• When to Fire Your Co-Founders, by Simeon Simeonov (CEO at FastIgnite and former partner at Polaris Ventures);
• What Constitutes a Start-up Mistake, by Simeon Simeonov;
• The 18 Mistakes that Kill Start-ups, by Paul Graham – I guess I was 3 short on my list; and
• How to Pick a Co-Founder, by Naval Ravikant.

Hope you enjoy these articles/posts and the additional info and perspective they add to this topic.

Chris McDemus is founder of VC Deal Lawyer, a blog devoted to providing insights on start-ups and emerging growth companies.  Chris is also founder and owner of MCD Law Partners, LLC, a boutique law firm focused on providing corporate, transactional and operational legal services to start-up and emerging growth companies.

If you are raising money from angels or institutional venture funds, then you will most likely utilize an executive summary format as your initial contact.  Angels and institutional venture funds play a more active role in valuation and deal terms.  Taking the time and expense to draft a private placement memo makes no sense when dealing with investors that have their own sense about valuation and deal terms.  The executive summary may eventually lead to a meeting, and then to a more formal company presentation that would involve a PowerPoint deck.  (For a good example of how to structure such a PowerPoint presentation see the template provided by Originate Ventures here and also see my earlier post and post).

Everyone has an opinion on what the executive summary should look like.  Most importantly, remember that the executive summary is meant to provide just enough information to pique the investor’s interest and lead to a more formal meeting where you can present the company on a broader scale.  The executive summary is a teaser, but it needs to contain the right information for the “tease” to turn into a meeting.  An executive summary should be 1 – 3 pages max.  Don’t include a cover sheet (just put your contact info and a JPEG of the company name in the header portion of the first page).  The following are the sections you should include.  Start all sections (excluding the intro paragraph) with a small section header.

• Intro Paragraph - it should be no longer than 2 or 3 sentences and should hit the two most important points head on:  (i) what’s your value proposition, and (ii) how big is the market.  I would suggest that investors who receive a lot of executive summaries lose interest and do not read past this introductory paragraph if these 2 or 3 sentences don’t grab their attention.
• Background - this section should lay out the background facts on the problem you are trying to solve.  If you assert real data then briefly show your source in a parenthetical after the sentence.  You want to leave the investor feeling as if there is a real problem to be solved here. 
• Solution - this is where you lay out your solution to the problem discussed in the “Background” section.  This is a description of what your company does and how you do it – your value proposition.  If there is proprietary technology, discuss it here. 
• Market- this section should discuss the size of your market as well as any barriers to entry.  If any section requires real data, this is it.  Show strong support for how big the market is.  Remember that investors are only interested in markets that they believe provide room enough for the returns they need to make.  That being said, don’t make the mistake of showing the top level market if your target is only a smaller subsection.  Don’t show how many consumer products are sold in the entire world if you are only focusing on selling widgets (a smaller subsection of all consumer products).  Don’t mislead.
• Financial Model – very simple.  How do you plan on making money.  Also, you should include projections here.  If the projections are based on any major assumptions, include those as well.
• Team - discuss the members of your team.  Provide their names as well as a very short bio.  Also include their title if they have one.
• Capital Raise – in this section, start out discussing any money that has been raised to date, including money put in by the founders.  Real founder money shows that the founders take this seriously and have some skin in the game as well, beyond just sweat equity.  You want to conclude this section with how much money you are asking for, how much of the company it buys (i.e., your valuation), and a short sentence on use of proceeds.

Another good resource for executive summary structure is Guy Kawasaki’s article.  His model aligns closely with mine, but he provides some additional sections and a bit more color on what those sections should include. 

Feel free to email me any questions or comments.

Most serial entrepreneurs know how to steer clear and avoid these mistakes.  Why?  Because they’ve been through it already.  They know the landmines and can generally avoid them.  But first time entrepreneurs, although having a great concept and skills to back it up, most likely have no clue how to get started.  You need to learn from other’s mistakes and avoid making them yourself.  Here’s my list of the 15 most common, but avoidable, mistakes made by high growth start-ups.  The goal here is to have you spending your time building value, and not wasting resources fixing what may be obvious to others.

1.       Making poor early hires and not firing fast enough – I don’t have enough fingers on both hands to count the number of times I’ve seen this happen.  The effect can be minimal or enormous, depending on the position, timing of hire, responsibilities, etc.  Two mistakes I see most often: 

• The C-level hire with an incredible resume of large company, Fortune 500-type experience, but that has absolutely “zero” start-up or emerging growth experience.  Certainly, you want to hire people that have great experience.  There’s no arguing that point.  At the same time, however, you want to make sure that the individual can utilize their skill set in a start-up environment.  Some individuals have built their careers operating under budgets stuffed with positive cash flow – the anti-thesis of a start-up environment.  Never hire someone solely on the basis that listing their former employer on your pitch slides looks great or because you think the company will grow into their skill set (you may turnover a couple of individuals in their role before you reach that size); and
• The hire that claims he/she brings something strategic with them, something that will only come into the fold because of their presence in the company.  I am not talking here about someone that brings a great rolodex, or a specific programming skill or the like.  I am talking about someone that says they have the contacts to help you raise $3M or someone that claims they have the prior relationships to land the 10 largest clients in your target market.  If someone lays claim to something so specific and strategic, and they are to receive a fulsome compensation package based on those claims, then condition some of that package on delivering on the promise.  X options for X amount raised, or X options for every top 10 client you bring in that signs an agreement. 

Consider the real reasons why you are making the hire and consider whether or not such individual may better serve the company at the advisory board level as they may bring significant industry contacts and the like.  Otherwise, just make sure you enter the hiring process knowing the traps that exist.  If you do end up hiring someone that clearly is not working out, then move on quickly.  It may cost you, but not as much as it would in the long run by leaving them in place. 

2.       Failing to assemble the correct management team – the management team that you form is incredibly important.  There are many schools of thought, but I invest in the jockey over the horse.  That’s not to say that the business model and having a large market aren’t important, they are.  Otherwise, you may not be able to develop the kind of return your investor is looking for.  But the team is uniquely important for two reasons: 

• Investors don’t want you learning on their nickel.  I’ve said this before.  For early stage start-ups, you want to see management teams that have some industry experience.  If you are in the technology space and your Senior V.P. of Sales comes out of the steel industry, there better be a great rationale for that.  Demonstrate that you have talent that knows the space; and
• A cohesive, smart management team can make lemonade out of lemons.  See Mistake #13 below.  You know what they say about “best laid plans”.  Nothing is foolproof.  But it wouldn’t be the first time that a smart management team saw a completely separate business model in the ashes.  That’s why you ultimately bet on the jockey. 

3.       Promising portions of equity to individuals in the beginning without a plan - my stomach always turns when I meet with an entrepreneur and they tell me that they struck a great deal with one of their lead employees – he’s doing all of his/her work for 10% of the company.  I can see the excitement in their eyes of having saved cash while getting their platform built.  Then I ask the follow up questions that should have been asked when the deal was struck, and the mood shifts.  Is this deal in writing?  What kind of stock does the employee think he/she is getting?  When and how is the 10% measured?  Is it measured at the time of the agreement or at a later date?  Is the number of shares represented by the 10% calculated on a fully diluted basis or not?  Can the 10% be diluted (i.e., if that 10% translates into 500,000 shares of common stock, will those 500,000 shares represent 8% when the outside investors put their money in or does the employee expect to be issued additional shares such that he/she still owns 10% following the outside investment)?  In other words, did you inadvertently agree to let them have 10% of the company forever.  Persons of reason laugh at the thought that anyone could think they’ve been given such a sweetheart deal.  Think again.  If you’ve just hired a very opportunist employee, they may have no qualms trying to hold you to a deal many would say borders on ridiculous.  Then it becomes a matter of how much you would pay to avoid litigating such an issue when you should be building your company.  This is an amateur mistake that is 100% avoidable. 

4.       Failing to properly structure founder shares - once you’ve decided who the founders are going to be, you’ll need to structure your founder shares.  Founder shares embody the concept that if a founder receives all of their shares upfront, fully vested, then there’s no incentive to stick around and help build the company.  That founder could walk one day, keep all of their shares and piggyback on the hard work of the remaining founders.  Founder shares usually vest over a period of time and are issued as restrictive stock grants.  By way of example, a founder may be issued a restrictive stock grant of 400,000 shares of common stock, vesting annually/monthly/quarterly over 4 years.  If the founder stays for the full 4 years, he/she keeps all 400,000 shares.  If the shares vested annually and the founder leaves 2 1/2 years later, they keep 200,000 shares (the company usually buys back the remaining 200,000 shares at the same price the founder paid for them).  If they are fired for cause, it is possible that they could lose all of the shares.    If there is just one founder, there is really no issue until such time that the company seeks to raise outside capital.  At that time, the investors may insist that the founder put some of their shares on a vesting schedule – again, to align both founder’s and investor’s incentives.  If there are multiple founders, then this is something that should be put in place at formation.  For some further info, see both of these articles from Mark Suster regarding Founder Prenups and Founder Vesting. 

5.     Picking the wrong type of entity and structuring early ownership 50/50 – see my earlier posts regarding picking the right type of entity and the difference between entities.  In my humble opinion, if you plan on seeking outside investors, then go with the corporate structure.  You avoid the whole issue of VC funds requiring blocking entities (a result of some of their limited partners being non-profit companies) and the possible need (and accompanying cost and time) to convert your limited liability company to a corporation at a later date.  In terms of how you structure ownership, if there are two founders then find some difference between yourselves to rationalize one person taking 51% of the ownership.  50/50 deals, absent some complicated deadlock breaking provisions, simply result in a standoff the minute the founders disagree.  In order to make the 51/49 split more palatable, you can give the 49% owner comfort that he/she will have a say in material decisions (e.g., taking on debt, sale of the company, major hires, etc.) by giving the 49% holder certain protective provisions (i.e., the need to obtain their consent in order to approve these material decisions).  If you do provide protective provisions, then make sure you look at them in the totality.  You don’t want the exception to become the rule and end up in a 50/50 situation inadvertently.  

6.       Failing to consult experienced advisors at the beginning – many of the mistakes in this post could be avoided by simply hiring experienced start-up and emerging growth attorneys and accountants from the very beginning.  See my earlier post regarding hiring start-up counsel.  First time entrepreneurs may balk at this, serial entrepreneurs do not.  Serial entrepreneurs know that they will save time and money resources (far in excess than they would have saved in reduced fees by going with inexperienced counsel) in the long run because they eliminate the clean-up necessitated by lawyers that don’t know what they are doing in this space.  Hiring experienced counsel doesn’t mean the big price tag it used to mean.  Contrary to many years ago, the marketplace has many start-up and emerging growth experienced attorneys at reasonable rates (see my earlier post on the changing law firm market).

7.       Not having a clear business plan – the mantra here is focus, focus, focus.  If you try to become all things to all people, you will likely end up being nothing to nobody.  Investors back business plans that are clear and show some rational path to acceptable returns.  I would advise having your attorneys and accountants also review your plan.  If you are following my suggestion in Mistake #6 above, those attorneys and accountants see many plans and can provide helpful comments to improve and refine it.

8.       Raising too much or too little money – raise too much money and you may have just bought yourself complacency (along with many of the other mistakes in this post).  Too much money allows for making poor early hires (Mistake #1 above), consulting experienced but not cost-effective counsel (Mistake #6 above), losing direction (Mistake #7 above) and spending endlessly or needlessly (Mistake #11 below).  Raise too little money and your runway may be cut short before you launch your product or have built enough to support raising additional funds.  Planning and projections are the name of the game here.  You need to look into the future as best you can and consider how much money you will need to reach the next fundraising stage.

9.       Failing to properly document early agreements – there are early internal agreements to think about, and that experienced counsel can help you prepare, such as (i) shareholders’ agreements between the founders, (ii) founder share agreements and possible 83(b) elections, (iii) non-competition, non-solicitation, confidentiality and invention assignment agreements for employees (these are critical, particularly for employees that are building your product, as you might not own what they develop without them), and (iv) proper equity compensation plans (i.e., stock option plans), and option grant agreements.  There are also early external agreements such as customer contracts, service agreements, licensing agreements, office leases and the like that need to be prepared.  I’ve seen scenarios where early stage start-ups leveraged the existence of early customer contracts, but due diligence by VC funds later uncovered that those contracts were not as strong as previously thought.  Use of experienced counsel early on will provide some assurance that the contracts contain the appropriate protections.

10.       Raising early money without complying with the securities laws – no matter how you slice it or dice it, if you are selling a stake in your company then you are most likely selling a security which means you need to comply with federal and state (blue sky) securities laws.  This is true starting with the issuance of founders shares all the way up to issuing stock to VC funds and beyond.  The key here is to make sure that the transactions are structured in a way that you can claim an exemption to the requirement of registering the sale of the stock.  It is very important that you properly structure these transactions because poorly structured transactions (i.e., those that don’t satisfy all of the requirements of an exemption) will cause significant problems down the road.  They can derail future fundraising or cause the company to expend tens of thousands of dollars to later rectify.  Properly structured, exemptions exist for shares issued to founders, and to employees under equity compensation plans and to VC funds.  Most securities sold to outside investors are structured to comply with Rule 506 of Regulation D pursuant to the Securities Act of 1933, as amended.  You will save yourself significant heartburn later on if you take the time to structure these sales correctly the first time.

11.       Poor cash management and spending money on the wrong things - California Historic Landmark No. 976 – the “garage” where Bill Hewlett and Dave Packard started Hewlett-Packard in 1939.  Simple beginnings for what is now a billion dollar behemoth.  That garage epitomizes boot-strapping.  Fast-forward to the mid-1990’s to late 1990’s, during the internet boom.  Companies with only a business plan and little or no product were raising millions of dollars at hyper-inflated valuations.  Many of these companies managed their cash poorly or otherwise spent their money on the wrong things.  Enormous, beautiful offices and brand new furniture.  Artwork.  Game stations.  There was seemingly no end in sight, until the whole thing imploded in mid-2000.  Today’s start-ups seem to have learned some lessons from those days.  You see more group-share offices, people buying used furniture off of eBay, jamming 20 employees into 4,000 square feet of Class C office space.  You also see less tolerance for poor cash management.  We all know “cash is king” and you really, really need to think about every dollar that goes out the door and what you are getting in return.  You need to show investors you have the discipline to manage the cash to reach positive cash flow.

12.       Failing to identify a market for your product/service - having and developing a product or service is one thing, but finding someone to buy it is a whole other story.  Unfortunately, some entrepreneurs make the mistake of investing time and money into building the product or service before they’ve even considered who is going to buy it or how you are going to market and sell it to them (see Josh Kopelman’s article regarding customer acquisition plans).  The investors that most often suffer from this mistake are the founders themselves, friends and family and, sometimes, angels.  Very often it is the technical entrepreneur that may get caught up in this problem as their skill set tends to focus them on product capabilities and features and maybe not sufficiently on the need for those capabilities or features by the potential customer.  The mantra here is to fail as early as possible.  Try to identify what the customer wants and doesn’t want early in the process in order to reduce the amount of time and money resources focused on that feature.  This mistake is not just made by early stage start-ups, as companies mature and launch new divisions and products, this mistake still ranks near the top.

13.       Not being able to re-invent as you go - in the movie Heartbreak Ridge, Clint Eastwood starred as a gunnery sergeant in the U.S. Marine Corps.  Anytime his soldiers would run into an obstacle or an unexpected problem, he would tell them ”improvise, adapt and overcome”.  This is the perfect mantra for an early stage start-up.  As I mentioned in Mistake #2 above, even the “best laid” plans run afoul and you need to be able to turn the ship on a dime and possibly take a different tack on the problem.  Many say the difference between success and failure is only one factor.  A capable and creative management team may be able to salvage the company by re-inventing it along the way.  As the business grows, this skill set is still very useful.  There were many companies that needed to re-invent themselves as of late in order to compete with some of the very capital efficient business models that currently exist.

14.       Hangups on valuation rather than focusing on getting committed funds to make a successful business - I would like to thank Bob Fesnak of Fesnak and Associates for this Mistake #14.  You can see my earlier post for more information on this subject.  I place higher negotiating priority on liquidation preference and dilution than I do valuation.  Don’t let your hangups over valuation stifle your change of closing on committed funds.  Without the funds, there is no business.  Read my earlier post in depth.

15.       Failing to build a sustainable business around intellectual property - I would like to thank Bob Fesnak of Fesnak and Associates for this Mistake #15.  It’s a classic and goes hand-in-hand with Mistake #12 above.  Intellectual property is only one leg of the stool.  You need all of the legs if you want the stool to stand and not wobble or fall down.  The only way to monetize intellectual property is to build a sustainable business around it.  This is the gap that technology transfer offices at the university level try to overcome on a daily basis.  Intellectual property is created as part of the academic or research and development process and the university or professor desires to realize some value from that intellectual property.  However, the university lacks the other legs to the stool and has to seek the private sector’s help to fill in the gaps.  Technology transfer offices do this by partnering with entrepreneurs who can license that intellectual property and build a company around it.

You’ll find many other lists on the internet that focus on costly mistakes made early in the start-up process.  For additional resources, I would point you to 25 Entrepreneurial Death Traps, by Fred Beste (Partner Emeritus at Originate Ventures).  Fred is a great guy (and VC) and Originate Ventures is a great group to affiliate yourself with and to raise money from.

Thank you and I welcome your comments or questions.

• Jon Brilliant from the Atelier Group;
• Adam Burgoon from KarpReilly LLC;
• Shira Sue Carmi from Launch Collective;
• Mark Friedman from Trilea Partners;
• John Nowaczyk from Milestone Partners.

The panel was moderated by Robin Harris from Luxeology.  The panel did a great job covering a lot of topics and answering direct questions from the audience.  The panelists themselves were diverse in their investing models, which proved for a more exciting program.

Prior to the panel’s presentation, David Rose, Chairman of the Board of the New York Angels, Inc., gave a speech entitled “Delivering an Effective Investor Presentation.”  Clearly drawing from his years as an angel investor that sat through countless pitches, the “Pitch Coach” as they call him gave some excellent pointers.  To start, David said that you need to demonstrate the following qualities when pitching to angels or else it’s a non-starter: 

• Integrity- people can smell bull**** 20 feet away.  Keep it real or else save everyone’s time and skip it;
• Passion – as an investor, you either sense the passion for the business or you don’t;
• Experience – they age old saying that no angel want you learning an area off of their nickel;
• Knowledge – you have to demonstrate some domain expertise.  Don’t show up with 5 executive team members sporting insurance industry experience to pitch a consumer products business;
• Skill – self-explanatory;
• Leadership – must demonstrate an ability to lead;
• Committment – you must be fully engaged and committed to the business.  It’s like charging up a hill in battle.  No matter what the obstacle, no matter how many times you trip and fall, you get up and keep going.
• Vision – self-explanatory;
• Realism – you must present a realistic business model and plan;
• Coachability- everyone can improve their skills, and entrepreneurs that want to get funded cannot come off like know-it-alls that cannot take outside advice.  Angels want to know that you will take constructive advice in how to improve your pitch, business plan or whatever else it takes.

As for your Powerpoint presentation, David suggested that a good approach is to use short bullet points, a better approach is to use headlines and the bestapproach is to use images.  You want to achieve emotional resonance with your audience, and images can do that (as he so adeptly demonstrated during his presentation).  Finally, in your presentation you want to first say and talk about a concept before you actually show the slide for it.  He suggested two books on presentations:  (i) Presentation Zen by Garr Reynolds, and (ii) Slide:ology by Nancy Duarte.

David wrapped things up with his top 10 list of things to do/not to do during your presentation:

      1.   Never, ever look at the screen.  Look at the audience.

      2.   Don’t ever read your speech.  Know it inside and out and present like that.

      3.   No live demos – they only fail at the most important times.

      4.   Always use a remote to move your slides.

      5.   Hand-outs should not be copies of your presentation.  Do not hand them out in advance (because then people stare at the presentation rather than you).

      6.   No jokes.

      7.   Don’t stroll and fidget.  Project and command.

      8.   Pace the presentation, keeping it smooth and even.

      9.   Check your equipment to make sure it is working.  Show up early and do a dry run.

      10.  Only the CEO can give a pitch for money.

David suggested that if you’d like more of his helpful pointers, you can go to the site for Rose Tech Ventures.

Angels are individuals that invest their own personal money in private companies, typically at a very early stage.  They are generally Accredited Investors under Reg D of the Securities Act of 1933 (meaning they have a net worth of at least $1M or that they made more than $200k the past three years or more than $300k, together with their wife, the past three years).  Most angels made their money themselves as entrepreneurs or executives.  A few of them deploy old family money, rather than their own.

What role do angel investors play in venture financing?

Angels bridge the financing gap between “friends and family” money and the initial institutional venture capital round.  As former entrepreneurs or executives, angels bring more than just money to the table.  They can be wonderful mentors and advisors.  Due to their backgrounds, they very often have specific industry expertise and/or operational or financial experience.  Also, many angels have stopped earning a paycheck full-time and they look forward to spending a little time in the trenches with the entrepreneurs that they invest in.  Some angels also have enormous rolodexes (for those of you younger than 20, that means contacts) from their own years of raising money and doing deals and can provide great contacts that may speed up the start-up process. 

Types of Angels

Angels come in all shapes and sizes.  At the bare minimum, they are all individuals.  Some desire to invest just that way and they will source their own deals and individually invest their own money. 

Over the past several years, however, many angels began to put some formal structure around their activities and angel networks or groups began popping up.  By involving themselves in angel groups, angels can be more efficient in reviewing possible investment opportunities, diligencing deals, negotiating terms and pooling money to take on slightly larger deals – all with the over-arching goal of achieving more competitive returns.   These groups can be loosely or highly structured.  Some may just be groups of individuals that come together quarterly to hear company presentations over dinner (usually 3-4 a night).  In these loosely structured groups, the ultimate decision to invest is the individual’s and they will all write their own checks.  The more structured groups tend to take on characteristics of funds, with capital calls, investment managers and due diligence teams.  Whereas individual angels would typically put from $10,000 to $250,000 into a company, the structured groups may put anywhere from $250,000 to $1,000,000 into a company.

I would refer to certain groups as angels since they invest at the angel level, even though they may not fit neatly into the categories above.  These groups come from a completely different angle by forming incubators.  Two well-known examples are TechStars and Y Combinator.  They put something like $20,000 into their incubated companies in return for 2-10% of the company and they provide the companies with high-end accounting, legal, operational, financial, sales and marketing support.  It’s sort of like the difference between a stove and a microwave.  Like the microwave, the likes of TechStars and Y Combinator seek to highly charge their start-ups in a short period of time, hopefully catapulting them past their competitors.

Where do you meet angel investors?

Finding angels is not necessarily easy.  They don’t advertise.  They are not in the yellow pages (if you find one there, I’d suggest you run in the opposite direction).  Some tend to like the obscurity because they don’t want to be overwhelmed with opportunities.  In fact, many angels rely on an informal network of filters to make sure that by the time someone does find them (sort of like when Dorothy found the great Oz), they’ve already been vetted a couple of times both from an opportunity as well as a personality perspective.  In that regard, the best place to hunt for angel investors is in your own network, through trusted advisors like accountants and venture attorneys (who interact with angel investors constantly), through institutional venture funds (some of these guys may even do some angel investing on the side with their own money), angel networks and angel groups. 

How do angel investors structure deals?

It can run the gamut from convertible debt, common stock or series preferred stock.  Most angels investors though will have a preferred method and will consistently invest the same way.  If you raise money by selling common stock or series preferred stock then you will have to negotiate a valuation with the angel investors.  This can lengthen the time to get an angel deal closed.  It can also, if you don’t engage the right kinds of advisors, wreak havoc on your next financing round (which, if all goes right, will be institutional venture money).  If the rights, privileges and/or preferences attached to the common stock or series preferred stock are too rich it may give the venture capitalists in your next financing round serious indigestion.  Not that you cannot overcome that, but it will greatly lengthen how long it takes to get the next financing round done (in addition to significantly increase your legal and accounting expenses).  Why?  Because some of the rights your angels have may have been more appropriate for a Series C round and now your Series A investor is saying – if the angels keep those rights we are not doing the deal.  The Series A investor is going to want the angel investors to restructure and re-align their investment so that it properly sits within a broader financing plan for the company.  If your angel investor decides he/she doesn’t like that, then you just bungled your Series A round and you’ll need to hit the fundraising trail again. 

One way angel investors avoid all of the subjective issues behind valuation and the rights, privileges and preferences associated with issuing stock is they structure their investments as convertible debt.  Some people are fine with this, others have issues.  To each their own.  I think it is a very acceptable way to structure an angel investment.  What you do is the angel investor loans the company money, rather than investing it as equity.  The loan is structured to be convertible into equity at a later date, with the conversion being automatic if the next financing round meets certain parameters (e.g., institutional venture fund money, minimum valuation, minimum aggregate amount raised, etc.).  Convertible debt provides the advantages of both debt and equity.  No time is wasted determining a valuation.  The financing is not dilutive to the entrepreneur unless and until they raise their first institutional round and the debt converts.  Convertible debt may or may not be secured.

Yes, angel investors earn interest on their debt.  But that is not the only compensation.  Angel investors deserve some sort of “kicker” for taking the risk of lending money (when no bank would) to a company with no assets.  In order to compensate for that risk, the company usually does one of two things:

• the company will issue the convertible debt accompanied with warrants to purchase common stock (usually at an exercise price of $0.01 per share).  The convertible debt will automatically convert at the next financing round (usually if it meets certain parameters as noted above) into the types of shares issued in that financing round and at the price per share of that financing round.  So if the angel investor loaned the company $250,000 and the next financing round sold Series A Preferred Stock at $0.75/per share, then the debt would convert into 333,333 shares of Series A Preferred Stock ($250,000/$0.75).  The angel investor keeps the warrant for taking the risk; or
• the convertible debt is structured to convert at the next financing round (again, usually if it meets certain parameters as noted above) into the types of shares issued in that financing round but it will convert at a discount.  The angel investor gets the discount for taking the risk.  Using the same example above, and assuming the discount was 20%, then the debt would convert into 416,667 shares of Series A Preferred Stock ($250,000/($0.75 x .8)). 

 Advice on raising angel money

• Be wary of the angel investor with only big company experience- I hate to generalize here, but for all the experience that former big company executives may have, the one thing they critically lack is startup experience.  In a startup, there are no big company budgets to create fancy marketing plans, or admins to run around making copies of the next investor pitch.  Not all former big company executives understand the mindset of an entreprenuer in startup mode.  These angel investors may disagree with you on where to spend your (their) money, how to market the product, etc.  At the same time, they may offer some big company strategies that fit well in the startup environment.  Just know the issue is there and be wary of it.
• Ferret out the tire kickers – In order to save enormous time during the fundraising period, do whatever background checking you can to ferret out which angel groups actually put money into companies versus which angel groups consist mainly of a bunch of bored retirees that just want to meet quarterly for dinner while networking and be entertained by company presentations.  The former is worth all your time, the latter you just need to ignore or use only as a practice run to work out the kinks in your presentation.
• Down economy means less angels- Many angels retrench in down economies.  Remember that these individuals invest their own personal funds.  When the economy hammers their portfolios, many angels will cut back on their angel investing.  This may seem contrarian since a poor economy may mean better investment opportunities (i.e., good companies with lower valuations), but it still happens.  See this article. 
• Take care to carefully craft the angel investment terms- As I noted earlier, a poorly structured angel investment could hamper or even kill your next financing round.  The goal is to provide the angel investor with reasonable terms without negatively impacting your next financing round.  One example of this is the discount rate on a discounted convertible note.  If the discount rate is too high, the Series A investors may take offense because the angel investors is buying into their round at a wonderful valuation.  Never mind that the angel investor is only being compensated for taking the early risk – it will still pieve the Series A investors and they may seek to have the angel investor adjust the discount as a condition to the financing round.

Other Interesting Articles On the Subject

• Article #1
• Article #2
• Article #3
• Article #4
• Article #5

I also enjoyed Jeff Bussgang’s article In VC deals, Price Doesn’t Matter – But the “Promote” Does.  It is a great add-on to my previous entry entitled Negotiating Term Sheets:  Should Entrepreneurs Focus on Valuation or Everything Else?  Jeff proffers a new term he calls the “promote,” in an effort to communicate the real value behind a deal and to take the focus off of pre-money valuation or post-money ownership.  It’s worth the read.

Finally, I thought David Feinleib’s article entitled When You Are the Product had some thoughful bearing on my previous entry Venture Conference Presentations.  He differentiates between pitching a customer (where you focus on the product you are selling) versus pitching an investor (where the focus is on selling yourself (and your company, market opportunity, team, model, etc.)).  One of my favorit points he makes is that it’s easy to forget that investors aren’t buying your product, they are buying a piece of your company.  So try and focus on the latter when you are pitching investors.

During the conference lunch I met a very interesting writer for Forbes.com – Maureen Farrell.  In addition to her written articles, she produces a video show called BreakOut!, in she which focuses on emerging growth companies with fresh, disruptive business models or products.  We got to talking about how to present at venture conferences.  For what it’s worth, here’s a list of my pointers (in no particular order):

• Consider who you are presenting to– There are two different ways of presenting the same company depending on whether you are presenting to a specific venture firm in their office versus pitching at a venture conference to an entire audience of venture firms.  In the case of the former, your presentation needs to be tailored to that firm’s style – get to know their investment profile, their current portfolio companies and spend time doing as much diligence as you can on what that firm looks for in presentations (speak to current portfolio companies or accountants and lawyers that are familiar with the venture firm).  In the case where you are presenting at a conference to an entire audience of firms, try to prepare a presentation that resonates globally.  Also, be mindful of what angels may be looking for in a presentation versus a venture firm.  If an angel has relevant industry or market experience (as many do), that individual may dig deeper into certain areas than a venture firm would.
• Answer the Question Asked – Make sure you listen carefully and answer the question that is asked, not the question you prepped for.  If the same theme in questioning is repeated numerous times, but in different ways – then you are not answering the question being asked.
• Relevant Experience in Team Members – Your team will have a leg up if it includes members with specific experience in the space or industry you are targeting.  If a company is pitching a new sporting good product, I would suggest that one of your team members should have specific relevant experience in sporting goods (e.g., a former buyer for Dick’s Sporting Goods, a former sales rep in that space, a former VP of Ops of Sports Authority, etc.).  Most investors, in particular angel investors, don’t want you learning a space or industry on their nickel.  Demonstrate you already have the talent that knows the space.
• Full-time – Be fully committed to your venture at the time of the presentation.  Venture firms are not going to put up a couple of million dollars for an idea that you don’t think is powerful enough to have already quit your job.
• Prep, prep and more prep – Talk to everyone that has experience in watching these presentations (e.g., venture firms, angels, lawyers and accountants) and learn as much as you can about what people expect and then practice, practice, practice.  Have your timing down perfect, and then be prepared to get pulled in different directions as people ask questions that may not be in the order of your presentation slides.
• Lifestyle versus Venture Backed – Know the difference between a lifestyle company and a company that could be venture backed.  Venture firms are looking for high growth potential in large markets.  Remember, they need to provide their limited partners with a return on their investment.  Many companies confuse a lifestyle company with one that is proper for a venture investment.  Lifestyle companies are just that, they provide a sufficient amount of money to live comfortably without working 80 hours a week, but they do not provide returns that are interesting to limited partners.
• Value Proposition – Explain in the first few minutes of your presentation who buys your product or service and why.  Give the value proposition up front.  There are lots of people out there that can build very cool, interesting technologies that fail to solve a problem for a customer and thus don’t have any buyers.  The products that sell are those that solve real customer problems.  “Build it and they shall come” doesn’t work in the VC world.
• Risks – Realistically present the risks faced by your company.  Any worthwhile company has them, otherwise there’d be no money to make.  Money is made off of the risk – otherwise, everyone would be doing it.  When you discuss the risks, demonstrate how you plan on mitigating them.
• Numbers that Make Sense – I’ve seen more than one presentation where the financial numbers on the slides didn’t add up, literally.  This is a sloppy mistake and one that can be avoided.  Have someone with “fresh eyes” review the final presentation and scrub the slides for those types of oversights.
• Be Honest – After you’ve seen a lot of these presentations, you get a sixth sense for who knows their stuff cold and who doesn’t.  No one likes have their time wasted with the latter.  If you don’t know the answer to a question, be honest – it may give you some credibility.  But I’d also suggest to offer to get that person an answer and do it quickly after the presentation.