In the business world, angel investing "commandments" are wise principles

03 Dec In the business world, angel investing "commandments" are wise principles

Madison, Wis. – Imagine a young cape buffalo snatched away from its herd by a pride of hungry lions at an African watering hole. It’s a frenzied situation that gets even more bizarre when, in the confusion of the moment, an opportunistic alligator enters the fray and attempts to steal the buffalo calf.
It’s a seemingly hopeless situation for the calf – being pulled at by the alligator and the lions while the buffalo herd scatters. But while the lions are distracted by the alligator, a leader brings the buffalo into formation and drives off the attackers, saving the calf from certain death.
The scenario, which is real and can be viewed in an eight-minute online video posted as “Battle at Kruger” on You Tube, might seem familiar to those of you who’ve gone through the often-wild early stages of a business.
That’s what Teresa Esser thought when her entrepreneur/angel investor husband brought the video to her attention. She quickly recognized the business lesson in the scenario, and used it for a management class she taught for computer and electrical engineers.
“I wanted to keep my concepts very basic, and this story fit the bill,” said Esser, managing director of the Silicon Pastures angel investment group in the Milwaukee area. “You talk about what a strong leader does, and this video relates that in a very memorable way: A strong leader getting his team into formation to overcome great challenges.”
Overcoming the odds
The lesson can apply to numerous situations in business, but it’s most dramatic in the early stages of a business when the company is most fragile and, under the strain of great challenges, all hope can appear lost. Good management can overcome seemingly insurmountable odds, no matter when those odds are not in your company’s favor.
The video shows what appears to be a lead buffalo that, presumably, brought the group into formation. While the herd moves in on the lions, the “leader” charges the lions, at one point flipping one through the air.
“I was really impressed by that buffalo; it showed drive, guts and initiative,” she said. Those are all good leadership traits – characteristics that investors want to see in a management team before they agree to provide financing.
Teresa related the vivid water hole story to drive home the importance of good management as part of the recent Wisconsin Early Stage Symposium panel discussion of the “10 Commandments of Angel Investing.”
Milwaukee businessman Dan Steininger, who recently launched the Successful Entrepreneurs Fund with two other angel investors, culled the commandments from best practices he identified at angel funds throughout the U.S. They were a great topic of discussion for the Early Stage Symposium, which not only attracts investors but also entrepreneurs seeking to make connections and learn how to better position their ventures for investment.
Relevant for businesses at any stage
The commandments are relevant for businesses at all stages, not just start-ups. For example, Teresa noted how the existence of a good management team can increase the value of a company. That’s true whether your company is in its early stage or later on in its lifespan.
“These are basic rules that will improve any business at any stage,” said Dan, who has led a large corporation but now focuses on helping smaller firms grow. “It’s interesting to note that turnaround specialists also have these kind of rules. They are going into businesses that, in many cases, haven’t followed these rules at some level, and they are bringing the companies back in line with the rules.”
Whether you are looking for angel investment in your venture or just want to set your company on a more solid path toward increased value, it pays to understand how angel investors operate.
The advice is particularly important for Wisconsin, which, as Dan noted, still lags in key areas of business development, including start-ups and early-stage support. The situation is significantly better than it was just a few years ago, but we still have a way to go to match the entrepreneurial vibrancy many other states enjoy. There are now 16 registered angel networks in the state. The first was established in 2000.
As one of the panelists for the “10 Commandments” session, I was able to share insights I’ve gained by being involved in several technology-based start-ups, some of which were funded with outside capital and had successful exits. In these cases, economically beneficial efficiencies came from robust technology we developed. But the practice of sound business principles and a smart business strategy were just as important as the technology in propelling those companies.
Along with Teresa and me, the panel included Dick Leazer, a principal with Wisconsin Investment Partners and former managing partner of the Wisconsin Alumni Research Foundation.
While the panel was asked to discuss Dan’s 10 commandments, three of the rules seemed to draw the most interest and response from the audience. So I’ll focus on those three, and particularly on how to determine market demand, which is a big challenge for many businesses.
Management
Commandment No. 1, which Teresa addressed, relates to management and states: “Invest in good management that demonstrates an ability to execute the business plan rapidly, provide sound cash management, raise additional cash, lead the organization and adjust the business plan when necessary.”
Think of that cape buffalo who led his “organization” and “adjusted his plan” when his herd was attacked.
For Teresa and the investors of Silicon Pastures, the need for good management cannot be understated. Angel investors aren’t always insistent that good management be in place when you’re seeking financing. But if you don’t have a great management team, expect that angels will require you to assemble one as a condition of receiving their money.
It’s hard for many entrepreneurs to surround themselves with strong management. But we’ve seen the value to such a move time and again. Teresa says it’s one of the best moves you can take to immediately increase the value of your business, and to help ensure that your business idea is fully realized.
Boards of Directors
Commandment No. 2 also involves leadership, but in the form of boards of directors. Dan says that angels should “invest only in companies where the majority of the board is comprised of strong outsiders who possess solid business expertise and, wherever possible, industry expertise.”
Most companies don’t do a good job of creating a board of directors, Dick said. Ideally, a board should have equal representation of the company founders, investors, and independent industry experts – preferably not investors. It’s easy to come up with the founders and the investors. The problem many companies have is finding truly independent outsiders, Dick added. That’s especially true if you’re restricting your director search to the local scene in order to save money.
With three distinct factions on a board, any ideas would need to pass muster with at least two sides for the action to proceed. That lessens your chance of going in the wrong direction, especially when you have the insight of independent outside experts.
“A good board can keep you from doing some pretty bad things,” Dick said.
Product Need
The focus of No. 5 is product need. “Invest in companies that have an in-depth knowledge of their customers’ usage habits and needs – through to the end user.” The corollary is: Make sure the company creates “must have” products or services and does not waste money on “nice to have” features.
Commandment No. 5 is really about efficient use of resources, too. This is especially important in my world of software product development. When we develop customer-specific software, we focus on applications that will add value to a company and discovering the features the market truly needs and wants — i.e. willing to pay for.
Sometimes entrepreneurs get caught up in building a better mousetrap. That is “The Field of Dreams” approach. It assumes the entrepreneur knows exactly what the market wants — build it and customers will come.
How to discern true market demands
Making the process even more challenging is that the market does not always know what it wants. Studies have pointed out that in new software development, over 45 percent of features initially specified are never used and 19 percent are rarely used. That begs the question: Why are valuable resources being spent on features that have little market demand and that don’t add true value to software?
To overcome this dilemma, we use highly iterative and agile approaches to new product development. The good news is that these methodologies used for years in the software world can be applied in other disciplines. Although there are hundreds of books on the subject, the general theme is that working versions of a product should be put in the customer’s hands as early and as often as possible.
The customer is a collaborator from the outset. Documenting in grand detail is not done up front, with the belief that in new product development, customers have difficulty articulating what they want and their priorities will change. The process encourages changing specifications as the customer gains insight during development and use.
Can you identify buyers?
If you’re looking for an investment in your company or your idea, it’s essential that you can convince the angel that there is true market demand for your product or service, and that you have a viable plan to respond to that demand.
Ideally, you should identify customers for the product or service. If there are no current customers, you’ll need to identify willing buyers. If you can’t identify willing buyers, can you detail a comparable market? If your situation doesn’t match any of those scenarios, don’t bother seeking angel money. You’ll either need to further refine your product or service, or do a better job identifying market demand.
It’s not only essential to identify a market but also to show the angels how quickly revenue can be generated.
Other observations on Dan’s 10 Commandments for Angel Investors include:
• Instill confidence in angels by being confident about your business plan. Confidence doesn’t mean knowing everything; you need to be able to state what you don’t know, and explain how you would fill those voids.
• Have an exit strategy. Angels want a return on their money, and that comes from selling the company. If your plan is to build a long-term family business, go to a bank for financing.
• Be realistic in what you plan to pay yourself. You need to be willing to take a working wage and earn value through sweat equity as the company develops.
• The more you can differentiate your product or service, the more likely an angel will invest in it.
• If you think you’ll someday need angel investment, start now to get yourself known and established.
• Look for angel investors who know your industry; many angel networks focus on specific types of business.
• While angels will benefit from their investments, the companies they invest in are the greatest beneficiaries.
• The Wisconsin Angel Network is a great source of information for both angels and people looking for angel investments.
As Dan Steininger noted in remarks to open the panel discussion, the success and development of early-stage companies is crucial for a vibrant Wisconsin economy.
“We really want these entrepreneurs to succeed,” he said. “We wanted to send them a message that investors are not bad people who impose onerous conditions when they make investments. Sure, some of these things may be tough to follow, but by following them you can more effectively build a more valuable, stronger company.”
Previous articles by Geoff Bastow
• Pre-eminent, web-based companies owe success to corporate venturing
• Geoff Bastow: Corporate venturing can nurture software success
• Geoff Bastow: Connecture’s Maynard finds IT business opportunity in adversity
• Geoff Bastow: Web-centric entrepreneurs find models that attract investment
• Geoff Bastow: New Silicon Pastures director envisions more home cooking for Wisconsin angels