There are many lessons for early stage investing in tech companies, but they don’t need to be learned the hard way.
Angel investing is an interesting ride for both the angel investor and the tech entrepreneur receiving money to chase their dreams. From the investor point of view, it is (or should be) play money they can afford to lose.
The returns could be spectacular simply because you’re the earliest investor in a company that could get very large. Most happy exits for angels are ones where they get their money out quickly or where the returns are large after many years. Most unhappy exits are well, zero, or worse than zero -- the situations where you put in more good money trying to help the entrepreneur stay alive and get zero again.
I recently had a happy exit with Summify, the young guys who built a huge following and sold to Twitter. And as with most angel investors, that success contrasts with three or four challenging investments.
As a venture capitalist investing alongside angels for many years, I have a unique perspective.
Howe Street Cowboys
The Howe Street cowboy, complete with red convertible and poodle, who gave the naive entrepreneur term debt rather than equity as the original investment. When more money came in as equity, he refused to convert and wanted to be paid out.
There never should have been debt in the first place, but how could a company with no revenue afford to pay out debt, let alone interest? And, after the government, guess who is at the front of the line in a wind-up situation? The debt holder.
The entrepreneur is now faced with losing their assets (mostly the software and intellectual property) to the angel investor instead of getting the cash infusion to take the company to market, thereby creating more value. Eventually, the cowboy agreed to convert to equity, removing the debt . . . but only after a lot of pain.
Lesson: If you can’t repay it, don’t take debt. Convertible debt is different because it becomes equity if things go well. Taking term debt when you have no cash flow is not a good idea.
'Good Guy' Angels
The “good guy” angels who supported a promising company and kept investing to get the same terms as the venture capitalists. It stinks sometimes that angel investors get the company through the most risky and difficult period only to have VCs come in afterward with preferred shares laden with terms. If things go wrong after a VC investment, friends, family, angels and the entrepreneur get squished as VCs try to maximize their investment.
In this case, the “good guys” put more money up to join the VCs to protect their investment. Only this one went very wrong. The VCs put more money up and tried to rescue the company. The angels joined in again. But the company went under.
The VCs manage their risk by investing in 10, expecting three to go bust. These “good guy” angels lost a lot on one company. It was their only venture into early stage technology investing. But if they had spread their money around, they might have done better and helped more entrepreneurs.
Lesson: Yes, VCs have crummy preferences ahead of your angel investment. But those preferences are minimal if the company does well. So take a deep breath and let your small investment ride. Once the preferred share investors are there, wish the company luck and move on.
The process of getting money is a courtship. You meet, you fall in love (the angel with the opportunity and the entrepreneur with the money and intangibles – experience, networks, etc.) and a deal is consummated.
I have seen more than one angel get the entrepreneur excited and espouse a simple, clean investment unlike other terms out there. They make it look like they’re the entrepreneur’s best friend. Then, as all other offers are declined and they are in the throes of getting the deal done, they make changes. They add terms. They introduce costs. Now the entrepreneur is stuck in an awful situation.
In my experience, if this is the negotiation tactic used, the angel will be nothing but trouble down the road as well. A tiger does not change its stripes.
Lesson: Get a detailed set of terms on paper in any deal. Agree to every business term and then get the legal paperwork done. This eliminates the grind at the end of a process to raise money.
There are many more stories about angel investing out there. Angels are a vital piece of the capitalization of the technology industry in B.C. And as the industry matures, everyone should be a little more successful.