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How to Attract Venture Capital Definition of An Angel Angel Activity & Importance

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How to Attract Venture Capital

Definition of An AngelAngel Activity & Importance

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Introduction

What is an angel? (As known as: Informal investor;

private investor.)

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Introduction

What is an angel? An individual who invests his or her

own money at arm’s length in a business owned by a third party.

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Introduction

What is an angel? An individual who invests his or her

own money at arm’s length in a business owned by a third party. Not friends, family

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Introduction

What is an angel? An individual who invests his or

her own money at arm’s length in a business owned by a third party. Not friends, family

Tend to be high net worth individuals who have had previous success in business

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IntroductionWhat do angels Look Like?

Mostly males, over 50 High income & net worth Mostly successful entrepreneurs

Very limited number of lawyers, physicians, dentists

majority are business owners and former business owners

Well educated professionals or have post-graduate degree

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IntroductionMust understand the process! The venture capital industry includes many firms with substantial funds to investIt is often a challenge for an entrepreneur to tap into this vital source of financing. The venture capital process begins with an introduction to a venture capitalist.

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Venture CapitalVenture capital provides long-term, committed share capital, to help unquoted companies grow and succeed. Venture Capital is a form of "risk capital” The main sources of venture capital are venture capital firms and "business angels"

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Venture Capital Obtaining venture capital is substantially different from raising debt or a loan Lenders have a legal right to interest on a loan and repayment of the capital, irrespective of the success or failure of a business Venture capital is invested in exchange for an equity stake in the business

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Venture CapitalVenture capitalist prefer to invest in "entrepreneurial businesses" Venture capital firms usually look to retain their investment for between three and seven years or more.

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Choosing the Right AngelThe criteria for selecting the right venture capitalists to approach include: geographic area industry specialization stage of development size of investment preferences.

Also important are whether the fund will act as a lead investor and whether there are complementary or competing invested ventures within the fund’s portfolio.

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Why are Business Angels Important?

1. Money: angels provide substantial quantities of financing

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Why are Business Angels Important?

1. Money: angels provide substantial quantities of financing

2. Position: Angels invest in growing firms, in segments where so-called capital market gaps are argued to be limiting

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Why are Business Angels Important?1. Money:

angels provide substantial quantities of financing

2. Position: Angels invest in growing firms, in segments where so-called capital market gaps are argued to be limiting

3. Non-financial contributionsenhance viability and improve growth performance

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Money: How Much?On average, an angel invests about $110,000 per firm in Canada.Have range of activity among angels. Some make 1 or 2 investments over five

years; Others make 2-3 investments per year.

Sometimes invest as part of syndicates; solo.

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Money: How much?

0%

5%

10%

15%

20%

25%

Percent of Investors 6% 18% 23% 11% 10% 21% 9%

< $25,000$25,000 - $49,999

$50,000 - $99,999

$100,000 - $149,999

$150,000-$249,999

$250,000-$499,999

>$500,000

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Money: How Much?

Angels provide substantial early-stage financing.How much? Recent large scale survey of 11,000

SME(Small and Medium Enterprise) owners reveals 18% of business owners have made investments in businesses owned by third parties during the last year.

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Money: How Much?Suppose ~1,000,000 SMEs; and an average investment of about $110,000

18% of 1,000,000 @ $110,000 =$20 billion per year, nationally.

Have at least four other assessments that Canadian angels invest between $1 and $5 billion annually.

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Money: How Much?Compare with investments made by

Canadian institutional venture capital firms: 2000: $6.6 billion 2001: $4.9 billion Wetzel (1983), Sohl (2001) report 4:1

ratio of angel to VC capital in USFor early-stage firms, angels are

collectively at least as important as the national VC market!

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Money: How Much?In addition to the funds they

invest, angels report holding substantial amounts of capital available for financing growing SMEs

The problem is not a shortage of risk capital.

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Importance: PositionAngels seek out high growth firms

To compensate for risk, angels look for annualized rates of return of at least 25%

Are patient 7-7 rule:

for each $1 invested angels want to exit with $7 after 7 years

Only growth-oriented firms can meet these rate of return requirements

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Importance: Positiontend to exit via strategic sale,

repurchases by original founders, third-party acquisitions

exits via IPOs (initial public offering), sales to VCs happen, but not as frequently as other exits

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Importance: PositionBusiness angels invest in most sectors (regional effects) and where many people say there is a ‘capital market gap’ – in early stage growth-oriented businesses

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Importance: PositionAngels tend to invest close to home in businesses with which they (or members of their syndicates) are familiar

Capital is put to work locally because scale of investments does not warrant long geographic reach

Contributes to creation, sustenance of business clusters

Fosters local networking and innovation

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Importance: Non-financial Benefits of Angel Financing

Surveyed 42 Ottawa-region technology firms to learn about non-financial contributions angels may have made to firms 33 respondents identified 66

examples of contributions

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Non-financial Benefits of Angel Financing

Non-financial contributions were coded into six categories Advice Contacts Hands-on assistance Boards of Directors & Advisors Market & Business Intelligence Credibility

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Non-financial Contributions of Angels

0

10

20

30

Num

ber

of M

entio

ns

Number of M entions 24 15 11 7 7 2

Advice Contacts Hands-On Assistance M arket & Business Intel l igence Board Involvement Credibil i ty

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Non-Financial Benefits of Angel Financing: Advice

“They [private investors] assisted by providing guidance to management, and … they also provided guidance in the development of a corporate governance process and reporting discipline.”

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Non-Financial Benefits of Angel Financing: Advice

“In addition to making cash available, [the] investor provided assistance preparing our business plan to present to potential investors, provided legal opinions, helped map strategy when dealing with difficult situations encountered with customers, provided assistance in accessing government programs, [and] assisted in dealing with banks during negotiations concerning lines of credit.”

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Non-Financial Benefits of Angel Financing: Contacts

“Both our significant angel investors … assisted by providing guidance to management, and through their networks of … contacts they assisted in finding individuals interested in providing additional financing.”

“[He] assisted with accountants, lawyers, hosting our website … got us meetings with his contacts that we would have had to work a lot harder to get otherwise.”

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Non-financial Benefits: Hands-on Assistance

“[They provided] legal advice, financial negotiations and seeks business opportunities … also brought to company rights to exploit several new technologies which he uncovered.”

“[They provided] office space and office furniture …”

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Non-financial Benefits of Angel Financing: Boards

“Served as directors and provided bank guarantees for the company line of credit. Also provided personal loans.”

“Sits on the board of directors, acts as a reseller of products, provides input for development, marketing, growth opportunities.”

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Non-financial Benefits of Angel Financing: Boards

“[They] provided introduction to our original part-time CFO, original introductions to VCs, and some customers, introduction to our first executive recruit – VP marketing, and [they] sat on board of directors.”

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Non-financial Benefits of Angel Financing: Intelligence

“… identification of possible customers, identification of technical partners or competitors… payroll benefits, handling employees.”

“… close working relationship with key angels - consultancy, re: takeover targets, financing.”

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Non-financial Benefits of Angel Financing: Credibility

“My company's ability to brag about a marquis investor opened doors to other investors, and potential strategic allies, and even a CEO.” “[Private investor(s)] … provided bank guarantees for the company line of credit.”

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Impact of Angel Activity: the Case of Ottawa

A Case Study

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0

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600

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Num

ber o

f Tec

hnol

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Com

pani

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1990 1991 1992 1993 1995 1996 1997 1998 1999 2000 2003

Growth of Technology Companies in the Ottawa Region (Source: OCRI)(Source: OCRI)

> 120% increase ‘90-95; > 120% increase ‘90-95; > 65% increase ‘95-’00> 65% increase ‘95-’00

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0

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50000

75000

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1976 1981 1986 1990 1991 1993 1995 1996 1997 1998 1999 2000 2003

Technology Jobs in Ottawa (Source: (Source: OCRI)OCRI)

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Ottawa Growth (Source: OCRI)

No (0) Venture Capitalists!!665 IT Companies

20 were public35,229 employment in technology

10.3% vacancy rate

14 Venture Capitalists1400+ IT Companies

40 were public75,000 employment in technology

3.9% vacancy rate

1995 2003

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Ottawa Growth: 1990 to 1995

120% increase in number of technology-based businesses 20% increase in technology-oriented

jobs Yet, had NO institutional VCs in

Ottawa between 1990 and 1995What financing accounts for growth

of cluster before 1995?

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Sources of Risk Capital (% of firms that had received external equity financing)

67.2

52.1

9.4 9.4

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25

50

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100

Perc

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f Bus

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BusinessAngels

InstitutionalVenture Capital

Non-FinancialCorporations

Other

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Breakdown of Equity Sources(Based on Fall 2000 Carleton University survey of 600 technology firms, 185 responses)

Had NOT Received Venture Capital

HAD Received Venture Capital

Total

Had NOT Received Angel Investment

129

(70%)

14

(8%)

143

(78%)

HAD Received Angel Investment

18

(10%)

24

(12%)

42

(22%)

Total 147

(80%)

38

(20%)

185

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Angels and VCs

In Ottawa, 57% of firms financed by angels

also obtained VC funding; 10% of firms without angel

financing received VC funding

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Why Do Angels Make Such a Difference?

angels’ financial and non-financial value-added! Angels are a (perhaps, the) primary

means through which local businesses and individuals network.

Leads to high rates of technology transfer and skills mobility.

Angels play a critical role in the commercialization of innovation.

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Angels Foster InnovationOttawa experience: A virtuous circle

Angels help to commercialize innovation Involvement of angels leads to business

success, job creation, and wealth creation more angels

more angels, in turn, participate in further commercialization of innovations through their investment and mentoring activity

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What Are Angels Looking For?

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What Are Angels Looking For?

3 Key Things: People Market potential of the product or

technology Adding significant non-financial value

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Majority Noted People as Most Critical Factor

“I invest in jockeys not horses. Good jockeys will ride good horses.”

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Majority Noted People as Most Critical Factor

Want people who are: Honest. Exhibit strong work ethic. Understand how to make a business

succeed. Are invested in own business. Have realistic notions of how to value

the business.

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SMEs owners are not well prepared to attract private investment (investor view). Inability of potential entrepreneurs to

manage the commercialization process,

Inappropriate views by entrepreneurs re the value of the firm and value of an idea compared to overall value of business.

Majority Noted People as Most Critical Factor

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“… A lot of times they have a great idea, but have no idea about how the cash is going to come in. I can think of cases where my first question is ‘how is this idea going to pay your bills?’ They say ‘well, I don’t know’. I say ‘well it’s a great hobby then’. It’s not a business until they can answer some of these questions.”

Majority Noted People as Most Critical Factor

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Market Potential Is also Key

“… if you are looking at something that is coming to you across your desk I would tend to look more for a technology that is what you would call "a platform", like something that has really great potential ... Something that is exciting. After that a very key thing are the people involved.”

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Seek Opportunities to Make Non-financial Contributions

Some investors are passive, But

Majority say they want to, and do, take on active roles in the management of the firms in which they invest

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Non-financial Contributions: Angels’ Perspectives

Being able to provide the benefit of their experience and knowledge is crucial to investors

“… An investment criteria for me is to be able to determine what value I can add and if I see no value that I can add to an investment then I tend to walk away.”

“When I want to be passive I go to the NASDAQ or the new York stock exchange.”

“I definitely want my hands on the steering wheel and they [business owners] know that up front.”

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What Do Angels Say They Want From Governments?

We asked them.

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Investors: Encouraging More Private Investment

Feb.-April 2001: 11 focus groups held with approx. 70 angels and local facilitators across Canada Asked participants how additional informal

investment might be encouraged Focus group participants were invited to

provide suggestions about ways by which government might encourage additional private investment and to rate various ways investment might be encouraged.

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Investors: Encouraging More Private Investment

Two primary responses: Reduce tax burden

Note Canadian context, passive investments in VC funds are tax-incented

Facilitate angel networking

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Investors: Encouraging More Private Investment

Angel Networking Best done through various types of

angel groups Allows angels to learn from each other Allows angels to refer prospects to others

with more topic familiarity Allows formation of syndicates Allows mentoring from lead investors

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Investors: Encouraging More Private Investment

Angel networking Can be low-keyand informal

e.g. dinner party Can be large scale

Investor forums Newsletters, internet Matchmaking facilities Market-maker facilities

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Investors: Encouraging More Private Investment

Re: Tax Credits“The problem with tax credits is sometimes the investment becomes more of a tax reason as opposed to an investment reason. … just simpler tax laws, lower tax laws, rather than targeting. … The danger with [targeting is] that [when] you start pushing in one place … you're [hurting] some other entrepreneur somewhere else.” “I'm in the grape industry, and I saw where the business was going. So we pulled out all the crap grapes, put in good grapes. Right after we do that, [government initiated] new incentive programs for all the slugs in the industry who wouldn't do anything [and then they] got grants to pull out their crap grapes and replace them. Why would I be on the leading edge when the slugs get the money from the government?”

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Investors: Encouraging More Private Investment

Re: Loss Carry-Back “As many angels have sold out of

[investments held for many years], they paid capital gains. Then if they were to lose money going forward on a new investment, they could only carry the loss back three years. … So, it [seems to make sense that], for angel investments, government should find some way that the tax loss carry-back on those kinds of investments could be extended [back farther]. Then you at least you're taxed evenly [on gains and losses].”

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Investors: Encouraging More Private Investment

Overall, respondents expressed the view that what is really needed is a generalized reduction of tax rates across the board. In their view, this would:

Help to attract and retain managerial and technical talent (human capital);

Reward successful commercialization of innovative activities;

Increase the availability of financial capital.

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Investors: Encouraging More Private Investment

The primary, indeed dominant, reason that angels reject investment opportunities in new firms is their perception that the new firmLacks the management talent

To commercialize successfully the innovation.

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Commercializing InnovationNeed more than a better mousetrapNeed the management, financial, marketing, exporting

knowledge and experience that transforms an innovation into business growth and wealth creation

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Investors: Encouraging More Private Investment

In the view of most angels, there is a gap in the market: an absence of well-managed investment opportunities.It follows that needed most are: an educational infrastructure that produces individuals able to manage the commercialization process; a tax regime that retains in Canada and rewards talented management; and, means of bringing these elements together with other angels and with innovative ideas.