Financing a Start-up in 2013
Much is being written about how “broken” our current venture capital financing model continues to be. One of the most seriously broken areas is financing an early stage company. Venture capitalists continue to publicly state that they wish to fund early stage companies. The true facts are that most early stage venture capitalists are not looking for early stage companies but rather companies either in revenue or very close to it. The line has shifted, and the definition of early stage seems to have moved or been changed for most venture funds.
Angels are now the logical financing source for most early stage companies
So, where does the capital come from to fund these early stage companies? Individual angels still exist, but the more sophisticated of the angels belong to at least one of the organized and established angel groups. Organized angel groups, such as the Band of Angels, The Angels Forum, Sand Hill Angels, Life Science Angels and many more have been working hard to fill the void left by the venture capital funds moving up market.
As an active angel investor with one or more of these groups, I have watched a steadily increasing problem arise. We believe that most venture capitalists are able to have a very high return on about 15% – 20% of their portfolio companies, and have either a breakeven or negative return on the rest. It is also true that organized angel groups, in general, have lower returns than the venture industry, and individual angels do not normally make any significant returns on investments.
Challenges for angel investors
What makes matters worse for angels is that if a deal starts looking like it can become a success and needs to raise large amounts of additional capital, the company usually goes to the established venture capital firms. Unfortunately VCs often try to dilute the angels who took the majority of the risk with the early stage company, to a point where the angels ROI on a successful deal diminishes to an insignificant level. This is further causing the angels, both individual and organized groups, to consider new factors when looking at prospective transactions.
These new factors center on:
• How much cash is required now to get the company to a meaningful milestone or two;
• What will the pre and post money value of the transaction be;
• How much additional equity does the company feel will be needed to get to cash breakeven or exit; and
• What is the exit strategy and timing?
So, when looking at a potential investment, not only do angels have to look at the things we have always looked at: quality of the business model, the management team and the technology; we now need to consider these additional facts.
Key for angels is capital efficiency
We now look for companies that are extremely capital efficient. We look for the initial investment to be within the range of angel investments, typically below $1 million for the first round. And we now look to where the next round of capital will be coming from. We try and identify who will be the next capital in a deal and get the future capital source interested before we even make the the early stage investment. Personally, I try to find transactions for the organized angel groups with which I work that have the following characteristics, at a minimum:
• A great, experienced management team;
• The Total Addressable Market (TAM) is huge, offering a large opportunity to create a business, and not simply a small product;
• Technology which is not so unrealistic, as to prove impossible to achieve;
• Defensible intellectual property;
• A pre money value that can give us, as the high risk investors, a proper rate of return for the inherent risk that we are taking;
• The total amount required to reach cash breakeven will be less than ~5 X what we invest in the first round;
• A group of investors who are interested in following the company and could be probable investors in a subsequent round of capital raised; and
• A likely exit in 3 – 5 years, with a significant ROI.
Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms. Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.
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