Angel Investment Journal - Angel Investing and Entrepreneur Blog

I was at InvestMidwest this week and saw some really exciting companies. I was impressed by the presentations and it seems many of the presenters were either coached on what their presentation should include or they just intelligent entrepreneurs that knew what needed to be done.

Most presentations I see include one aspect that is so common it has started to frustrate me. It happens when the presenter gets to the part of the presentation about projections. They start talking about revenue projections and they present the figures, but say that they believe this projections to be “conservative”.

I don’t know why it frustrates me, but apparently I am not the only one that feels this way. Fortunately, I only heard one entrepreneur (out of 12) claim their projections were conservative. And, upon hearing this, I saw another investor look at his buddy and smile.

Why shouldn’t you use the word “conservative” when talking about your projections?

First, when coming up with projections, especially if you are a start-up, it is extremely hard to predict what you could actually do. But you should do whatever you can to support your projections. So don’t try to say you just need to get 1% of a gigantic market in order to experience huge success. Talk about what aspect of that market you expect to penetrate. But since it is so hard to predict, you probably don’t know what is conservative and what isn’t.

Second, why would an entrepreneur that is trying to “sell” the concept of his business and raise money quote conservative numbers? It is unlikely you would, so don’t try to make the projections look bigger than what you actually believe.

Finally, even if your numbers are conservative, don’t use the word “conservative”. Don’t qualify your projections at all or maybe use a different word like “realistic” if you actually believe those projections are within reach.

Will Price put together an investment checklist that he goes threw when considering an investment in a company. A great checklist for angel’s and VC’s.

This week Venture Voice has a great interview with Tom Perkins of Kleiner Perkins.

Most investors generally talk about how they prefer to invest in people over the ideas. Some claim that there are plenty of ideas out there and it is unlikely you will come across a totally unique idea. Execution is generally considered the hard part. And that is why I was surprised to hear Tom say he invests in ideas, not people. He supports his claim because, first of all, people with good ideas are generally good people. He says he is also able to build a good team to help support the company. It is hard to argue with a person with so much success in investing in companies.

He goes on to talk about building a team. He says you don’t need a good team right away. A main reason is because if you are seeking to build the best team that you can, it is unlikely the best people won’t come on right away when company is in its highest risk state. So you need to prove the company has potential and when there is less risk and a proven potential, it is easier to get successful and experienced people to lead the team.

That point does support the idea that the team is very important, but it seems Tom and his team have enough experience building companies that they can provide the assistance necessary to get the company to the point of being able to prove the potential.

The host of Venture Voice, Greg, asked Tom about their “ICU” for failing companies. Tom said they put failing companies in an ICU where the companies will either fail and they shit everything off completely or they make it out. The idea of “killing” the company completely even if there is some potential left is interesting. It reminds me of one of the central ideas behind Seth Godin’s “The Dip”. You don’t want to dedicate resources to things without a great deal of potential. You have limited resources and need to make sure you are focusing them on things with the most potential.

Hopefully you get a chance to check this podcast, I highly recommend Venture Voice and only wish it was done on a more frequent basis.

Paul Graham has an interesting post that discusses his idea on how you can determine how much equity should be given to an investor or employee. This is often a tough thing to determine for entrepreneurs, but Paul tries to simplify it. His Equity Equation can be easily explained:

If an investor wants to buy half your company, how much does that investment have to improve your average outcome for you to break even? Obviously it has to double: if you trade half your company for something that more than doubles the company’s average outcome, you’re net ahead. You have half as big a share of something worth more than twice as much.

The equation is: 1/(1 - n)

In the general case, if n is the fraction of the company you’re giving up, the deal is a good one if it makes the company worth more than 1/(1 - n).

Venture Hacks followed this up with his thoughts on the post.

He makes a few good points, but these two are great to keep in mind and explain why you can’t just use the Equity Equation to determine how much equity you should give an investor or employee.

You have to pay market rates regardless of the equity equation.

This is true. If it is absolutely necessary to get something such as an employee or money, you will have to pay market value for them, even if it is not in line with what you can justify with the equity equation. If you can’t justify it, you shouldn’t do it, but sometimes you don’t have a choice. The other option is that you may be able to get money or employees for something well below the cost of what you could justify with the equation.

Consider the opportunity cost of spending shares on employees and investors.

Just because you can get an investment at terms that will make it beneficial for you, doesn’t mean it is the best use of those limited resources. For example, you give up 30% of the company for something that will double your company. What if you could double your business by only giving up 20%? Just because an option is good for you, it doesn’t mean it is the best.

VentureHacks has a good post discussing ideas to consider when you are determining whether you should raise debt or equity for your company.

Paul Graham has a great piece called The Hacker’s Guide to Investors. He makes a lot of great points, but a very interesting point is this:

“A high valuation can be a bad thing. If you take funding at a premoney valuation of $10 million, you won’t be selling the company for 20. You’ll have to sell for over 50 for the VCs to get even a 5x return, which is low to them. More likely they’ll want you to hold out for 100. But needing to get a high price decreases the chance of getting bought at all; many companies can buy you for $10 million, but only a handful for 100. And since a startup is like a pass/fail course for the founders, what you want to optimize is your chance of a good outcome, not the percentage of the company you keep.“

In addition, a valuation that may be too high may make it difficult if you need additional funding. Mainly because the initial investors want to see that their investment has increased, so they will expect the next round to be higher. However, if you increase the valuation too much, it makes the investment less attractive to the potential investors in the next round.

Congress is discussing passing legislation that would give tax breaks for angel investments. Tax breaks are given to corporations for a variety of things and they get tax breaks for moving (or keeping) a factory in a certain city, state or even the country. But how much does keeping factory jobs in the US actually help the economy? Companies that are pursuing new ideas and innovation are things that have grown this country (and others) and encouraging that type of activity is a fantastic way to continue economic development.

Seth talks about how finding your niche is much better than attacking an entire market.

Related to this, a lot of entrepreneurs try to present to investors and say “We only need 1% of the market”. Guy says this is pretty ridiculous. First, why would anyone want to get a 1% market share? Second, how do you know 1% will be the magic number? How do you know it won’t be .1% or 5%? Entrepreneurs should do a bottom’s up forecast. Define the niche in the market you are going to target and make a forecast based upon this. Don’t say you need to capture 1% of the worldwide hat industry. Instead, say you want to capture 20% of the Church Hat market (that was a quick plug for Evetta).

Side note, isn’t it cool to be known just by your first name (like Seth and Guy).

Entrepreneurs looking to get funding for their start-up company often value their company much differently than investors. Entrepreneurs use the concept for the business (the product or service) as the driving factor behind the valuation they seek and feel they deserve. In fact, they usually think the idea is so brilliant, that they attempt to keep it top-secret and prefer not to disclose many ideas. They even like to require that investors sign an NDA (see my previous post related to investors and NDA’s).

Unlike Entrepreneurs, investors tend to place much more value on the management team. Bill Payne’s book, The Definitive Guide to Raising Money from Angels, shows the general breakdown for what he considers when valuing a start-up:

Management Team - 30%
Size of Opportunity - 25%
Product or Service - 10%
Sales Channel - 10%
Stage of Business - 10%
Other Factors - 15%

Even though this breakdown makes the percent of the valuation attributed to the product or service appear to be very minimal (10%), Bill mentions that there are other factors that are directly attributed to the product or service, such as size of the opportunity. But it is obvious that the management team of the start-up is very important. Some of the most successful companies are not a result of the initial product idea. For example, you probably know that Flickr started as an online multiplayer game. The team behind the company adapted and made it into something huge.
So just because a company has a brilliant idea or a fantastic technology, it does not support a huge valuation.

By the way, if you have not checked out Bill’s book, I would highly recommend investing the money to purchase it.

A team that is attempting to compete for the Lunar Lander X-Prize is trying to raise money by auctioning a piece of the action. The auction on eBay says that you can bid on the chance to not only sponsor the lander which they build, but you get to keep one of two crafts which will be used in the contest. In addition, you get 50% of the prize money, meaning you could win up to $675k. Via Engadget.

This is a creative and potentially successful way to help raise money for their venture. Not only does it help raise funds, but the method of raising the money can generate great publicity.