Guide to raising capital from angel investors ebook from the startup garage by The Startup Garage

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The Startup Garage works with entrepreneurs in early stage, high-growth companies to attract investment and get out of the “garage.” We help startups achieve the milestones investors care about. Our team has helped raise over $200 million for startup businesses.

Guide to Raising Capital from Angel Investors The Guide to Raising Capital from Angel Investors will walk you through the process of obtaining seed capital for your startup. It covers the milestones angel investors look for when evaluating your business and gives you options for how to find the angels best fit for your startup. This book will help you enter the investor arena prepared and knowledgeable of all the boxes you will need to check.

The S tartup G arage.com • (800) 385 - 7 984 © 2013 The Startup Garage — All rights reserved. This article may not be reprinted, reproduced, or retransmitted in whole or in part without the express written consent of the author.

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Guide to Raising Capital from Angel Investors ABOUT THE AUTHOR

Bio: Tyler Jensen

INTRODUCTION

Business Plan Product Development Founding Team, Key Hires, Advisory Board Legal

Intellectual property Market Validation

Angel Investor Overview

The Growth of Angel Groups

What Angel Investors Are Seeking

Funding Timeline

Milestones Needed to Raise Seed Capital

Why Angels Invest What Angels Expect

Putting Together Your Angel Investor Pitch

Preparing Your Talking Points Preparing Your Paperwork

Targeting Your Angels

Narrowing Down Individual Angels Narrowing Down Angel Groups Accreditation

Making The Connection

Preparing For The Meeting

Rounding Out The Details

Legal Issues

Preparing For The Future

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About the Author

“Starting a business is a very personal experience. I’m a serial entrepreneur and have started and helped start over one hundred businesses. I have a special interest in high-growth startups and have made it my objective to understand what it is investors look for when evaluating the potential of a business. My goal is to coach entrepreneurs in scaling their startups while maintaining the work/life balance and achieving personal goals. In this book, I share my business plan writing process to start you off in the right direction.” -Tyler Jensen

TYLER JENSEN In 2008, Tyler founded The Startup Garage to help entrepreneurs and business owners achieve success in their business ventures, as well as their lives. Tyler is a serial entrepreneur, having launched or help launch over 100 companies, including non-profits and social enterprises. He has developed an extensive network of business relationships focused on achieving the milestones investors care about. Tyler heads up The Startup Garage team, which has helped raise over $200 million for startup businesses.

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Introduction Startup Funding Timeline for High Growth Businesses Startup funding for high growth businesses is acquired in multiple rounds throughout the business lifecycle. This funding cycle applies for most high growth businesses — including mobile, web, manufacturing and other tech industries, as well as consumer brands. This lifecycle is different for small businesses that only need enough funding to get the business off the ground. High-growth startup funding is typically split into three rounds: • Family, Friends and Founder (FFF) capital – ranging from $25,000 to $50,000 • Seed Capital from Angel Investors – ranging from $250,000 to $750,000 • Series A and Series B capital from Venture Capitalists – ranging from $3,000,000 to $10,000,000 The most important principle of startup fundraising that every entrepreneur needs to know regardless of the round of capital they are targeting is: raise enough capital to achieve a set of milestones that will allow the company to attract the next round of investment. Initial capital from friends, family, and founders (FFF) should be used to achieve the milestones that will attract seed or angel investors and the use of your seed or angel funding should be directed towards achieving the milestones that will attract Series A investors or venture capitalists.

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Milestones Needed to Raise Seed Capital From Angel Investors Below are the milestones you will need to achieve in order to attract angel investors:

Business Plan You may have self-financed the initial startup costs and/or raised FFF capital without a business plan, but in order to attract seed investment from angel investors you will need a comprehensive plan. This should be complete with extensive market research and a detailed financial model. A major piece of the business plan will be your capitalization strategy demonstrating the milestone timeline discussed above as well as the effects of accomplished milestones on the company’s future valuation.

Product Development Depending on the complexity of your product you may or may not be able to complete a working prototype or beta version with your seed capital. If not, at the bare minimum you will need an interactive wireframe or mockup to demonstrate product features and functionality. You will also need proposals for the cost to develop the minimum viable product (the features that allow the product to be deployed).

Founding Team, Key Hires, Advisory Board Seed investors heavily weigh the importance of the startup team when evaluating an investment opportunity. The reason is simple, the company will face adversity, things will go wrong and the plan will change. With the right team in place, the company is more likely to overcome obstacles, fix the issues and adapt the plan. If you cannot afford to hire the individuals with key expertise, you may need to bring them on as cofounders with an equity stake or hire a part-time, interim individual or company. You can also bring these skillsets to the organization via a board of advisors. In any case, you should plan on having a team member, service provider, or advisor for every part of the business other than your area of expertise. For example, if you are a tech expert launching a mobile app, you will want a team member, service provider, or advisor fulfilling the roles of CEO, CFO, sales, and marketing. At this stage, it is fine for one person to fill several roles so long as they have the expertise to fill these gaps at their fingertips.

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Legal Be sure to budget a small amount ($2,500 — $5,000) of your startup capital to ensure that you legally setup your firm. Work with a lawyer to ensure that you are setting up the business according to what’s best, given your goals and capitalization strategy. It’s better to pay a little now and get it right rather than have to go through the costly and arduous transition down the road. There will be some additional legal fees to complete the paperwork to close the fundraising round.

Intellectual property If your business can secure any intellectual property rights now would be the time to do it. Common types of IP rights include copyright, trademarks, patents, design rights, and trade secrets.

Want more information? Access extensive business planning info and advice on our blog. TheStartupGarage.com/ Blog

Market Validation While all of these milestones are vital to the success of raising seed capital, market validation is towards the top of the list. In your pitch to FFF investors you told them that there was a need for your product in the market. In your pitch to seed investors, it’s necessary to show investors this need. If you were able to build your product or a working prototype or beta version, it’s time to get either paying customers or free users. Obtain customer feedback and demonstrate that your product is fulfilling a real market need.

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Angel Investor Overview Angels are well known in the entrepreneurial world as private investors that financially back startup companies. They are typically around 45 years old with an annual income of $90,000 and have experienced a high enough degree of business and/ or entrepreneurial success that allows them to be deemed an accredited investor, meaning they have a net worth of at least $1M. Unlike venture capitalists, angels are not professional investors that represent an outside company. Instead, they invest their own resources into the company. As a result, angels tend to give less money to entrepreneurial companies than VCs do and invest earlier in the startup lifecycle. Angel investor groups are organizations made up of individual accredited angel investors brought together under the purpose of creating efficient financing presentations, pooling investment funds, and learning from one another. Angel groups saw a huge rise around the 1980s and 90s as the Internet’s influence grew and helped to establish networks of private investors. Because many individual angel investors are not listed in local directories, angel groups are an easier way for entrepreneurs to get their foot in the door with angel investments. The amount of angel financing is rather large. According to Venture Research at the University of New Hampshire, 2008 saw angels invest $19.2 billion into the hands of new ventures. Collectively, angels typically invest no less than $100,000 and rarely more than $750,000 per startup. Each individual investor typically invests around $37,000 per startup. Angels invest across industries as demonstrated in the sector breakdown below: • Healthcare: 16% • Software: 13% • Retail: 12% • Biotech: 11% • Industrial/Energy: 8% • Media: 7% • Other High-Tech: 33%

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The Growth of Angel Groups Time Efficiency: For both entrepreneurs and angels, an established angel group can provide the most efficient way of finding an investment relationship. This is due to the fact that entrepreneurs can present their business plans to many angels at once. For example, an entrepreneur can present to roughly 50 potential investors at once – much more effective than 50 individual presentations. It also allows for angels to hear multiple presentations within a day and be able to measure their options against a broad spectrum of choices. Pooled Investments: An average angel will invest $37,000 in a company. Because of each angel’s monetary limitations, individual angels can collaborate and pool their funds into group investments in order to increase the amount of investment into the startup at hand thereby increasing the power of the angels’ negotiation terms. Due Diligence: A comprehensive background check of investment opportunities allows angels with expertise in areas such as finance, law or marketing, to assess the opportunities for the best potential for return on investment. By working together as an angel group to conduct due diligence, angels research and validate both financial and legal documents as well as marketing strategies presented by an entrepreneur. Social Benefits: Both information flow and learning from one another are benefits of being involved in an angel group. These organizations often provide specific training services, group and committee meetings, as well as lectures and discussions that would broaden knowledge and enrich the investment experience for members. Finally, there is a social benefit to surrounding yourself with people of similar interests. Here, mentors can be found, business relationships jump-started, and friendships created.

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What Angel Investors Are Seeking Why Angels Invest Angel investors finance entrepreneurs for many different reasons. • First and most importantly, angels are looking for a great return on their investment. Knowing that the likelihood that a startup will fail is so high, angels engage in this high-risk type of investment as the rewards of a startup succeeding are also very high. Angel investors can expect an average annual return of 26%, but they also believe that one third of their investments will result in a substantial capital loss. • Second, an angel will sometimes back a company because they trust the entrepreneur behind it. • This, they believe that they can be a valuable resource and give the startup advice and knowledge that will help it succeed. • Fourth, many angels are past successful entrepreneurs themselves and either feel like giving back to others in the same situation that they were once in, or they would like to be part of the entrepreneurial process again without starting their own company. • Finally, many angels invest in companies for the thrill of it. They love taking chances with their money and see investing in entrepreneurs and startups as a higher-risk game with more hands on interaction than the stock market.

What Angels Expect Like venture capitalists, angels check to see if your company can be liquidated quickly and for a big return before they finance your company. On average, an angel investor will get about a 30% return on their investment. Therefore, a startup needs to show that it can be bought by another company or be put up for public offering so the investor can get his or her money back. An angel investor also checks to see if you have a strong management team, a good exit strategy, that the market opportunity is large, and that your asking price is not too high. Passion and coachability are two personality traits an angel is looking for in an entrepreneur. With passion, an entrepreneur will be able to see and keep their eye on

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the end goal of success, and has the belief in their idea to see it through the tough times without being derailed. However, the passion must be balanced with an ability to accept advice and guidance and to not be stubborn with a piece of your business that is not working to full potential. As a former entrepreneur, your angel will want to provide you with their feedback and expect you to be receptive to it. Aside from the personality of the entrepreneur, there are a variety of other things that an angel may be looking for. They will want to see that an entrepreneur has invested their own money into the company, which is a sign that the entrepreneur believes in the idea enough to risk their personal finances on it. The angel also does not want to hear an entrepreneur claim that they have no competition, because any angels know this is simply not true. Angels want to be assured their investment will be used 100% to grow the company, rather than pay any outstanding liabilities or large salaries for the entrepreneur. Angels will be wary of a company that is heavily dependent on licensing, because it adds another layer of unpredictability to the deal. An angel will also look unfavorably on a company that does not have any external board members on either the board of directors or board of advisors, as this is a sign of hesitancy to accept objective advice.

Want to connect on LinkedIn? Meet Tyler on LinkedIn www.linkedin.com/in/ tylerwjensen

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Putting Together Your Angel Investor Pitch Preparing Your Talking Points Elevator Pitch: An elevator pitch is designed to communicate your company’s value in the amount of time spent on an elevator ride. You must come up with a concise way to explain everything an investor would need to know to be interested in your company. Design a sixty-second pitch and test it out on friends and colleagues. It’s a great tool to have ready to take maximum advantage of a brief opportunity to talk to someone who has resources to help you.

Preparing Your Paperwork Legal Counsel & Accountant: Make sure you hire an attorney that you are comfortable with as well as an accountant. These two new team members will become crucial when it comes to preparing and reviewing your PPMs and due diligence documents. A Business Plan: Many people think that a business plan is old school and not needed in today’s world of PowerPoint presentations and flashy animations. This advice couldn’t be more wrong. A business plan shows investors that you put in the time to research every possible market your company can exploit and every competitor your company will contend with. It shows that you understand the financial position of your company and what it takes to establish a successful, growing business. In short, your business plan lets angels know that you know what you are doing. Private Placement Memorandum: PPMs are disclosure documents required by the SEC for outside investors who are putting money into your company. A PPM includes your business plan along with a summary of subscription, a summary of the offering, a list of the risk factors involved, use of the proceeds, management compensation, principal shareholders and capitalization table, subscription agreement, and an actual subscription form that the angel signs. However, if all angels investing are accredited, a PPM is not required as accredited investors are exempt from the disclosure requirements under Regulation D. Please consult and attorney as this is not the only requirement needed to be met to avoid a PPM. Realistic Investment Terms: This does not have to be a formal document, but it is crucial that you and your team discuss realistic investment terms. Individual angels often try to negotiate with a startup. Therefore, it is important to have terms that have been mapped out ahead of time to present to angels.

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Due Diligence Documents: Before an angel gives you money, he or she will perform what is known as due diligence. Essentially, the angel is doing research into your startup to make sure he or she didn’t miss anything. Make sure you have the following prepared so angels can perform their due diligence without delay: • Background of the company • Background of the company’s management • The company’s business plan • Financials • Management discussion of the company performance • Capitalization table • Leases • Employment agreements • Purchase or sale agreements • Previous letters of intent

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Targeting Your Angels Narrowing Down Individual Angels Networking is a crucial part of finding angel investors. There is no such thing as too much networking, so don’t hesitate to get out there and meet potential investors. It’s not always about selling your business, either. Building personal relationships with potential investors and the other people you meet while networking will pay off in the future. Part of effectively building professional relationships includes always being positive and polite, and dressing to impress. You only have one opportunity to create your first impression, so make sure you are ready for it. Unfortunately, you will hear many potential investors tell you “no.” It doesn’t mean your business isn’t a good one, it just means that for some reason your business was not the right fit for that angel’s investment. If someone turns down investing in your company, always ask if the person knows an angel that would be interested. If the angel is receptive, you can also ask why they said no and use their feedback to further perfect your pitch. Another avenue to consider is asking your bank if they have any connections to angels. As the bank has an interest in your venture’s financial success, they may be willing to share access to their network of investors with you.

Narrowing Down Angel Groups Angel groups are becoming more popular but are constantly forming and rearranging, so you have to constantly keep an eye out for a new opportunity. Some websites have developed an angel group matching service, so that is an option to try. Another option is to attend an investment forum. If you live near a major city, you can likely find an investment forum nearby. Investment forums are similar to angel groups in that many investors attend in order to learn about promising new companies to invest in. These events can often attract advisors, customers and other strategic partners along with the angels. The forum may also host workshops for investor education, and these may be useful for you to attend in order to get into the mindset of an investor and see what they are looking to learn.

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Accreditation An accredited investor is one who meets specific criteria as defined by Regulation D of the Securities Act of 1933. The angel investor must have an individual net worth (either alone or joint with their spouse) that exceeds $1 million at the time of investment, or have an annual income that exceeds $200,000 (or $300,000 if joint with spouse) for the two preceding years and reasonably expects the income to remain stable in the current year, to be considered an accredited investor. If your investors are accredited, then you do not need to create a PPM to go along with their investment. The purpose of the PPM is to give the investor full disclosure of the risks of the investment. But an investor who qualifies as an accredited investor can bear the risk of a complete loss of their investment and is presumed to be a sophisticated investor. Regulation D makes it possible for entrepreneurs to avoid the costs of preparing a PPM by pairing them with investors who are sufficiently positioned to assess the merits of the investment independently and to bear the costs of an investment that goes sour.

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Making The Connection Once you have found an angel investor that you want to invest in your business, you must approach them in a way that maximizes your chances to gain the investment. Now that you have the angel’s contact information, consider how you got it to guide your first move. Did you already meet the angel in person at a networking event? In that case, you already have a sense for the way the angel investor wishes to be contacted. Is the angel a referral from someone else you met? Ask the person who referred you for more information on the angel’s preferred communication style. Whether it’s a phone call, e-mail or personal visit, make sure you tailor your first communications to the angel. You will want to provide them with your company’s executive summary as well as any substantial recent updates or successes. Tell the angel you will follow up with them in about a week. Hopefully the angel investor responds to your initial contact, but if they do not be sure to follow up with a phone call on the schedule you promised. If you have made a followup call and still haven’t heard from the angel, try once more to get in touch. Angels are very busy and they may have forgotten to respond. Be careful to not be overly aggressive in trying to get in touch with them if you still haven’t heard back. If the angel was a referral, you can ask the person you got the referral from if they know of an extenuating circumstance prohibiting the angel from having time to get in touch. When you get in touch with the angel, set up a meeting that is convenient for them in terms of both time and location. A good rule of thumb is to ask for 45 minutes of the angel’s time. They can extend or shorten the window if they think necessary. On the day of the meeting, make sure you know where you are going and where you are going to park. While this seems like novice advice, it is easy to take for granted that you have a normal transportation routine and it could negatively impact the success of your meeting if you are running late and flustered. When you are finally face to face with the angel, resist the urge to dive straight into your presentation. It is worth the time invested to solidify your personal relationship with the angel, so prepare some points to open the conversation with.

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Preparing For The Meeting Investor Presentation: You will want to use a visual aid such as PowerPoint to create a slide deck that you can share with investors to help explain your company. A rule of thumb is to use no more than 10 slides. A 10 slide maximum forces you to edit and revise extensively before you approach angel investors. There are several goals you should have for the content of your slide deck: • Explain what sort of business your company is engaged in • Explain what solution you have come up with to solve a problem customers have • Explain why your solution to this problem is better than other solutions • Explain how you know your business plan • Explain why your management team is the right fit for execution of your solution If you can, customize your presentation to target the particular interests of the angel. For example, if the angel is most interested in your liability protection, be sure to discuss that detail of your plan thoroughly. Do NOT include any information that is proprietary or confidential in your presentation. You are not in a good position to protect the information at this point in your relationship with your investors, so it is not worth taking the risk. Practice Your Presentation: Since it is your business, you know more about it than anyone else. By practicing in front of an audience that will give you helpful feedback, you can understand the parts of your presentation where you trip up or do not adequately explain something. Mention Money: As you are ultimately looking for an investment from the angel, make sure you mention money. But be tactful with the subject and avoid asking outright for an investment. You can tell the angel how much you are looking to raise in general, and invite them to be an investor.

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Rounding Out The Details Legal Issues Non-Disclosure Agreement: After your initial meeting with the angel, if everything is going well, you should invite the angel to your office to see the company for themselves. It gives them an opportunity to see firsthand your employees and company culture. However, as the angel is now on your company territory, be sure to protect your company by having the angel sign a non-disclosure agreement (NDA). By having the angel agree to and sign an NDA, you demonstrate your concern for protecting the company as well as putting yourself in a position to safely share sensitive information with the angel. Due Diligence: Once an angel decides they are serious about moving forward with you and your company as an investment, they will begin a due diligence process. This requires your compliance in providing the angel with any documents they wish to review, as well as provide information about any contacts and references they want to talk to. Every angel conducts due diligence differently, but their goal is to get a more objective assessment of you and your company. They understand that you have put forward your best so far in order to wow them, and now they want to know what your worst is too. They will want to find out what potential challenges you face in the future. It is important to be open and honest with the angel during this process. The angel was most likely once an entrepreneur his or herself, so he or she will understand you may have incomplete information and that not everything is perfect. However, angels must protect their investment money by making sure they really understand the circumstances of their investment. Although not comprehensive, the following documents should be ready for the angel investor once they begin their due diligence process: • Information about subsidiaries, joint ventures, and partnerships • Minutes of stockholder meetings, board meetings, and committees • Charter documents such as articles of incorporation and bylaws • Financial information • Lists of stockholders and information about their issued shares • Information about all company employees and company management structure • Information about any past or pending litigation • Information proving compliance with relevant laws and regulations • Information about any intellectual property rights

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Term Sheet: A term sheet outlines the details of the investment you and the angel agree on. Some of the things you should include on a term sheet are: • Type of financing: debt or equity • If debt, will it be convertible? Secured or unsecured? • If equity, will the stock be common or preferred? • Amount of financing • Will the angel be active or passive after the investment has been made? • What happens if the company faces a liquidity event during the course of the investment? Negotiation Strategies: When it comes to the part of the deal with your angel investor where a valuation must be determined, make sure you are prepared. The valuation will likely fall below what you consider to be the value of your company, but there are many factors that contribute to an objective valuation. A valuation can assess your company’s liquidity, cash flow, and the value of similar companies. You must also consider the value of the angel themselves, especially if they are well-connected in the investment world, have a lot of experience and advice, and if they provide an opportunity for follow-up funding.

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Preparing For The Future Follow Up: In order to maintain a good relationship with the angels you meet throughout the process of seeking angel financing, make sure to keep in touch with them after your conversations. For anyone who you have a meeting with, send them a handwritten thank you card. If they end up not funding you, you can keep them posted on your company’s progress. You never know, they may change their mind and provide you with funding in the future! For an angel who does invest in your company, keep them updated on everything about your progress, for the better or the worse. Share your successes and milestones with them, but be honest about problems you are struggling with. They might be able to help you get through the rut. Be sure to thank your angel frequently for supporting your company and making your passion possible.

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