A few weeks ago at the Arizona Angel Investor Conference in Phoenix, Pat Sullivan, co-founder of software success story ACT!, and John Purtell, one of his financial backers, reenacted a negotiating session that took place between them back in 1986. The reenactment demonstrated to the would-be entrepreneurs in the audience how their own negotiations might unfold.
At key points, Purtell, the investor, had to correct himself. He recalled that during the negotiations he had insisted on two investor seats on the ACT! board of directors. "Today, you wouldn't do that," he explained. "You wouldn't want to be on a board without the right insurance."
When the discussion turned to the stock ACT! would issue to the angel investors, Purtell made another correction. At the time, his group took common stock, he recalled. "Today the investors would want preferred stock" to provide more protection in case the investment soured.
Those kinds of corrections were, in many respects, more instructive than the actual negotiations about the pre-money and post-money valuations between Sullivan and Purtell. Since the ACT! deal was negotiated 18 years ago, so-called angel investments have become less angel-like and more venture-capital-like.
Many angels took big hits after 2000 as Internet-related businesses crashed and burned. For investments that survived the carnage associated with the Nasdaq decline, more problems surfaced when the entrepreneurs and their angels sought venture capital to finance additional growth. The VCs routinely insisted on "down round" -- valuations lower than what the angels had originally accepted. All of this prompted angels to organize themselves and seek out more legal protections, the kind that have long been standard for VCs.
The transformation of the angel community is quite radical, historically speaking. William Wetzel, a retired University of New Hampshire business professor and the first academic to seriously research angel investing, used to bemoan in his research studies the difficulty entrepreneurs faced in finding angel investors. They tended to be lone rangers, or else they just invested with a few close friends or colleagues.
Today's angels organize themselves into local investor groups, which meet every few weeks or months to discuss opportunities and listen to presentations from promising entrepreneurs. Some of these groups even have part- or full-time executive directors who sift through candidates on behalf of the money guys (and gals). About 200 of these organizations are scattered around the U.S. and Canada, and they even have a trade organization, the Angel Capital Assn. (www.angelcapitalassociation.org).
Angels also have big bucks behind them. Whereas in the 1980s they typically invested $50,000 to $100,000, today's angel investment is more on the order of $500,000 up to $1 million. Moreover, instead of bowing out in favor of venture capitalists for follow-up rounds, angels increasingly hang around to make second-round investments. The Angel Capital Assn. crowed in a news release last summer that a 2004 survey listed three of its members among the top venture-capital firms in the U.S.
Recent research by William Wetzel's successors at UNH indicates that 225,000 angel investors committed $22.5 billion to 48,000 ventures in 2004. That's roughly equal to what venture capitalists invested during the same year, according to data from the The MoneyTree Survey, a collaboration between PricewaterhouseCoopers, Thomson Venture Economics, and the National Venture Capital Assn.
The local angel groups often pool the funds of their investors, much like venture capitalists. Increasingly, it's the "herd approach" that determines whether investments are made, rather than an individual investor deciding to take a flyer on an intriguing new company.
For early-stage entrepreneurs seeking financing, the transformation of angel investors to more closely resemble venture capitalists has important implications. First and most important, the days of informality and deals done on a handshake are over.
Entrepreneurs need to approach angels much as they would approach venture capitalists. That means being prepared with a sharp presentation that highlights the venture's opportunities and risks, along with supporting documentation, including a summary business plan, financial projections, and background information about members of the management team.
The new reality also means that entrepreneurs who attract angels' attention should be prepared with legal support. Angel investors will demand preferred stock, along with other "preferences," such as veto power over certain managerial hiring and firing. So entrepreneurs need to be ready to negotiate the finer points of financing deals that would normally not have come up unless and until they sought out venture capital.
Finally, today's angel investing means entrepreneurs seeking smaller amounts of money -- say $100,000 or $200,000 -- will encounter more difficulty than those raising $500,000 or more. Like venture capitalists before them, angels are moving up the financial food chain. Increasingly, they seek companies that are more established and less risky -- and the earliest-stage companies tend to be the riskiest. It's enough to make one long for the good old days.