Brock Blake: [music] This is Brock Blake, CEO of FundingUniverse.com. Welcome to our exclusive podcast series featuring the nation’s leading experts in entrepreneurship, angel investing and venture capital. In addition to producing this one of a kind series, FundingUniverse.com is a place where accredited investors may view hundreds of business plans from entrepreneurs across the country at no cost. Entrepreneurs compose their business plan on FundingUniverse.com and use our resources to take their companies from start-up to success. To start reviewing business plans, post a business plan or sign up to receive helpful newsletters with headlines from the world of entrepreneurship, visit www.fundinguniverse.com. [music]
When we decided to dedicate this week’s podcast to the art of angel investing, it didn’t take long to agree on the ideal subject – Bill Payne. Bill is, bar-none, the nation’s leading expert on angel investing. No one else in the country had spoken at more events, consulted more start-ups and advised more angel groups. He’s a current Entrepreneur-in-Residence at the Kauffman Institute for Entrepreneurship.
Pull out your pen and paper as FundingUnivers.com presents part-one of a two-part podcast series with Bill Payne
Bill Payne: [music] If you think about it, the entrepreneur has two hats on and they are really different hats. One is an investor hat; he’s got a large stake in the company. At exit, he’ll probably have ten to fifty percent ownership of the company; at the beginning he’s got a hundred percent ownership of the company – a very large equity stake. But then, he’s also got his entrepreneur-operating-CEO hat on which has a lot of ego attached to it. What I try to explain to entrepreneurs is we want to grow this company as rapidly as possible and build the highest amount of value in the company in the shortest period of time in the best interest of the investors; and you, Mr. Entrepreneur, are our biggest investor. So, we’re trying to build a substantial stake for you and your family. There will come a time, probably, when the growth of the company will be limited by your growth and management skills and your limited experience in operating the business. So, it would be in everybody’s best interest, including yours, at some point in time when we achieve a certain milestone to say, “It’s time, Mr. Entrepreneur for you and the investors to go higher, an experienced, surreal CEO who had known how to run a company in this ventricle and grow it to the next level.” That’s a tough thing for most entrepreneurs to bite-off but if you think about it especially with the investor hat on, it’s really critical to the success of the business.
I think, any angel investor who has invested in, let’s say, ten or more deals, can tick off all the mistakes they’ve made. Even on successful exits, we usually have made lots of mistakes. Sometimes, we didn’t do the resume checks well enough and discovered we have invested with somebody who’s credentials are what they said they were. But, usually, it’s not that. Usually, we miss something in the business plan. One of my favorites is the sales cycle. The sales cycle is how long it takes from the time you first approach a customer to actually close a sale with that customer. You probably won’t be surprised to know that if you’re selling a product to a small business man, that sales cycle could be a day or a week. And, if you’re selling that to a large government, that could be a year or two years. If you think about the sales cycle, it’s really a critical ingredient in the use of cash of the company. Let’s assume that you assumed the sales cycle is three months and you based all your financial statements and your use of cash on a three-month sales cycle, and the sales cycle proved to be six months. You could just bet your bottom dollar that that company is gonna run out of cash before it achieves the milestones necessary to have a positive cash flow.
So, sales cycle is just one example of the many kinds of mistakes that we, investors, and we, entrepreneurs make when we’re trying to design a business plan and figure out what our cash run-away is. How long will our cash last before either we have to raise more capital or we achieve positive cash flow and can grow our own internal earnings?
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There are many aspects to a successful business plan. The top two in my mind are the management team and the scalability of the business. In order to justify angel or venture capital, a company has to be able to demonstrate the opportunity to grow rapidly because angel and venture capital investment is highly-risky. So we, investors, expect a very large return on our investment. Many of the investments we make go belly up and so those that succeed need to provide us with a substantial return. So, you will not find angels or venture capitalists who will invest a million dollars in a company, who in five to seven years might have ten million dollars in revenues. They have to scale more than that. So, we’re looking for companies as angels if only angel money will be required that will scale to, say, fifty million dollars, thirty million to seventy million dollars in revenues and therefore valuation in five to seven years. Venture capitalists will seldom look at a deal that they feel doesn’t have a chance to get to a hundred million dollars in valuation in five years. We’re both looking for companies that will scale.
Investors are also betting on the management team. There’s a pretty standard adage among investors in early stage companies that we would all rather bet on an A team in a B product than an A product in a B team. Why is that? Well, an A team with a less than stellar product can come up with a stellar product. A B team may not be capable of executing on a business plan with an A product. So, we always like to bet in the jockey. What does a management team mean? Well, at a very early stage, we would love to have a surreal entrepreneur who is starting his fourth or fifth company and we’d love to invest in that experienced CEO and entrepreneur; but, seldom do we find that. So, what we’re interested in are entrepreneurs who are knowledgeable in space, who have some management experience in other businesses in their lives, but, especially, those who have a passion for the business and a great integrity. So, we’re looking at things like motivation, integrity, enthusiasm for the business and knowledge of the space, and the ability to build a team and work with others
We like to talk to entrepreneurs, especially first-time entrepreneurs, before we ever make the investment in a company to discuss with them how far they can take this company. To approach an individual investor, I think that the entrepreneur must understand that the investor needs a very clear, concise and quick understanding of the investment opportunity (i.e. I’ve got a good product, it does this, we can sell it into these markets and build a company up to this many million dollars of revenues and the amount of investment will be this many hundred thousand dollars). The mistake that entrepreneurs make is they spend their whole time with the investor at the first exposure talking about the product and the technology. Maybe not even the product; they’re talking about the technology. The product and the technology are important, but, they’re just one of many important pieces to the puzzle of the business plan. The two pieces that entrepreneurs need to have at their fingertips are the elevator pitch which is a two to three-minute explanation of their entire business plan that they can use to get investors excited about the opportunity, and the executive summary which is a two or three-page written document that they can introduce investors by mail or electronically to the investment opportunity.
So, that’s how entrepreneurs approach individual angels using their elevator pitch and their executive summary. We do pretty extensive background check. You will find angel organizations that do credit checks, criminal checks, etcetera, but we also check references. We ask for half a dozen references, we talk with them and we get other references from those references. Frankly it’s when you get about three deep on those references that you began to learn how really good this person is or you begin to uncover some issues that may question whether you want to invest in this company or in this entrepreneurship. But, we do extensive interviews and resume checks on the entrepreneurs of the investment.
I think that Funding Universe is providing a great service to the entrepreneurial community by making it possible for local angels and local investors to reach one another when they are outside of each other’s personal networks. Funding Universe is also developing software that allows angel organizations to manage their deal flow, and I think several angel organizations are discovering that this is a valuable tool and one of the critical components of sustaining angel organization. And, I think that Funding Universe was founded my right-minded people who really want to see entrepreneurship grow in this country and entrepreneurs get funded by right-minded angels.
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