Earning an Annuity as an Angel Investor- Yes, Virginia it can be done

Similar to other investment options, an investment in a private company can produce annuity type income.   When starting out as an angel investor an investor should plan on making multiple investments with diversification of industry and structure as a core principal.  Accredited investors with sufficient liquid capital to make multiple strategic investments over a period of time, will likely diversify their portfolio of private equity stock investments to include multiple types of investment structures.   Similarly to an investor looking to get involved in real estate investments with different targeted outcomes; short term return (flip), revenue producing (rental), and long term (raw land). An angel investor should seek to diversify into multiple types of offerings:  debenture with option to convert (flip); royalty or revenue cycle financing (rental); and traditional equity (raw land).

In this episode of the Compassionate Capitalist Radio Broadcast (REPLAY) http://www.blogtalkradio.com/karen-rands/2014/03/25/earning-an-annuity-as-an-angel-investor  Karen Rands shares her insight into the different types of angel investments and specifically how to identify private alternative investment opportunities that can produce a re-occurring revenue stream.

The conventional wisdom for angel investing is similar to venture capital investing— invest in 10 companies, wait 5-10 years to discover which one or two of the lot produced a big enough return on the investment to make up for the 4 that lost all of the investment and the 2 that broke even and the 2 others that gave you just a teeny return.   It doesn’t have to be that way.   When wealth men and women apply the same discipline they have learned when managing their public stock decisions and their real estate investment choices, and seek to have a long term strategy that calls for diversification of industry and investment type, they increase their odds of a higher rate of return because they have balance and load.

Diversifying by industry and into market areas that an investor already has an interest ensures some level of insulation from the natural economic ebb and flow industries experience.   Diversifying by product / investment type allows for shorter term results off set by long term hold.   For example, an investor just starting out could “loan” money as an investment secured against orders with the option to convert or to have it paid back but with warrants, then they get their money back, but have an option for discounted equity.   After a couple of those types of investments, they begin to accumulate additional liquid capital that could be invested in to an offer for royalty or revenue cycle financing.   This is a type of investment that is made but instead of an equity stake, the investor received a re-occurring revenue stream as a % of revenue until an agreed to multiple on the investment is paid back, usually 4X the investment.  Companies with the potential for long term growth and opportunity to go public are ideal for equity investments where the investor will have their investment capital tied up and illiquid for 5-8 years.   This type of equity investment is the most risky, because a lot can happen in 8 years to cause a company to not succeed, but if they do, then the results can be 10X to even 25X return on investment.    Early investors in Microsoft, eBay, Amazon and many others all experienced this type of return.    Keep in mind though… for every one of those, there are at least 10 that never got that far and never gave a return on investment.   There are some, like the companies that went public with a big splash… Web Van, even Facebook,  that did not hold its value after going public, but the initial angel investors made their money back and them some, probably at least 5X if they sold when it first went public.

You have an opportunity to get more information on this type of diversification by listening to the podcast or buying the Inside Secrets of Angel Investing.    This is the topic discussed in detail in Chapter 5.   You can also sign up for free excerpts from the ebook, Inside Secrets to Angel Investing.

Are you an investor that is tired of the volatility and unpredictability of the stock market? Are you frustrated that you have little influence to affect the management or operation of that public company? Have you realized that the public stock market is actually pretty risky and the overall return on investment isn’t that great?  The Join the New National Network of Angel Investors and be a part of the growing community of wealth men and women that want to master their wealth portfolio and learn how to be Compassionate Capitalists  – make money and contribute to the economy at the same time. 

Found a great Blog Directory: Blog Flux

It seems so hard sometimes to find a good blog directory that actually will take you to the blogs on the content you are seeking information on.   I discovered BlogFlux and recommend it as the go to spot for readers wanting to find a source that is easy to navigate and to particpate in specific blog communities.   It is also good for bloggers who want have their blogs reach a growing community.

Blog Flux Directory

What is the best way to get started Angel Investing?

This question comes up now and then.   You may not even realize what you want to do is “angel investing”.   Sometimes when sophisticated investors are trying to grow their wealth they will talk about being a “silient partner” or “owning a piece of a lot of differnt companies” or even “loaning some money to a company that is just getting going and then having a little bit of stock after they pay me back”.   All of those conditions are variations on angel investing.  Very similar to deciding to invest in any new class of asset, when you decide to start investing in private companies you need to do a few things:

  1. Read up on it.  The Learn to Be an Angel Investor series of books (www.learntobeanangelinvestor.com)  is a good foundation since it is a compilation of many text book type books on angel investing written for entrepreneurs but interpreted for the investor by the author, years of experience in seeing the decision process in the works by experienced angels, and raw research on the Internet and elsewhere.  If you haven’t read Robert Kiyosaki’s, “The Cash Flow Quadrant” or “Rich Dad’s Guide to Investing” then you should.  Get access to a glossary.  There is one in the Learn to be an Angel Investor series, but you an also look up terms on “investopedia”.
  2. Attend Seminars and Workshops.   Although there aren’t a lot of seminars available regarding angel investing, there is the occasional Conference or panel discussion regarding angel investing.  The best one coming up is the Southeast Private Equity Conference (SPEC) in Atlanta on April 28th and 29th (www.sePrivateEquity.org).  This conference will have a number of break out sessions of specific interest to investors.  Also, you’ll have an opportunity to network with a 100 other investors and to learn from them and their insights.   SPEC Talk Radio, every Friday at Noon, will cover elements of the conference and new announcements http://www.blogtalkradio.com/Karen-Rands  The first episode contains an interview with SPEC keynote speaker Wes Moss and Karen’s insights into why early stage investing isn’t being impacted by the looming recession.
  3. Decide the type of returns you want to receive.   Just like real estate investing, you need to decide if you want a recurring revenue stream, a “flip” in a few months, or a long term big capital gain.    The recurring revenue stream happens when you invest through a royalty financing plan, debenture that pays interest only for a period, or into a legal entity that passes revenue through to owners (LLC, S corp).  A “flip” occurs when you provide bridge financing or contract financing that pays you back in a fixed period of time plus high interest, and sometimes has a sweetener with warrants for equity or actual equity.  The long term big capital gain is when you purchase the private shares at a low valuation and must wait until the company is bought or the shares are made available for public sale at a higher valuation.
  4. Determine your annual amount to invest.   It is OK to start your first year with the decision to only invest $50,000.   You might be able to invest that in two deals and at least hedge your bet by having two that might hit or offset a loss in one.  But, if you emotionally plan to invest $50,000, you should have the ability to actually invest $200,000.   Most angel investors allocate a portion of their portfolio or plan that as one class of asset liquidates (real estate for example) they will move that money into private equity to facilitate the diversification.   Or if they are an executive in a company. a partner in a law firm, or sales executive, then they may allocate their corporate/sales bonuses to go into private equity.  Once you are comfortable with the process, then progress up so you can be making multiple $50,000 investments in a year.   Then when one of those hits, you can diversify that return into private equity AND a long term, moderate risk asset.
  5. Gain access to high volume, quality deal flow.   The reason you want high volume (not hundreds, but dozens) is so you have choices.  If you only get to see deals your close circle refer to you, then you are limited in the variety of industry, stage, and type of offering. Or if you only look at deals your accountant or lawyer brings to you, then you eliminate the potential for the “wow” factor.   Sometimes you see an entrepreneurs presentation and go “wow!”, but it doesn’t have the strict industry or stage that you told your lawyer you wanted.  You would have missed that deal.  You want to know about deals your friends are investing in so you can also participate with them, assuming you trust their judgement.  However, by belonging to an angel investor club, you gain access to a volume pre-screened deals.  This will save you time by your not having to personally do the initial read on the plan to see if it has merit or meet individually with a company until you want to consider that opportunity seriously, and you  have the variety necessary to cherry pick the best deals. Ideally you can belong to a community with other investors that hold regular meetings in order to manage your time regarding reviewing opportunities and managing your investment budget.   Attend private equity conferences, in your region and in other regions that have a national draw.  Both the SE Private Equity Conference (SPEC) in April in Atlanta (www.seprivatequity.org), and the tri-annual New York Private Equity Conference in New York City (next is March 27th) put on by Starlight Capital and Segal & Associates (http://events.starlightcapital.com/events_list.asp) will have companies from across the country.  Don’t be afraid to invest in a good deal that is outside your back yard, just be familiar with the other local investors and the quality/experience of the management team.
  6. Narrow your focus on stage and industry.   Although you should stay open to every industry and stage so you can maximize your options and ultimate diversification within the class of private equity transactions, it makes it easier to get to a “short list” if you know you don’t want to invest in life sciences or high tech, for example.   On the opposite end of that is only belonging to an investment group that invests in one industry like technology or only companies that already have $500K in revenue.   Limiting your access to deals to a specific industry makes you more susceptible to economic influences within that industry.   The Dot-Bomb had the most impact on investors in the tech sector, not consumer goods or life sciences.    Only considering companies that have a half million in revenue is a way to minimize risk because you know the company can at least sell something.   However it is a false security blanket.  In no way does it guarantee that the company can become a $10M company or get to a liquidity event.  And by having that bar, you set yourself up to investing at a higher valuation than a company that is pre-revenue, you may miss out on a deal that goes from angel round (pre-revenue) straight to VC round with $1M in revenue. There are other ways to mitigate risk and ensure the company can execute than having a sizable revenue milestone as the mark.
  7. Finally, don’t go it alone.   If you aren’t in an angel investor network or club, then make sure you at least have 2-3 other friends that want to invest in private companies so you can have others that you can use to help evaluate the deal and won’t be evaluating from a pure financial or legal aspect but because as business people and sophisticated investors, they have the potential to co-invest.

Hope this helps.   Just like doing anything the first time, there is a certain risk of the newness and uncertainty and then the thrill of actually doing it.   First Love, First time riding a bike, first time traveling out of country…..first time making a private equity investment.   There may be pain along the way, but the journey and the end result when it works is worth every bump or bruise.

To get the full list of Free or Near Free resources, go to www.launchfn.com and click on the Information section.

Get your 5 Free Investor Tips Now! Go to www.getinvestormoney.com

Check out these investment websites: www.kugarandholdings.com, www.nbai.net, www.kyrmedia.com, and www.entrepreneurblogspace.com

How do you Know an Early Stage deal is a Good Investment?

An investor called me yesterday asking if I knew of any sources, or guides she could use to analyse a deal to see if it was a good investment.   It is challenging to make definitive decisions when investing in private companies because the information you would use to make an investment decision about  real estate or a public company are generally not available to the investor.   Yes it is true, you may not have a P/E Ratio to consider, or a robust balance sheet and historical financials, and much of their story is an attempt to predict the future.   Heck, they can’t predict the future in the stock market or the real estate market….otherwise no-one would lose money in those areas….so who thinks they can really predict the future of a private company that is early stage?

In reality, there are many things you can scrutinize with regards to a private company to determine if they are a worthwhile investment.   Keep in mind, the whole idea of being an accredited investor investing in private companies is that there is a strong likelihood you could lose everything.   Money invested in a private company should be money that is not needed, not needed to pay for your kid’s college education or anything else, but when it produces a return of 2x to 10x or more….you know exactly how you will spend it celebrating!

So what do you look for to mitigate risk when investing in the riskiest of investments?   The actual fundamental formula has been proven time and time again and is quite logical actually.   An Class A Management team with a B Grade product/offering is more likely to succeed than a Class B Management team with an A Grade product/offering.   It is kind of like one of those 80/20 rules….  80% of your business comes from 20% of your clients.   I don’t know why these things are almost always the case, they just are.    So the obvious next question is; How do you know you have a Class A Management team?   And that is simple….either they have built a company in the past that produced a return on investment to the founders and investors and/or they are currently executing on their business plan successfully.   Current and past performance are the greatest indicators of likely future success.    A blog entry at AlarmClock.com said it this way: “We have a template response: 1) Have made money for investors before 2) Have lots of users or 3) Have killer tech.”   (Full entry can be found in link below.)   Both 1&2 have to do with past performance and current performance.   #3 is the other thing you look for.   Does the technology or offering solve a fundamental need or gap in the market and therefore is there little to no current competition?  To build upon that, is the technology/offering protected so that it can’t be stolen or knocked off….protected by patents, copyrights or really well managed trade secrets?  And I’ll add a 4th point to look for….does the go to market strategy make sense and is well thought out?  Do they know how they are going to sell it, to whom, and for what price that makes a profit?    Finally, the decision to invest, after all the above bars are met, comes down to terms.   Sometimes an investor must accept the proposed terms the company puts forth in their Private Placement Memorandum.  Sometimes they can pool their funds with other investors and create leverage to negotiate different terms.     

So what is an angel investor to do?   The number one reason an angel investor that could invest doesn’t invest is because they are uncomfortable with the process….the due diligence process.  It takes a lot of time to meet with a company, review their due diligence, and assess these different strengths and weaknesses.   In our angel investor group, The Network of Business Angels & Investors (www.nbai.net) they manage this problem by having a firm do the initial screening to determine that the fundamentals are in place and if it is a management issue, then it is identified up front.  We use the Launch Funding Network’s screening process (www.launchfn.com) and have angel investor forums about every 6 weeks where companies that have been screened and scrubbed get the opportunity to tell their story.    This saves time for the investor because they get a volume of deals at once and they know that the “sniff” test has been passed.  

 Finding good deals to invest is a matter of having a system that can handle volume and having a community that you can co-invest with and share the due diligence work with.   Most Posting Sites don’t offer any of this.  They just post without any screening or validation.  If you don’t have a community to participate with,  you need to hire a small team to do it for you—lawyers, accountants, business advisors etc.    We like our “country club for Investors” approach.   Have fun and make money too!

http://www.thealarmclock.com/mt/archives/2008/02/fundability_lau.html#Permalink

 

To get the full list of Free or Near Free resources, go to www.launchfn.com and click on the Information section.

Get your 5 Free Investor Tips Now! Go to www.getinvestormoney.com

Check out these investment websites: www.kugarandholdings.com, www.nbai.net, www.kyrmedia.com, and www.entrepreneurblogspace.com

Should I invest in a web 2.0 company?

I was finally catching up on old magazines and came across a September issue of Business 2.0 and an interesting article “The Facebook Economy.”   We hear so much about web 2.0 social communities, so how does an angel investor determine the hype from the substance?  Do they watch this trend flame out or do they jump on the wave?  The danger of the hype of the web 2.0 companies is that we can get caught up in the same groundswell of exciting yet non-commercial concepts as we saw happen in 1998 with the flood of dot-com investment opportunities.  It is important to understand that “web 2.0” isn’t a new technology platform or a new World Wide Web, rather it references the changes in how software developers and end users use the web.  It is kind of like the difference in 2-D and 3-D video.   It is still video but in changing the way it is used, you create a whole new experience.  Visit http://en.wikipedia.org/wiki/Web_2.0 to get more insight into the start and evolution web 2.0.

The west coast angel investors seem to “get” the web 2.0 social community concept and invest seed and early stage capital.  The shock of the market value on such early market makers such as Myspace and YouTube got the attention of angel investors seeking the excitement of jumping in and being at the forefront of another trend.    The east coast private equity investors and venture capitalists seem to be much more hesitant for two very valid reasons: 

1.  It is hard to identify the shining golden apple from a whole bushel of apples…..   so many of them are popping up all over how does one know which one is the one that will make it when you don’t want to be the one that bet on Pets.com (the one with the sock puppet) , a pure Internet play, rather than the investment in a hybrid that made it like PetSmart.  

2.  Similarly to the dot.com bubble, the revenue models for the “social community” companies is often ill defined.   Therefore, individual investors have a difficult time understanding how the company will scale and produce an expected return on investment.   Wise early stage investors are wary of an exit strategy that is solely based on attracting enough users (eyeballs) to the become an attractive acquisition candidate, but lacks a strategy to create positive cash-flow.  Fundamentals of business should still apply regardless of whether or not a company is part of a hot trend or not.

 So here are 4 revenues streams that a web 2.0 “social community company” ought to address….either because it is included in their revenue stream or because it is not, and therefore why it is nota valid revenue stream for them….what is now being called the “facebook economy”:

  1. Sell Ads:  obvious and the most documented source of revenue for web 2.0 communities.   The problem is that it depends on the volume it drives.   The very nature of web 2.0 social communities is that they have a viral appeal that causes one friend to tell another friend and so on and so on.  That is very “trend” centric and anyone who has paid attention to trends know that the come and go and the Internet speeds up that process of fire to flame out significantly.    The whole world of pay per click and screen real estate selling is changing more rapidly than one can even forecast therefore it is an extremely unreliable source of revenue for a start up/ early stage company to build a whole company on.
    Take away:   if  a web 2.0’s company’s primary source of revenue is advertising they are a turtle with their head in their shell.
  2. Attract Sponsors:   This is a viable alternative to advertising in that the “sponsor” is advertising but to a very targeted group and often it is related to a symbiotic product or event.  It is similar to product placement in a movie or show.   When you see the stars of your favorite show drinking Budweiser instead of some unknown foreign beer or no name, you connect with that image. 
    Take away:   If a company has some focus group that it has been successful in targeting, sponsoring because a valid alternative to advertising….it is like the “infomercial” for an online alternative.  It takes longer to develop the validation of a sticky community, but can be much more effective because the community doesn’t realize they are being “sold to”.
  3. Sell services:  This is  as a result of the large onslaught of ancillary applications (widgets and plug-ins) that avid users of social communities use to enrich their experience.   Usually there is a “free” version to get started with and then a for fee version for an enhanced functionality.   
    Take away:  This is a very viable business model because a compelling application or service will gain a loyal user community.  Awareness often comes from others seeing the functionality or the use of that app/service and with built in click appeal, that company has a new user.   As an investor, you need to make sure the management team really understands the viral marketing strategy and knows what their target market will bear.   You don’t reach users and paying customers with a Google adwords campaign for this type of business model.
  4. Sell Products:    Typically, this is affiliate products being sold for pennies on the dollar.   The idea is “now that I have eyeballs at my site, let’s sell them something”.   It gets very compelling when the products are actually originated and centric to the community.   The products become popular in the same viral way the web community gets known and embraced.
    Take Away:  This is much more like an old school business model that has a new twist because the “store” and the target market is all virtual and none of the old rules and methods apply.   But given a management team with insight and knowledge on how this can be done, in part because they are part of the “facebook” economy as users, this can be very solid.

The article only listed the 4 revenue sources, and I’d like to add a 5th: Subscriptions.   We are seeing a trend where users are willing to pay a monthly subscription to get better or more services.   They can participate a long as they want for free for basic service or usability, but at some point their hunger for more will drive them to upgrade.   This revenue model has the greatest scalability and brings together both worlds:   Cash-flow and the hype of a large user community.   The other revenue streams (advertising, products etc) can add onto the foundation of subscription revenues.

Bottom line:  An early stage investment opportunity needs to have a plan to reach cash flow positive in the foreseeable future.   It doesn’t take a lot of money to launch a web 2.0 community and to make it known if the company knows how viral marketing in social communities works.   Often, the company will grow organic and have minimum friends and family seed investors involved and only seek significant capital when they are ready for the real push into the market and their platform needs to be enhanced to make it more robust to handle volume and incorporate new features.   This is a good time to get involved for an angel investor because the valuation is still low, but the basic market appeal and business model has been proven.

I welcome any insights you may have as investor who has invested in web 2.0 communities, the decision process you went through, or other insights you have gained regarding investing in this sector.

UPDATE  to POST 2/14/09.  

Statistics posted at www.techcrunch.com shows that the term web 2.0 is dropping off dramatically in search engines and in the way that companies describe their online business.   I commented that we have seen the same thing when companies submit their business plans to angels for investment.   I think web 2.0 isn’t going away or dying, it just isn’t novel anymore.  Companies aren’t using it to describe their companies because it as assumed they are integrating that functionality in any web design.  Like not calling your company a dot.com company by year 2000. 

How does an Angel Investor Mitigate Risk?

Risk in private equity investing is inherent in the process.   Often the greater the Risk, as in early stage the company, the great the Reward…if the terms are right.   Lots of “ifs” involved in angel investing.   You get the greatest return when you invest and the company has a low valuation.   But that is often based on not accomplishing many milestones yet.   Without the milestones to show a company can execute, the risk is greatest.   So what are some key milestones a company should have at the major stages of development?

Start Up or Seed Stage:

  1. Has a working business plan that delves into key areas of the business so they know what they don’t know and what they will need to get help on.   For example:  Figuring out the actual cost of goods when manufacturing.  Or will they hire sales reps or outsource sales etc.
  2. Has protected the product and offering with patents, copyrights, or at the very least explored it and determined trade secrets are best.
  3. Fully understand who their target market is and why they want to buy that product or service and what are they willing to pay for it.
  4. Have assembled a good advisory board, even if they don’t have the funds for a management team.   They should be people that have relevant experience.
  5. Has been able to raise a “friend and family” founders type round to at least get the $100,000 to $200,000 needed to build the balance sheet, pay for the patents etc, allow the CEO to actually be a full time CEO, and ultimately do the things that validate the business.

Early Stage:

  1. Building upon the seed start up stage, as a company enters into Early Stage they should have a finished product and either customers already buying or at least have a serious pipeline of customers they have been courting and will be buying.
  2. The money that comes in at this round should get them to cash flow positive.  
  3. They should be expanding management to include “execs with checks” or at least management that believes enough in the project to share risk through compensation from shares.  No Hired Guns.
  4. They should have analysis on the exit….do companies such as theirs get bought or go public.  Who in their industry has done either?  Who has bought companies like theirs.   Because if they know what they are going to grow up to be, they can put a plan in place to get there.   This is where you get your return, so this is important.

Expansion Stage

Angel Investors really don’t play at the expansion stage, and at that point the risk is still greater than a public company borrowing money from a bank, but not near the risk associated with Early Stage or Seed Start up Stage companies.  

 At just about every stage, you can also mitigate risk though the use of key-man insurance to protect in case something happens to the inventor/founder etc.   Also you can mitigate risk in the structure of the deal so that if the company has to go to a firesale, you can get all or most of your investment back when the company is liquidated.  

Angel investing can be very rewarding if the risk is appropriately mitigated.     

What is an Angel Investor?

Angel Investors are the start up company’s best friend.  Some say they are called “angels” because they are an answer to the entrepreneur’s prayer for money to get their business launched.  

Angels are the financial fuel of the economy.  Before Venture Capitalists get involved, before banks will loan a company an unsecured note; Angel Investors provide the capital that fuels the entrepreneurial spirit and helps inventions become products and ideas become reality. 

 Angels are wealthy individuals who provide seed capital and growth capital to companies in start up and early stage of their company’s lifecycle.  Their capital can be offered in exchange for equity in the company or as some specialized form of debt facility.  Investing in this stage of company is the most risky, but it can also be the most rewarding.  Rewards come not just from the financial returns, but also from experiencing the purest form of capitalism…bringing value to the market by supplying a product or service to satisfy a market demand.   There is a definite sense of pride and accomplishment from being able to say you were an early investor in a block buster like MicroSoft or Starbucks,  and surprisingly, there is little regret from the early stage investors in the near misses like WebVAN and PETS.com because they got their sizeable returns.   That is how it works for the wise angel investor.

Investing or buying Private Equity of early stage companies is one of the secrets the wealthy use to create more wealth.  As Robert Kiyosaki says in his book,  Rich Dad’s Retire Young, Retire Rich on page 127, “the rich invest in shares of a company when the company is still a private company”  This course (www.howtobeanangelinvestor.com) will teach you how to identify and screen opportunities for early stage private equity investing so that you have potential to reap the rewards of those early investors who took the risk and invested in MicroSoft or Home Depot.

What is Angel Investing?

Angel Investing is the industry term used to describe when a private individual invests money into a start up or early stage company before that company is public.   High net-worth men and women provide needed capital to entrepreneurs that cannot go to a bank to get because their company is still unproven.   Just about every company that ever went public, had at one point in time attracted the investment growth capital from individual investors.   And even in the case of flame out companies like WebVan, the angel investors in that deal made their money because they bought their shares at a lower valuation, say $1.00 a share, so that when the company went public, at say $25 a share, that investor made 25X their investment.   A $100,000 investment in a company such in that example, became $2,500,000.   That is how the rich get richer.   But it is never a sure thing so an angel investor must also be prepared to lose the full $100,000 if the company fails to execute on their strategy and go out of business before a liquidity event happens.   This is partly why the SEC regulates private equity investing in non-public companies and tries to ensure that only accredited investors make that type of investment.   Accredited investors have enough income or accumulated wealth that the government assumes they should know if an investment is good or not.