5 Keys to Angel Investment
by Tim Berry, Guest Blogger
- Created: April 29, 2014, 5:36 pm
With this post I’d like to give my personal answer to the frequent question, “What do angel investors look for in a business plan?” I can’t promise that what I think applies to anybody else. But I’ve been in an angel investment group for five years now, and I’ve seen a lot of businesses evaluated. Here are five things I say matter.
1. A believable market definition
It’s not just the numbers. Especially not huge numbers that lack definition. Too many of the several dozen business plans I’ve read this year lack a good market-defining story. Market numbers are useful, yes, but they don’t stand alone. Investors want to believe the story first, then get the numbers.
The story is about the use case, also called “why to buy,” and market need.
I like the business pitches that put a picture on a slide and explain how that person has a problem that this business solved. For example, one recent pitch starts with a picture of a middle-aged woman and explained how this new business creates a channel for her to sell her craft goods effectively. Another pitch I saw showed a picture of the garbage area behind a restaurant to pitch a system to save unused food and make it available to people who need it. Then they go to the numbers, after explaining the need.
2. Believable growth plan
Startups become good for the early stage investors by growing. While there are some extremely rare cases where traffic and position alone created value (such as Amazon in its early days, Facebook, Twitter, Instagram, etc.), for most of us it takes sales growth.
Investors want to see and believe the growth plan. For example, if it’s a physical product to be sold in retail stores, there should be a plan for getting the product into distribution, and a sales forecast based on sales per store and stores’ growth by year. Or if it’s a mobile app, then sales growth based on potential user base and ways to drive traffic to the app via the various download stores.
Sales forecasts based on details are more credible. I liked a plan I saw recently that presented a forecast of sales of a product related to bars by showing actual sales in the first four bars and extrapolating those to all bars in the U.S. The methodology made sense.
Defensibility is whatever quality keeps a startup from being overwhelmed by competition that stunts its growth. Most investors look for proprietary technology, such as patents — when they are good patents that experts say will be reasonably defensible — or trade secrets. This is also called “barriers to entry.” There’s limited value to an idea that any other business can just copy.
The lack of scalability in most service businesses is why investors generally prefer product businesses and why the classic service businesses aren’t as attractive. The test is whether it can double sales without doubling fixed costs and employees. Most service businesses don’t scale: the classic consulting business, for example, or attorneys, graphic design, programming for hire… these service businesses are hard to scale.
With product businesses, when a widget starts selling in most cases you can make more widgets with automation.
And there are some service businesses that are scalable. Generally, they relate to software services over the web. The travel buyer sites are services, but they scale.
5. Potential exit
Angel investors make money by investing money in a business today and getting money back from that business in a few years when it grows, increases its value and sells out to a larger company or registers its stock for sale on a public market.
What many people don’t realize is that outside investors don’t make money just from owning a small portion of stock in a successful business. Theoretically, there could be dividends eventually, but growing companies don’t normally generate dividends. Angel investment assumes that the businesses create some way for the investors to sell their shares.
Having a minority share in a healthy, happy company – one that doesn’t need any more outside investment and has no reason to invite a larger company to purchase it – offers no return on investment for the early investors who aren’t employees.
About the Author
Founder and Chairman of Palo Alto Software and bplans.com, on twitter as Timberry, blogging at timberry.bplans.com. His collected posts are at blog.timberry.com. Stanford MBA. Married 44 years, father of 5. Author of business plan software Business Plan Pro and www.liveplan.com and books including The Plan As You Go Business Plan, published by Entrepreneur Press, 2008.
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