Notes from Seminar: The Power of Angel Investing

I attended the first half of a seminar yesterday at the University of Utah by the Kauffman Foundation on angel investing. Kauffman does a lot to promote entrepreneurship. They have presented this “Power of Angel Investing” seminar more than 20 times. Led by Entrepreneur-in-Residence Bill Payne, the presentations and materials were designed to help people become angel investors or to learn how to be a smarter angel investor. I found it very worthwhile (especially from the standpoint of an entrepreneur trying to discover how angel investors think.)

Angel investing is becoming more organized and more professional with the formation of the Angel Capital Assocation which is holding its 2005 Summit in San Francisco on April 3-5. I wish their web site has a list of members. They don’t, but Gaebler.com has links to angel investor groups in almost every state.

I keep wondering why more investors don’t do more seed stage investing (because it is so much fun), and after seeing this chart from Venture Economics and the HFRI Equity Hedge Index (2001), my wonderment has increased:

Historical 20-Year Returns

Seed Funds, 22.4%All Venture Funds, 18.7%Hedge Funds, 18.7%Buyout Funds, 16.5%S&P 500, 14.9%NASDAQ, 13.2%

One VC yesterday admitted that most VCs have a Lemmings or herd mentality. If Kleiner Perkins makes an investment in networking technology (or whatever example he used), then all other VCs scramble to find a similar deal. If JP Morgan does a medical devices investment, everyone flocks to similar deals. (As an example, remember the flood of social networking deals 1-2 years ago.)

One counter example is Draper, Fisher, Jurvetson. They continue to be 1-2 years ahead of most other VCs. They are definitely risk takers and pathfinders. From internet (Hotmail) to open source (SugarCRM) nanotechnology (multiple deals) to Voip (Skype). I even loved their experiment with meVC, a venture fund that was publicly traded to help the little guy get into the big investment deals. In fact, if you want an awesome experience peering into the future, spend 30 minutes studying each of a few dozen of the 250 companies in the Draper Fisher Jurvetson portfolio, especially those funded in the last 2-3 years.

I came away yesterday with hundreds of pages of resources for angel investors and notes on valuation methodologies and deal structure suggestions.

One of the most valuable things I picked up yesterday was this link to a set of public domain model legal documents created by the National Venture Capital Assocation. The docs include a model Term Sheet, Stock Purchase Agreement, Certificate of Incorporation, Investor Rights Agreement, Voting Agreement, Right of First Refusal and Co-Sale Agreement, Management Rights Letter, Model Opinion Letter, and Model Indemnification Agreement.

I know this list of docs is completely overwhelming for young entrepreneurs, but sooner or later you’ll probably need to understand the major elements involved in each one, why they exist, and how you can make sure that your deal is not unfairly favorable to the investors. As Bill Payne mentioned yesterday, angels are pretty tolerant of founders, and usually let them stay around for a long time even if performance isn’t great, but VCs are much more likely to replace the founders quickly. Before you take capital from anyone, you should realize why they might dump you and how, and what you may end up with.

Bill Payne has invested (if I recall) if more than 30 deals. Here are some of his guidelines for angels:

  • He likes to do due diligence and term sheet negotiations simultaneously. He does due diligence to validate the claims of the business plan.
  • Angels should use a due diligence checklist. (We got a 6-page list in the handouts. I think entrepreneurs should see some due diligence lists to prepare themselves for what might be asked. Here’s a shorter due diligence checklist from Heartland Angels.)
  • Angels and VCs don’t sign NDAs. Business plans and exec summaries don’t need to disclose secret sauce. If there is secret sauce (like source code or a patentable idea), a very specific NDA can be signed when it is disclosed.
  • Don’t require the entrepreneur to be both visionary and operationally strong. It

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