Beware Of Angel Investors Who Aren't
Posted by Pierre de la Fortune on April 13, 2015 @ 12:01 a.m.
Written by Brad Feld and David Cohen
Theyíre looking for startups that they can jump on board with, either as an employee or consultant. Or they are there to meet rich people, drink wine, and eat tiny sandwiches. Finally, theyíre often there to preside over cute little startups that ask them for money. As a special bonus, they get to have a good laugh afterward.
Do I sound jaded? I draw on direct experience. When I first started angel investing, I quite naturally joined the local angel group in my city. Iíd estimate that 95 percent of the members of the group had done at most one angel investment in their entire lives and many had never done any. I quickly figured out that I could generate much more interesting deal flow by getting to know other real angel investors and by creating my own independent brand and visibility. It turns out that strong entrepreneurs are pretty good at finding people who actually make angel investments. And it seems to me that people who donít actually make angel investments, but tell the world they do, arenít really serious about it.
Adverse selection was plainly evident to me in the angel group meetings I attended because the companies that were pitching typically had been unsuccessful at raising money from committed and professional angel investors. While there were a few exceptions, these companies already had some momentum with their financings and were looking for a few more investors to help them finish up their round.
After talking to a number of other active angel investors, I determined that while there were a few excellent angel groups, most of them were full of fake angel investors. These fake angels are unlikely to fund your company. Thereís also a second class of angel investors who really arenít. They are the unscrupulous types that often use egregious tactics and terms.
One example that I seem to encounter over and over again is the bait-and-switch angel investor. Heís usually got an interesting background and it seems like he might have a pile of cash to invest. The story goes something like this. He offers to put together a half-million dollar round for you. Heís committing a hundred thousand dollars! So far, so good. However, once the round starts coming together, he starts backing off his personal investment (usually all the way down to zero) and instead rides the momentum into a job. Instead of investing, heíll become the CEO or chairman, and will take a bunch of equity to boot.
Unbeknownst to you, this supposed angel investor is running this same game with as many interesting (and struggling!) startups as he can until he finds one that people actually want to invest in. Bingoóthe bait-and-switch angel investor just landed a year or two of guaranteed salary and a bunch of equity on the backs of bright young entrepreneurs overly desperate to raise a round.
Then thereís the term driver. This type of angel investor is going to drive a hard bargain. Theyíre going to put in $50,000 and spark the round for you. They just ultimately want about 75 percent of the company to do it. They simply donít get it and are hunting for suckers. Youíre not a sucker, but youíre still going to spend months with this person if youíre not careful. The cost to you is going to be measured in time.
There are a handful of very straightforward tactics to making sure youíre dealing with a legitimate angel investor. First, ask the prospective investor how long he has been making angel investments, how many he has made, and how much he typically invests each time. If you get dodgy answers, or fundamentally tiny ones such as ďIíve done one angel investment in the last seventeen years,Ē beware. Donít proceed with any other questions until you have this answer.
If an angel investor says he is just getting into making angel investments, this should set off your Spidey sense. In this case, do your homework and start checking highly trusted references that you source yourself. Check with known reputable angel investors and local venture capitalists on both the person and the companies he has been involved in to get a sense of how real the prospective investor is. Research his backgroundóis he really likely to have the type of money necessary to make angel investments?
If your prospective investor says heís been investing for a year or more, ask him to introduce you to two companies he has invested in during the last year. If he canít name two in the past year, then ask him for the last three he has invested in. If there arenít three, recognize that this person is at best investing as a hobbyist and has very limited experience doing so. Now call or e-mail all three companies and ask to speak to the founders. Verify that the person actually invested dollars in that company. Check the reference while youíre at it and ask if they were helpful to the company or not.
None of these questions or tactics will be offensive to real angel investors. In fact, they will give the real ones more confidence in you. These tactics might offend the fake ones, driving them away. Recognize that thatís just fine.
Beware of angel investors who arenít. Theyíll put you through endless diligence, play bait-and-switch with your financing, and generally waste your time.
For more info please visit: http://www.businessinsider.com/book-excerpt-do-more-faster-2011-3
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