Angel Investors Can Bedevil You
Angel investors are an invaluable resource – if you handle them right.
In 2003, three Brown University undergraduates, Eric Shashoua, Ben Rubin and Jason Donahue, sat in a school cafeteria and mused about their grogginess after an all-night study session. They knew that the stress of exams played a role, but they started wondering about the science of their exhaustion. Little did they imagine that their discussion would eventually lead to the founding of Zeo, maker of the first direct-to- consumer sleep device that analyzes nighttime sleep patterns.
Zeo’s product, the Personal Sleep Coach, uses a soft headband loaded with sensors to monitor brain waves. The data are sent wirelessly to a small device on a small device on a nightstand; from there they can be uploaded to the MyZeo.com Web site. MyZeo.com then analyzes the data and e-mails back a strategy and suggestions for improving the next night’s sleep.
However, once these three would-be entrepreneurs decided to create a science-based aid for the estimated 70 million Americans suffering from chronic sleep disorders, they realized they were lacking a key ingredient: an investor–or several–to fund their research and development. Initial fundraising began in the cafeterias at Brown. “We literally went table-to-table to talk about our innovation and get people interested in contributing,” Shashoua recalls. Those discussions led to introductions to wealthy Brown alumni, experts in sleep research and so-called “angel investors.”
Angel investors are individual entrepreneurs who provide start-up capital to other entrepreneurs to get businesses off the ground. Their investments are often the bridge between self funding and venture capital investment. The term comes from Broadway, where producers have long sought investors to help cover theater production costs. Today, angels support a wide variety of industries, including high-tech, biotech, movies and restaurants. Their levels of investment typically range from $150,000 to $1.5 million, and they commonly expect a five-year return rate of at least 30%. About a third of all angel investments result in a capital loss.
A growing body of angel investors pool their capital and share research information to make their investment decisions. They form what are known as “angel networks.” Members of an angel network can invest as a group or as individuals. The highest concentration of them can be found in Silicon Valley and Boston. Their funding levels are similar to those of individuals, multiplied by the number of people involved.
In the first three years, Zeo’s founders met with more than 400 potential angel investors and got money from 50 of them. But identifying those potential investors proved to be a lot easier than getting meetings with them.
“I called a director of one major company in sleep technology every other month for more than a year,” Shashoua recalls. “He wouldn’t return calls, and his secretary turned me down each time, but I would call back when I had news to share. Eventually he agreed to talk to me and became one of our most valued investors.”
There are more than 260,000 angel investors in the U.S. According to the Center for Venture Research at the University of New Hampshire, these helpers invested $19.2 billion in 55,480 companies in 2008, down 26% from the year before. Venture capitalists, by comparison, invested $28.1 billion in 3,630 companies, down just 10% from 2007.
Budding companies shouldn’t always take angel money, Shashoua warns. He says if your company has a vision that doesn’t fit with a potential investor, it’s better to not accept the dollars.
Benjamin Wayne, chief executive officer of Fliqz, a provider of video solutions for Web sites, agrees. Wayne, who has founded four companies since 1995, divides potential angel investors into two categories, amateurs and professionals. Wayne says the amateurs tend to invest based on what feeds their egos and become mercurial about their investments. “Angels often make emotional decisions based on very little data,” he says, “which would be almost funny if they didn’t have the ability to wield enormous influence over the management teams of their start- ups. It can truly be a case of the inmates running the asylum.”
Professional angels, on the other hand, are often people with serious operating experience. They can be very good at guiding early-stage companies through their initial growing pains, providing management experience, brokering early partnerships and mentoring first-time executive teams.
When you work with an angel network, you can worry much less about individual idiosyncrasies, says Stephen Viscusi, CEO of the Viscusi Group, an executive search firm. “Individual angels romanticize why they are making the investment. They have a passion for an industry they never had the guts to go into themselves; now they’re rich and can dabble in it. I always think people should call angel investments ‘devil money.’ In most cases, when angels don’t see a fast return on their investment, they turn into devils. They want the soul of the CEO.”
To avoid fracturing relations between entrepreneur and investor, you need to make sure your backers have realistic expectations. Explain all the risks, and undersell the likely return on investment. “Not all ventures go the way you want them to. That is the nature of the beast,” says Jon Black, CEO of the medical Web site CheckMD.com. “If you see red flags with a potential investor early on, pull the plug and move on to the next opportunity. If a current investor is unreasonable or is otherwise draining energy from the company after you’ve done everything you can to resolve his concerns, seek a way to end the relationship.”
Having the courage to walk away from a potential investor isn’t always easy, but Dewey Gaedcke, CEO of Minggl.com, agrees that some angel money is best left on the table. “We’ve avoided and refused money from all moral-agenda based groups such as right-wing Christians and pro-life enthusiasts, anyone who might want to control rather than empower users of the social Web,” he says.
Minggl (pronounced “mingle”) enables social Web site users to manage multiple accounts through a single sign-on. When potential angel investors aren’t familiar with new technologies, or in Minggl’s case with Facebook and Twitter and the like, Gaedcke advises them to bring along technology experts when they come to meetings. Those experts can help them evaluate market opportunities, explain the space and impartially observe progress.
Such technology experts often end up serving on the board and acting as interpreters between the founders, who might be very technically minded, and investors, who might not. Vinit Nijhawan, executive-in-residence at Boston University, observes, “Many of the strategic decisions made during board meetings require an understanding of the market. The investors on a board can have a healthy skepticism of the CEO’s position but be likely to accept an independent-industry expert board member’s views.”
Independent expertise is critical in the early stages, when strategy and market focus can gyrate wildly. Seymour Duncker, CEO of iCharts, recommends that as soon as you’ve got your money you focus on building up your investors’ trust in you. “You earn it by delivering on their expectation that you will take things to the next level and that you will earn them a decent return on their investment. The scenario that all angel investors dread is that the first time they hear from you after investing, you show up, hat in hand, telling them you need more or your company will go under.”
In the six years since those first table-to-table chats with Brown University classmates, Shashoua, Rubin and Donahue have raised $3.5 million from angels and an additional $10.5 million from venture capitalists. The Zeo Sleep Coach debuted on June 18, 2009. It sells for $400. An early review in The New York Times says, “The Zeo does make you a better sleeper.” Stay tuned to see if it repays its angel investors.
Date:
July 16, 2022