Fund Raising in a Recession

While it seems the Pacific Northwest may be shielded from the worst effect, each day it appear clearer that the country is headed toward recession (if not already fully enmeshed in one). Consumer spending, the engine of the most recent economic boom is drying up, with the problems in the capital markets trickling down to the lowest levels.

We thought it would an interesting time to address the question of how this will affect angel and venture capital investing. Typically, angel money dries up first during a serious recession as angels have no need to spend those dollars on investments. Looking at the dollar amounted invested by the Alliance of Angels over the last 10 years, it closely mirrors an graph of the US economy with about a one year lag. Thus far we have yet to see any real drop off in investments but it is something we will keep our eye on.

Different theories abide on Venture Capital investments during a recessionary period. One one hand, ad revenue dropping will hurt start-ups depending on that strategy and require VC's to keep more money reserved for follow on investments. On the other hand, VC's with a fund already raised will need to find opportunities and valuations on good prospects should fall.

Any entrepreneurs out there- how are you finding the current fund-raising process?

"Conservative" Financial Projections?

As program managers here at the Alliance of Angels, we see 20+ pitches per month. As you might guess, out of those 20+ pitches, we rarely see even one that doesn’t have “conservative” projections. :-) However, we’ve found that investors aren’t as interested in conservative projections as they are in transparency. We find that “aggressively reasonable” projections coupled with full disclosure of the assumptions behind the projections gives investors what they are looking for. This way, investors can see the scenario the entrepreneurs are shooting for while having the information they need to develop their own scenarios.

Other keys for building good, transparent, believable projections include:

• Build from the ground up - avoid building projections that are simply based on taking a percentage of the market.
• Display the projections in an easy to read bar chart.
• Include the key driver(s) (# of customers? # of sales partners signed?) in the bar chart
• Make sure your market analysis, go to market strategy, and projections are all 100% in sync.

Investors love to see a good looking hockey stick at the end of a compelling pitch – just back it up with a full set of assumptions and they’ll have the information they need to decide for themselves if the projections make sense. For a sample financial projections slide and other information about building a great pitch, check out our sample deck or enroll in one of our popular pitch clinics.

Record-breaking Investments in 2007: The AoA Play-by-Play

Here at the AoA we think transparency is a good thing. Plus we're data junkies. Below please see a few facts and figures from our record-breaking deals in 2007. If there's anything you'd like to know and don't see, we can pretty much slice and dice our stats any way that may be of interest, so don't hesitate to email us . Also feel free to post a comment (if you didn't get enough from the thread following John Cook's blog); this month the topic of angel investing has ranged from spectator sport to bench-clearing brawl.

As with any sport, we have our own ground rules for reporting:

• We only report investments made in companies that were screened, coached and selected to present to the Alliance of Angels membership. Red flag: some groups report all investments reported by their members, regardless of whether or not the angel organization was involved.
  
• We clearly distinguish "direct investment" (our own members' investment in the companies described above) from "indirect investment" (additional investment our members facilitated through their network). Yellow flag: some groups will consolidate both categories into a single group of "facilitated" investment.
  

Just the stats, ma'am:

• 174: companies interviewed, coached, screened (90 minute meetings)
• 32: new investment opportunities that were selected from the above, and presented to our membership
• 15: investments in new companies (just about 50% of the new opportunities reviewed by our membership).
• 9: 3 minute updates made by companies who had previously presented and were funded by AoA returned to give brief presentations when seeking another round of funding.
• 8: of these 9 received follow-on funding
• 21: additional AoA portfolio companies from prior years received follow-on investment from our members.
• 44: grand total of AoA investments tracked in 2007.

Show me the money:

• $3.9 million tracked in direct funding from our membership, in AoA companies
  
• $3.3 million in additional sources facilitated by AoA ("indirect" funding)

• 87% of the new companies who received investment were high-tech
• These deals received 85% of the total direct dollars (the other 13% of deals, 15% of dollars were consumer product and retail).
• 93% of companies receiving follow-on investment were high-tech, and received 92% of this category of funding (correspondingly, 7% of the deals were consumer/retail and received 8% of the dollars)

For more fun with stats, and some color commentary, check out our press release.

Debt vs. Equity-Battle Royale

At our first members-only fireside chat of 2008 we enjoyed a lively discussion about valuation trends and the merits of debt vs equity with top notch participants David Clarke (partner Perkins Coie), Peter Parsons (partner Davis, Wright, Tremaine), Geoff Entress (Madrona), Robert Headly (Ignition), and Dan Rosen (Chair of Alliance of Angels). With the panelists addressing the issues from the point of view of both investors and entrepreneurs it was a night to remember. Some insights gleaned from the discussion

Valuation

• "More of an art than a science"-Geoff, who went on to remark that you could always try to use a DCF but more than likely it will end up getting thrown away.
• Peter-Angels need to be careful not to be too generous in an A round because they will get crammed down by VC's in the next round.

Term Sheets

• Robert-VC's may get nervous if a company a large number of individual investors (e.g. >30).
• Geoff-In an angel deal find terms consistent with what VC's will look for later on to minimize attorney fees.
• If you are going to pursue more than just friends and family money, convert an LLC to a C-corp early on to save yourself a headache.
• Option pool-be analytical!! Think about necessary hires and what they will expect (eg. CEO 7-10%) and craft size of option pool to conform to needs for that round.

Convertible Debt vs Equity

• Have a clear end point (next round of funding) in mind with convertible debt-6 months is normal outer limit for the next funding to occur. David suggested setting a cap on valuation if there are questions about the timing of the next round.
• Between the attorney's and VC's on the panel the market discount rate for convertible debt appears to be 25-30% with some cases of the rate escalating month to to month after a certain point.
• In a debt deal, make sure to note what will happen if a sale occurs before the next round of financing-set a valuation or an agreed upon return for debt investors.

Expense Budget for an A round

• David gave an estimate of company counsel costing $50K and investor counsel between $25-35K for a normal series A venture round, with an angel round costing perhaps 2/3 of that. Although Peter, in a friendly dig at the competing firm, noted that perhaps Perkins is on the high side and his experience showed it to be a bit lower.
  

Update 5-22

• Since we are still seeing quite a number of debt deals coming through our process I thought it would be interesting to link to a new article contending that convertible debt is a bad deal for angel investors. The arguments put forth in the article are the same we have been making here at the Alliance for some time, regarding the instances where convertible debt is an appropriate instrument. It does make the interesting addition that debt can be a good deal if there is a cap (agreeable to the investors) on the pre-money because in the event of a negative exit, debt holders will at least have first right to any assets...
  

Alliance of Angels Portfolio Roundup: Merry Funding and Happy Series A

Several AoA Portfolio companies have closed out 2007 by closing out their funding rounds…read on for a snapshot. Congratulations to all!

• Fyreball: Bellevue, WA. According to CEO Pete Parsons, “Fyreball is a rich and playful alternative to email for sending stuff to your friends. It's being developed by a team of game industry veterans, internet addicts and Spartan warriors. We think Fyreball will be a great way to track, send and receive cool content on the web.” We agree! We’ve tried it and it is contagiously fun. We could tell you more but we’d have to kill you. Or sign up yourself.
  
• Pete comments: "The Fyreball team is honored to be working with the Alliance of Angels. We look forward to the support, counsel and feedback of this outstanding group as we work to make Fyreball great."
• Additional press for Fyreball: San Jose Mercury News, John Cook's blog (twice)

• Green Couch Conspiracy- Seattle, WA. These guys are as local as you get- Garfield High grads with street cred that includes bootstrapping their first start-up (Serials Solutions) to a successful acquisition. Co-founder and CEO Steve McCracken describes: “CultureMob.com is a new site offering personalized local events discovery: music, movies, theater, sports, and more. Our philosophy is to release early and iterate often. This a fraction of what we'll be releasing over the upcoming months.” Check it out here.
  
• Steve comments: "Thanks again for all the support that AoA provided during our recent fund-raising round. We were able to subscribe the entire round in approximately 60 days "deck to check." AoA played an important role in that, both as a partner for helping us refine our pitch (this was our first time seeking outside funding), and introducing us to prospective investors. I've encouraged several entrepreneurs to contact you."
• Additional link: A mention on John Cook’s blog.
  

• Elemental Technologies- Portland, OR. CEO Sam Blackman got the band back together from Pixelworks to create a GPU-based video processing software solution…the holy grail of better, cheaper, faster software for professional video applications. With seed funding from Pixelworks, Elemental closed out this $1.05M round with groups including the Oregon Angel Fund, Bend Venture conference, and AoA. Learn more here.
  
• Additional press on Elemental Technologies: The Oregonian, Northwest Innovation, Oregon Live
  

Is there room in BioTech for Angels?

Recently at the Alliance of Angels, we have been confronted with the issue on whether biotech deals can work for angel investors. Traditionally, individual investors have regarded many of these types of deals (and rightfully so) as extraordinarily capital intensive and unfriendly for angels, as there is often no clear exit in the near term. Three letters alone, FDA, are enough to send most angels running for the doors.

But, is there a model out there in which angels can participate in the enormous upside potential without being entirely diluted by the tidal wave of follow-on financing. Getting all the way through phase 3 of FDA trials can cost a company hundreds of millions of dollars, but will generally assure a lucrative acquisition. However, if a company can get to mid-stage clinical testing, can they justify a high enough valuation and secure an exit at that point???

• Dan Rosen, chair of the Alliance of Angels feels that dilution is not necessarily the only concern. “In a deal where you are raising $50M the possibility of having to raise unexpected rounds increases, as does the likelihood of a down round. For an early investor holding a small equity stake, can you hold your share during a down round?” This is a concern to all early-stage investors in these companies, but particularly to angels.

One interesting model with which we have recently become familiar comes out of our own backyard. The Ratner Biomedical Group, led by Buddy Ratner at the University of Washington, works extensively in the areas of molecular bioengineering and nanotechnology and spins off successful ideas as independent companies (two of whom we have seen at the A of A, Healionics and Calcionics). In this type of model a company might come in seeking to raise a small initial round, perhaps around $1M to work through pre-clinical development milestones. Later rounds are planned to get the company through mid-stage clinical trials, but smaller numbers for the Bio Tech world- with figures that might be in the arena of $35M in future financing.

The argument for these type of investments is that although $35M has a significant dilutive effect for an early investor, however we have seen those type of follow-on numbers in other industries and the upside in Biotech is tremendous. Who wouldn’t want to be holding .01% of a billion dollar company? Bio Tech (even minus Med Devices) reportedly made up 10% of Angel investments in 2006-so someone is playing. If nothing else it can be a great addition to the riskier side of an individual’s portfolio.

AoA in the Community: November Activities

Having reached over 500 entrepreneurs with variations on the theme of our "10-Minute Pitch" clinic, we thought we'd list some of our pro bono speaking events this month. Feel free to contact us if you are a non-profit or academic institution looking to provide tools to your membership on how to effectively engage the investment community.

November 7, Science and Engineering Business Association, Entrepreneurship Week
“Perfect Pitch” workshop: 2-4 PM, Foege N130A.
In this hands-on workshop, the Alliance of Angels offered engineering students tips on how to structure a business plan and proposal, as well as how to use the language and concepts of business and investment to build a management team. We'll certainly keep an eye out for these entprepreneurial PhD's at the University of Washington's Business Plan Competition.

November 7, Venture Capital Investment Competition Class
Guest lecture at University of Washington, 6:30-7:30 PM
This course is led by Susan Sigl of Seapoint Ventures, and designed to prepare students for the Venture Capital Investment Competition. This now international competition has an 11-year history, and University of Washington teams have taken first place twice in the last three years. Helping students gear up to take back the championship, the Alliance of Angels offered their "Think Like an Investor" workshop to the class, comprised of both MBAs and engineering grad students. Students should be forewarned that should they succeed in winning the $10,000 purse, they'll also be stuck with the bar tab at the competition in lovely Chapel Hill.

November 10, 2007. American Society of Mechanical Engineers' Invention to Venture Workshop.
Seattle Sheraton Hotel, 9 AM- 5 PM
Hosted by the American Society of Mechanical Engineers and sponsored in part by the Technology Alliance, this all-day workshop was designed for the science, engineering, and technology communities, as a one-day "entrepreneurship boot camp" that teaches technology entrepreneurship basics. The AoA tailored its pitch clinic to a high-impact “Perfect Pitch" presentation, offered to to engineers, student teams, investors, and members of the ASME and NCIIA(National Collegiate Inventors & Innovators Alliance).

November 30, University of Puget Sound School of Business and Leadership
Guest lecture, 9AM-10AM, McIntyre Hall, Room 108
In our third visit to Professor Lynette Claire's classroom, we tailored our workshop to a group of undergraduate business students seeking to fine-tune taglines for their start-ups. The "Elevator Pitch" presentation has now been offered to some 60 UPS aspiring entrepreneurs.