It is like going fishing for the wrong fish in the wrong pond with the wrong bait - most unlikely to make dinner tonight.

So in the interest of better fishing let's study the angel fish.  It is easy because: 

• these days most angel fish school in groups 
• most states and regions have well advertised (web) ponds, 
• the fish have the kindness to spell out in advance what bait they will strike

Here is an example taken from "one billboard at a well known California pond":
      Tech Coast Angel members invest in southern California companies, only. We look for products and services that can achieve rapid adoption in very large markets. Some of our criteria: 

• Scale: annual revenue potential of at least $50 million
• Market: a compelling, well articulated strategy for capturing and defending a significant market share
• Barriers to entry: patents or proprietary technology
• Team: a strong, not necessarily complete, team
• Exit strategy: some idea of who will eventually acquire your company
• How we fit: a desire for advice and coaching
• Valuation: you must fit within our risk/reward expectations

At other ponds the billboards list:

• specific industries (because the fish have expertise in them)
• level of business development (no pre-revenue plans)

So, figure out what business (bait) you have and decide if you stand a chance to catch angel fish.  If not, go fish for other species that bite on different bait, presumably the one you have. Here are examples:

Friends and Family:  this species bites on you personally and your trust factor with them.  Returns are hoped for but often the motivation is to help you along with the world changing idea you shared with them.

Banks: They still have money and do lend it if your business is the right bait for them. You'll need collateral and cash flow to have an chance. Beware of lines of credit that appear to be a strike, but you cannot count on for very long. 

Factors and Receivable Discounters: They bite on (and take a good chunk of) invoices you carry as receivables from financially reliable customers (they bite on someone else credit). 

There are many more, each specialized in different aspects and needs of your business.

Back to that favorite species: the angel fish.  The words that carry value with them (shiners in the fishing parlance) include:

Scalable: 1. the business can grow into a big business, 2. you and your team are capable to grow it

Market size and dominance: "1% of the world" is probably meaningless, "80% of left handed investment bankers with an income over 500k" is a concept one can measure and relate to. Attractive markets have size and allow some level of dominance.

Early Exit: a plan with an Exit is a requirement (remember: angel fish get to eat only at exit time). Early Exit is golden. More on this in a forthcoming post.

Barrier to Entry: the stronger your position, the less spooky the fish will be

Risk: This is the monster from the dark depths that scares angel fish away. They know it is part of the game, but they hate it. To manage their fear, show that you have identified fall back positions and fail safe conditions at every step; be able to simulate the cash flow projections accordingly. 

BE BRIEF: this is the most impatient fish in the world 

Happy fishing.  There is fish in that pond for the right bait. Do not waste time otherwise.

Marco Messina

Brevity again... The One Page Term Sheet

In my continuing search for KISS answers - Keep It Simple & Short, I read Basil Peters' proposal for a One Page Term Sheet. I've been following Basil's blog for years now and I think it's one of the best sources of experienced and clear thinking about angel investing. It will be a wonderful day when this becomes a best practice because it will set owners and investors much closer together at the start of a negotiation by establishing shared expectations. In a few words we will start from a known point and negotiate the variances required by the specific circumstances.

As an investor do I believe all the terms in here ideal? I do not pretend to argue that point here. In time the industry (angel investors and funds) will refine it and the sooner the better.

As an entrepreneur pitching your deal to angels, you can only hope they pitch back to you something this clear and straightforward. Now, read and hope.  If you have guts, present it as the guideline you positioned your company by and for: at a minimum you might just impress your angels as the first instance they encountered in which the "seller" appears to have made an effort to understand the "buyer" - what a concept.

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The 'One Page' Term Sheet for Angel Investors

This is not a theory or academic exercise. This term sheet is in actual use today by angel funds in BC.

This term sheet is based on exchangeable shares. This simplified term sheet is based on the underlying assumption that an effective, independent board is in place and that the board will make the best decisions for all shareholders. It also assumes the company is built on a fair and equitable structure.

Term Sheet offered to the"Company"

This Term Sheet has been prepared for angel investments made at an early stage by "the Angel Fund". The terms have been simplified to match the stage of investment and are offered for consideration and acceptance.

Offer of Investment

The Fund will purchase, together with any syndicated investors, (collectively the "Investors"), common shares (the "Shares") at a price of $* per Share. The total round for all Investors will be $* of which the Fund will invest $* to acquire a total of * Shares. So long as the Investors hold their Shares and until a liquidity event, they shall have the right to exchange them for the same kind and class of securities issued by the Company (the "New Securities") in any follow on financings should such New Securities have rights superior to the Shares. The Investment will be made pursuant to an Investment Agreement made between the Investors, the Company and certain of its principals (the "Principals"). The capital structure on closing will be as described in the attached Share Register.

Board of Directors

The Fund believes that early stage investments need strong mentoring and governance provided by a high quality, engaged Board. On the completion of the investment, the Board will be comprised as follows:

• a total of five members, being the CEO, one nominee of the Fund and three nominees independent of management that the Company and the Fund agree on; and
• each director must have made a meaningful investment in the Company.

Share and Option Vesting

The Fund believes that it is important that the Principals' interests align with the Investors. In this regard the parties agree that all stock options and all nominally priced previously issued shares will vest on the following basis:

• 50% of the shares will vest daily and linearly over a three year period; and
• the other 50% will not vest unless and until there is a sale of the Company.

All share and option vesting will accelerate on a sale of the Company. An Escrow Agreement will be entered into to provide for the vesting.

Liquidity Event

To ensure that a return can be provided to all of the Company's shareholders when an opportunity presents itself to sell the Company, the Fund will require a "drag-along" right be added to the Company's constating documents to allow the holders of 51% of the issued shares of the Company to cause the sale of all of the shares of the Company.

Reporting to Shareholders

The company will send a CEO Update monthly to all shareholders. Financial statements are also available upon request.

Investor Rights

Investors have the right of first refusal to participate in future financings.

Any changes to the capital structure, new shares, options or debt requires the approval of the majority of the investors in this round.

General

The Company will pay the legal costs of the Fund not to exceed $6,500, plus taxes and disbursements thereon. The Company will keep confidential this Term Sheet and all discussions with the Fund for a period of two years.

Binding Nature

This Term Sheet will terminate on *[date], unless terminated earlier by the Fund. The Company will not seek alternate financing unless and until this Term Sheet has terminated or been terminated by the Fund. The confidentiality provisions will survive termination of this Term Sheet. Acknowledged and agreed to by the Company and by the Fund this * day of *, 200* by: [Signatures]

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Yes! That is all of it!

Comments will be greatly appreciated.

Marco Messina

How to P... off an angel

I considered holding this post off.  Then I realized that my raw response to the circumstance that originated it may be a useful component of the lesson.

Background
Last week I met a college student intent in starting a new business and looking for help financing and marketing his venture. Admittedly I am a deal junky and cannot resist helping a startup along; here is the result.

Anatomy of a (lost?) deal
The young man I first met (P1) seemed quick thinking (+), amiable (+), articulate (+) and entrepreneurially flexible and opportunistic (+)
At our first meeting he gave me no means to contact him (-) but he followed up and contacted me (+) [if you want to appear like you can play, at least get some $5-precut-forms-inkjet-home-printed business card]
The business idea may have legs (+)
I have a lead into a potential customer and stated so (+)
The prospect, on my recommendation, may be willing to pay for a pilot test (+)
I asked for a follow up meeting specifying what  I needed for my due diligence before pitching their deal to my prospect.  To T-up the meeting I emailed that: i) I'd be willing to sign an NDA, ii) I need to know material costs to figure the financial commitment required to do a pilot (particularly if I and friends are to be angels), iii) I need to satisfy myself that there is a really working system capable of doing what is proposed, before I go put my good name on the line.
The meeting was scheduled but no information requested was sent ahead of time (-)
At the meeting I met Partner #2 (P2)
P2 from the outset displayed a surly and arrogant attitude apparently intent to require my demonstration of why I should be granted an audience (-)
P2 barely introduced himself [another one with no business cards] and gave no additional details about himself or his experience (-)
P2 pointedly asked whether I had a resume to demonstrate I deserved any attention (-)
P2 shoved in front of me an NDA of 4 pages (filled by hand with the company name), folded open to the signature page requesting I sign (apparently without reading it) before we continued (-)
After a few years experience with hyper-self-important student entrepreneurs, this was not a total surprise. Rewind to 1973 and probably there go I. I declined signing an NDA I could not review for lack of time. I proposed to limit the conversation to information not requiring NDA.
As expected, I got none of the information I sought (-)
P1 tried to mend fences offering whatever information he could without agitating P2 (+)
P2 spoke in roundabout ways of their IP, yet unfiled, unsearched, unsubstantiated (-)
At first sight P2 has little sense that his "idea" is unlikely to be defensible from competition (-), particularly because all components of hardware and software are readily commercially available (-) and the idea was already published by many including Steve Wosniak five or six years ago (-)
Speed to market is their ace, P1 gets it (+) P2 doesn't (-)

Conclusion
The odds that I will find the time and motivation to try again have dropped by 90% (-)

Lesson to be  learned
Angels invest in people first.
Beware the partners you have and display in public.  In a single session they can trash whatever you had carefully T'd-up.  For student entrepreneurs there will be many more chances. Later in the career path you may be betting the house on a losing hand.

Marco Messina

Talking to Angels - The Executive Summary

I said it many times in these posts, but it is worth repeating. If you want to communicate to Angel Investors, your challenge is to be brief and exciting at the same time.  Angels read dozens of plans and pitches a week, thus develop a short fuse stretched to its limit and a deja vu mindset. Every single word you use should be valued as an opportunity to break that fuse and lose your audience.  Furthermore, the specific words used must strike a balance between creating "excitement, belief, opportunity-to-change-the-world,  high expected returns" and projecting a perspective of "naive, smoke-and-mirrors, improbable deal, too-good-to-be-true".
Angelsoft is the software most angel groups now use to manage deal flow, presentations, investors collaboration, etc. They developed a great template for an executive summary. If you apply to present to a group that uses Angelsoft you'll end up supplying information in that format.
The same template, however is great for writing your executive summary of any deal regardless if presented to an angel group.  Here it is

Learn from The Master

How to pitch to today's angels

Serial tech entrepreneur and renowned angel investor David S. Rose talks about the growth of angel investing, and offers advice on how to successfully pitch to potential investors

More "Talking to Angels" - The PowerPoint Slides

In a prior post Talking to Angels  I described the guidelines the Arizona Angels recommend to produce PowerPoint slides for presentations to our screening committee and members.  Since then I've been asked to provide concrete examples.  Unfortunately most presentations are confidential and cannot be published here.  Therefore I prepared a presentation for a fictitious company, albeit a little tongue in cheek, to provide the desired example.  I hope it helps.

Marco Messina

The Myth of The Outsider

Innovators are by nature curious people with a strong desire to improve the world around them.  Upon encountering a problem, an inconvenience, or a task too cumbersome, instinctively they seek to find a remedy for it.  That drive has been at the foundation of innovation since the invention of the wheel, the first disruptive technology shaped by man (fire and stone tools were not invented, were "found" and nurtured).

Since then, innovators have nurtured the romantic idea that a single bright mind can find an answer to a vexing need and be recognized (financially or otherwise) for it.  Over the centuries it has certainly occurred, but in modern day, that notion may not hold as well. I lost count of the many ventures I have seen presented whose business plan calls for commercializing  Joe-Invenor's "idea or solution" the viability of which has was vetted only by Joe's friends and other supporters devoid of domain knowledge and experience.

Indeed, "people from outside the industry" have, occasionally, succeeded in seeing solutions insiders did not, but I believe those were the exceptions, or, more often, that conclusion was reached with incomplete information.  For instance, in the popular culture many believe the myth of: "bright college drop out (Bill Gates) develops a computer operating system that mighty IBM could not, thereby creating a bright new world".  The reality, however, is that Gates, due to a most unlikely coincidence, had over 10,000 hours of programming experience before going to college, was indeed very bright, and dropped out to make a microcomputer version of a programming language (BASIC) previously developed by others when Gates was 9, not an operating system.  The staggering success that followed came thanks to a lot of hard work to be sure, but also more coincidences, personal and family connections, quick thinking and, in the end, the wisdom of assembling a team with the brightest industry experts. IBM conversely had all the resources and talents to make their own solution, but simply chose the buy vs. make route. Due to more coincidences it unwittingly helped a major competitor to be born. A similar review would correct the popular myths on the birth of Google or Netscape or Apple and others.

If we dig deep enough for details, there are very few demonstrable cases of successful innovation by an "outsider" blessed with "new eyes" vision. Invention is another matter since invention (including a patent) requires only a "novel idea" with no consideration to any practical implementation potential, let alone actual implementation.  The world is covered with ideas. Most do not see even an attempt at implementation because that requires hard work well beyond "imagineering". A few ideas see implementation only to die early for lack of  practical underpinnings, or of a value proposition that moves customers to act (these are the solutions in search of a problem).

Today, innovations cannot stand alone.  They have to integrate in a complex web of interfaces, other products, services, regulations, business processes, cultures, vested interests, user habits, etc.  On its own each "new idea" may be commendable, but, if its implementation requires changing the world all around it, it is probably dead on arrival.  The same goes for creating new standards or modifying existing ones.

New eyes may appear to see new solutions, but, often, only because they do not see the reasons why the new idea cannot interface well enough with the reality around it.  The only fix for that blind spot is to bring into the team the best domain experts available.

Experts are those that through practice had the opportunity to learn all the interfaces required for any system component to fit its ecosystem. Often they will show why "it" won't work.  I those cases, be grateful: avoiding wasted time, which is even more important than avoiding wasted money.  In the best cases the domain expert may suggest modifying the "new idea" and make it possible to be more than a flash in the pan.

Inventiveness creates ideas.  Innovation creates results through inventiveness checked by practicality.  Beware the single minded genius, particularly yourself.

Whether the entrepreneur or the an angel investor doing due diligence, involve domain experts if you are an outsider. It will lower your risk.

Marco Messina

Be Mindful Of Your Audience

Entrepreneurs must be able to SELL. Selling, of course, involves all the steps leading to closing a deal such as: understanding the customer's need, presenting a solution, explaining features and benefits, articulating a value proposition, etc. Most entrepreneurs become quite skilled at selling their products and services.
Raising financing for the business, however, involves selling the idea and future prospects of the business to investors.  The entrepreneur must sell a small piece of the company to outsiders to finance its growth.  The process is similar, not the same and angel investors routinely confront skillful business owners who do a poor job of selling the investment deal.Why?  I believe this happens because most often the seller is not mindful of his/her audience.

Let's look at the parameters of  two "Acts" that occur in the "Play" of business building and financing:

Act 1:  Entrepreneur E is pitching Product/service P to prospective Customer C

E understands C's problem well
C understands well and is painfully aware of his problem
C appreciates the difficulty of solving the problem (it is yet fully or partly unsolved)
E has put a lot of time, effort and creativity to find his proposed solution
E is particularly proud of the obstacles encountered and overcome along the way to create the solution being proposed, and explains them in detail to C who is interested in and understands the details and is impressed by E's competence
C is looking for reliable continuing long term performance and support in the solution he buys
E  promises to be around forever to service C's needs in a continuing relationship

Note: Over time Act 1 is repeated regularly, frequently and profitably thereby creating a practiced habit which makes its performance easy and almost automatic.

Eventually when financing is needed to grow the business the Entrepreneur must perform in a new Act with little or no prior practice as follows:

Act 2 - Entrepreneur E  pitches Business B to Investor Group IG

IG need a vehicle to invest their cash at as good a return as they can find
IG decided that buying a piece of a good business (B ?) run by a good operator (E ?) will give them good returns

IG, looking at business B,  are focused on: how fast it will scale, how profitable it is, or will be, and how fast they get their money back, and how many times over

IG, in the first presentation, do not have,  individually, the technical competence to assess or are interested in the minute details of business B's products
E is expected to make his pitch to address the interests of IG.

E instead remains true to his well practiced past presentations:
E focuses on product minutiae that go right over IG's head - IG is confused and bored
E demonstrates his creativity by the complexity of the solution and all the things that went or could go wrong with it, that E had to master - IG is scared by complexities as opportunities to lose money
E is proud of his business plan to create a business that will grow, change the world and last forever - IG see their investment locked inside a business, never to be returned

This performance becomes the concluding Act of a "Tragedy of missed opportunities". Missed opportunities for both the Entrepreneur who gets no funding and for the Investors who were bored and scared away from a business that possibly had real potential.

The fix is for the Entrepreneur to learn about the Investors audience as diligently as he learned about his customers.  Then speak to them on their own terms:

• KISS - make complexity simple and brief (Elevator Speech and One Page Summary)
• The company is the object of the pitch not the products - Investors assume the products work, at least in the first presentation.
• Scalability is the key to big ROI - Convince, why it is possible and likely
• Specific parameters of  profitability and scalability yield ROI and return multiples that interest angel investors  Few types of businesses can do it (see AngelCalc post) at the right size of investment, do not waste your time otherwise.
• Business does not happen, a team (more than a founder) makes it happen.  Sell the team, have a team that can be sold, evolve the team it if necessary.
• If there is no competition, you have not found it yet. Even if true, doing nothing is always an alternative.  Investors are afraid of competition that has not yet been identified, so should you. 
• Investors love simple solutions to serious painful immediate problems, are leery of solutions in search of a problem and markets needing years of gestation, or of new standards to be created to coerce the world to do it your way.

Mostly, practice KISS: know your audience, speak to them on their terms.

Marco Messina

Patents - What do they mean to you?

If you are interested in this subject you probably fit one of the following classes:

1. You are an expert angel investor with IP due diligence experience - your comments would be most welcome.
2. You are a potential or new angel investor (bless you for helping to grow our country). In this case you might be interested in one (mine) practical view of what protection a patent gives you.
3. You are an entrepreneur that could use some financial help to get your invention (IP) to market (bless you for helping to grow our country too). In this case, you should know what questions to expect from your angel investor and have good answers.

This post attempts to share, for the benefit of the last two groups, my experiences over twenty-five years as an inventor, patent holder, investor in technology ventures, an acquirer of intellectual property (IP), licensor of IP, entrepreneur commercializing my own or someone else's IP. If you want legal opinions or legal advice on this, call your attorneys. If they are IP specialists they'll have legal details and perspective far more reliable than mine. However, beware: because they are so familiar with the domain, they will often presume that you understand the nuances of IP legal protection principles and legal practice, not necessarily the practical aspects of it, which is what I am focusing on here. Mine is a "business" view of patents, not a "legal" view and therefore focuses on what is practical not only what is legally rightful.

What does a US patent give the inventor?
In simple terms, the RECOGNITION by the US government that he/she is PRESUMABLY the inventor of a certain concept, product or process and therefore has the EXCLUSIVE RIGHT to practice the invention for a certain period of time (e.g. 17 years) without competition. Note that contrary to public perception it does not give the inventor any real protection (with one exception) unless (s)he takes steps to enforce that right. The exception is that the Customs Office will do their best to stop an infringing product from entering the US if they are provided with a suitable request, documentation and proof of patent infringement. Otherwise, the inventor is solely responsible to enforce his patent rights, which implies taking legal action against an infringer generally at some considerable protracted cost.

Against the above background then a number of questions arise:

Can one afford to sue the infringer?
Practically speaking, only if the practice of the invention has a cash flow worth protecting in an amount that covers the expenses, distraction, aggravation, etc. associated with a litigation. Winning the case may not produce cash flow or a significant pay off; it may produce only an injunction against the infringer, which by the way does not preclude another one from coming along.

What if in the course of litigation one discovers that other aspects of the product infringe on patents held by the infringer or someone else?
This is very common in the electronics industry where frequently patents have great value to counter-sue and eventually settle by reciprocal licensing. Much of this jousting is now going on and reported in the press involving Apple and their iPad against various competitors among which only one (the smallest and weakest) was actually sued for infringement. In these cases there may only be legal expenses and the benefit of upsetting a competitor's product development road map.

If one has a validly issued patent, how much protection does it provide?
Better than none to be sure, but hardly a guarantee. The case of RIM (Research In Motion), makers of the Blackberry, is very instructive (details): It started in 2000 when RIM was a startup with strong beliefs that their issued patents covered their products well. After a surprising chain of events, by 2006 they settled for $650 million with NTP (plaintiff) after a court injunction forced the Blackberry network dark for one day (RIM by then had a $2 billion business at risk of going dark worldwide, hardly a desirable bargaining position). Since 2006 and continuing to this date "patent reexamination" action by RIM has sought to void NTP's prior art claims; NTP is responding in kind. One can hardly imagine the costs involved (at $500 or more per hour). Needless to say RIM investors had been confident of their IP position and of the issued patents. Conclusion: even ISSUED patents are no guarantee since prior art can be submitted at any time and re-examination requested.

Is a patent much ado about nothing?
Definitely not. A Provisional Patent filing, if properly written and searched, tells potential investors that there may be more than just an idea. It says that the company and the inventor understand the IP implications of their business and have invested time and money to protect their innovation. If a patent is issued, it tells investors that a pretty solid stake is in the ground that proves innovation, at least from a theoretical and PTO standpoint. If potential competitors exist, they are obviously not easy to find and on the time-line may be behind the current inventor and therefore not innovators in the PTO sense. Of course they could still come out later with proof of "prior art" and open the RIM type can of worms.

It should be noted that claiming infringement while holding an issued patent has risk. The "infringer" may turn up to have prior art and that may invalidate the patent. To wit, I had occasion of working with a small manufacturer who was an outstanding and recognized innovator but never filed a patent. He explained that, not being interested in having investors or selling the company, patents to him were a cost and of no value. His strategy was to practice whatever innovative process he devised without fear. If anyone came to try and stop him he depended on his meticulously documented prior art files from many years back to trump the action. Furthermore he had no interest in licensing his own inventions and felt that since issued patents files are open to the public, they are more risky than helpful unless one deals with fundamental inventions. By those strategies, his company never grew to dominate his markets, but he was happy with his lifestyle company; my lesson was to beware that prior art occasionally may come out only when one "kicks the beehive".

Why uncertainty cannot be eliminated
In the US the PTO operates on the doctrine of "first to invent". This means that anyone can come and claim to be THE inventor of anything if he can show with a preponderance of evidence prior art precedent to that of any patent filed. If a patent had been issued, reexamination is the cure. Documentary proof of prior art can be from most kind of documents, preferably lab books (numbered non-removable pages), dated and witnessed affidavits, etc. Elsewhere in the world the "first to file" rule is followed therefore it is imperative to not delay a viable filing and one can depend on the value of an issued patent to a greater degree.  Even there a patent can be contested with suitable evidence that the prior art was "published" and therefore in the public domain prior to the filing of the issued patent. Demonstrations of preponderance of evidence of prior art are not easy to do, so an issued patent is still a strong stake in the ground, but...


Conclusion
Beware: from a business viewpoint, the value of a patent is not an absolute one. It depends on the circumstances of the business, the market, the product, the objectives of the inventor, the objectives of investors and many other factors. Deciding to file a patent (the inventor) or to assign a value to a patent (the investor) is a problem without an optimal solution. Clear understanding of options, implications and trade offs is the best one can achieve in reaching an entirely subjective decision.
My "Should I get a patent" Roadmap may help with that analysis. Read more about my Roadmaps

By the way for my own IP I still file patents, but I am cognizant of how thin the ice is that I stand on.  If I cannot justify a costly fight to defend it, my patent is not more than a feather in my cap.

Marco Messina

Talking to Angels (angel investors, that is)

We all have angels of one kind or another. As a Tech-preneurs you have at least one kind you may wish to talk to ("pitch to" in the parlance of the angel investing community). The good news is that to learn to talk to those angels you do not need to retire to Nepal spinning prayer wheels or to Rome chanting psalms in Latin for years.
Angel investors are easy to "pitch" if you understand some basic rules:  Like all angels they are in high demand, hear requests for help almost continuously so they develop a short fuse.  Your "prayers" better be short and to the point, present facts clearly, use facts to support your claims and plans rigorously so that they are more than hopes.  Most importantly remeber that this "business" type of angels respond primarily to credible promises of significant rewards in return for their help.  Emphasis is on credible and significant.  It's that simple and we'll see how to "talk" to them in their language later on.

Angels, like all beings run in packs and cluster in places, so they are easy to find.  Universities, business schools, departments of commerce and other entrepreneurs, all know where to find them. In Arizona, this is your path to the Arizona Angels Venture Group of which I am part along with the Thunderbird Venture Fund, ATIF (Arizona Technoligy Investor Forum), the MIT Enterprise Forum, ASU Technopolis Invest Southwest Capital Conference.

Once you find them, follow carefully their instructions (rember the short fuse) on how to make contact and how to present your case.  Most often their rules are clearly published in their web sites.  For the above groups that I am familiar with, below are guidelines on how to present.

To avoid wasting your time, however, understand clearly what kinds of businesses stand any chance (see how).  If you don't fit their expectations, save the effort and frustration and find another route to get your business into the INC500. There are other alternatives, some published in my blog (e.g. SBIR grants, etc.)

Guidelines for Companies Presenting to Arizona Angels Venture Group
PowerPoint Presentations

General Guidelines

• Presenter must be the CEO.
• Presenter remains at podium throughout presentation.
• Presenter must wear formal business attire for presentation (not required for screening committee presentation)
• Use of props or demo products is up to the company.  Realize that small items may not be visible to everyone in a large room and circulating items will be distracting from the overall presentation.
• Presenters changing their own slides is preferred. Automation or outside helpers are risky and prone to untimely failures.

Guidelines for 10 Minute Presentation

• Presentation must be 10 minutes or less, NOT more..
• Must be in Powerpoint 2003 or 2007 versions with no extra software for animations. (animations are uncontrollable, risky and not recommended)
• 10 to 15 substantive slides for presentation (excluding cover page and thank you/Q&A)
• The 10 slides below are required for the Arizona Angels screening panel presentation and strongly recommended (few more if you must) for the full presentation.

1. Statement of the problem

• This should identify the customer pain and the Company's solution for that pain.

2. Product or Service Description.

• This should be a balance of information that gets the essential product/service idea across
•  If the product/service falls within a recognized category, it is generally useful to identify that category.
• Include proprietary protection, if that is applicable (e.g., patent owned or applied for).
• Recommended: 2 minutes out of 10 of total presentation. A common mistake is to get stuck on ths overmuch.

3. Current Status Description (with historical information, if relevant).

• Give a brief picture of where the Company is with relevant information (number of employees, development stage, early revenue, number of customers, etc.). 
• Include historical information if it is helpful to understanding the current stage.

4. Description and Sizing of the Target Market.

• This is one of the most important slides, because the investors will use it to determine if they have any interest in even thinking about the Company.
• Their interest depends upon whether they think the market for these products and services is big enough to support the growth of the Company into a big company.
• The information should be as pertinent to the Company as possible (i.e. the market information should relate to the market for these products and services and not a larger market of which these are a subset.). To the extent possible, use third party information (e.g., Gartner's, or IDC). If third party info is not available, make educated guesses, and indicate that the info is Company estimated.

5. Business Model (how we make money).

• This also is extremely important. The investors want and need to understand how the Company makes money (e.g., licensing model, service offering, whether there is recurring revenue, etc.).
• The Company’s "go to market" strategy: how it plans to manufacture, sell, distribute, support (e.g., distribution model—direct or indirect; partnering; go it alone; brand play for penetration; etc.).
• How soon will it make money with that strategy? Until then the cash-burn-rate will work to kill the venture.
• Common mistake is to be unclear either in the mind of the entrepreneur or in the explanation to the audience or both.

6. Competition.

•  Identify who the Company's top competitors are and how the Company's believes it is positioned to successfully meet that competition.
• Remember: a. doing nothing is always an option if there is no compelling reason to act,  b. the company with no competition does not exist
• What is the company sustainable competitive advantage against competitors.
• Barriers to entry?

7. Management Team Slide.

• This is a very important slide. It should highlight relevant domain knowledge of the team and prior experience as a team. This is not a resume, do not over do the slide. MUST BE LEGIBLE
• Advisory Board: valuable are domain experts and members with key industry contacts to open doors and willing to do so.

8. Historical and Projected Financial Data (1-2 actual, 5 year projected P&L).

• Don't be too granular. Include current financials. Generally, all that is needed are Revenues Gross Margin, Expenses, EBITA, cash burn. More at your risk – MUST BE EASILY LEGIBLE.
• Identify key assumptions orally.
• The information should summarize (and be consistent with) the Company's underlying detailed plan.

9. Amount of Investment Funds Sought; Use of Proceeds.

• Generally, this is a simple slide showing planned use of the money by 4 or 5 categories, and total being sought.
• Call out unusual uses, such as for an acquisition, paying off loans, buying a building or expensive production/test/laboratory equipment.
• Your proposed pre-money valuation. Articulate why you think is justified.
• State if more raises will be necessary before exit 

10. Most likely way to exit and rationale for expected valuation

• Do the math for the investor. How many times their investment will they get back, what ROI
• Restate why it is believable (IP, team, experience, market dominance, market growth)
• How have you covered the downside risk

General Guidelines

• The presenter/team determine the order of the slides, and if more than the above are necessary to tell the story then use them, but experience shows: (a) the fewer the better, and (b) more than 15 total slides is not likely to work well.
• The openingtitle slide and last (Thank you/Q&A) do not count.. The 10 minutes time limit begins when the CEO begins his/her presentation.

Some Insights and Caveats from Experience

• Investors respond to a compelling story of a serious need for which you have a (nearl) unique and practical solution that will deliver strong market position or dominance that justifies your projections of fast growth and ROI that lead to a successful exit where you AND the investors cash out of the deal.
• Stay focused on your target audience and be courteous to a fault. Help everyone understand why you are excited about what your company is doing and how it will impact the world. Do not “dumb” your presentation down.
• Communicating is YOUR responsibility, the audience owes you no duty to easily or quickly understand any of it, but they have the funding you seek.
• There are potentially only a few people in the audience who may be deeply familiar with the technology and the competitive landscape in the area you are addressing. They are your most likely investors and it is most critical that you convince them that you are on the cutting edge of the market and/or technology.
• Keep the slides as simple as possible; cluttering is distracting, and investors are quick to be distracted. When busy reading or making sense they tune you out. Font size must be readable from the last row. That translates to about 3-4 bullets per slide, about 8-10 words max per bullet. Less is better (see http://bit.ly/pp10-20-30)
• Use graphics carefully, strategically and sparingly. If they do not communicate better than word or numbers, they are distracting (e.g. pie charts with too many undistinguishable slices are useless). Make the numbers and elements of graphs readable or skip them

Now that you have the roadmap, qualify your business for fitness to the angels' criteria (see how) and go angel hunting (begging is more like it).  Good luck, and ask for help, many angels are passionate about helping you succeed.

Calculating with Angels - Angelcalc

Do you know when your young business venture is "fit" to attract angel investor financing?

There are many theories and rules of thumb being bandied around about how angels seek their targets. The reality is that angel investors can be roughly divided in two groups, each with dramatically different decision making processes (and ROIs).

"Golf Cart Investors"

These are the ones who buy into a deal on a hot tip, topically received by a buddy on the golf course. Most often the buddy has done little or no due diligence, has little or no knowledge of the industry and technology involved, and has received the supposedly hot inside information from another buddy in similar fashion.

These angels are dangerous to your and your business' health. They invest with virtually no understanding of the deal, have unjustified expectations and eventually will prove to have little or no patience to wait for the business to succeed. Their returns are almost inevitably negative and most often they will do no more than one or two deals before they go back to golfing only. Unfortunately they will tell others that angel investing is a crap shoot and waste of money, thus limiting startup capital availability in the community.

"Professional Angels"

These are the real Angels entrepreneurs want to work with. Frequently they work in groups so that they can share the heavy burden of due diligence research required and they bring to their side of the table scientists, engineers and management experts in different industries and technologies. They will ask a lot of questions and then more questions and then proof and supporting documentation. They will not move fast but will cover their bases well. When they invest they will stay involved and help with seasoned advice and working their contacts to help the business succeed. These are true ANGELS.

Research by the Kaufman Foundation shows that their returns are on average quite attractive (2.6 times their investment in 3.5 years). On the other hand, a rule of thumb often quoted is that these angels consider a deal if they see a potential to earn 30 times their investment in about 5 years. These two seemingly conflicting perspectives are reconciled if one presumes that the probability of success of a well researched deal is only about 10-12%. From experience I believe that it is a reasonable and not overly pessimistic expectation considering that the typical business that fits angel investors has many or all of these characteristics: Little or no sales, limited proof of market, may have lab tested technology, but little or no production, no proof of scalability, delivery, distribution experience. Moreover, all of the following may aply: in some other garage a similar or better mousetrap may be ready to come to market, the management team may have or may develop unforeseeable weaknesses (from sociopathy leading to financial embezlement to personality incompatibilites to love affairs - I've seen them all as causes of aborted successful businesses); "effective" IP protection may prove difficult to obtain or worse may be revoked when prior art appears unexpectedly (see the post about patents and RIM's adventure), government regulations may prevent or delay market acceptance, unforeseen and totally unrelated vested interests may create insurmountable barriers to market acceptance. All considered the 10-12% probability may even be high, but it appears to be what angels use implicitly if not explicitly.

So, with all this in mind, below is AngelCalc (copyright Marco Messina 2007-2010). Its intent is to help you determine if your business has sufficiently high growth and profitability potential in an industry with sufficiently high PEs to satisfy the requirements of the Pro Angels. Services, generally are unlikely to qualify unless they have a unique IP component and market dominance potential. If your business cannot meet the angels' criteria, your funding efforts will be better put elsewhere. F&F (friends and family) may be an alternative at least until the criteria may be met.


Calculating with AngelsThis model attempts to explain the finance-ability of a business based on angel investors' required returns.

Its objective is not to set a valuation. It seeks to determine whether the relationship among the following factors allows a viable solution that meets investors criteria.

The factors for a P/E-Multiple based calculation (as for a public company) are:

1.  time horizon is 5 yrs, 
2.  future EBITA,
3.  future PE and market cap (from current comparables),
4.  investor's average returns and required return,
5.  the ASK needed to implement the plan
6.  The % equity to give up for the ASK

 The factors for a valuation based on revenue multiple (e.g. selling the company) are:

1.  Time horizon is 5 years
2.  Revenues in year 5
3.  Applicable multiplier for comparable companies sold

With both valuation methods the implied probability of success is 12% because it reconciles the return multiple identified by the Kaufman Foundation research (2.6 times return in 3.5 years) with the rule of thumb often quoted of "30 times the investment".

See input instructions above

Questons or comments? I'd love to hear from you, particulalry if you disagree.

Good luck. May you be so lucky to find a real ANGEL.

Marco Messina
The Angel Pitch Guy