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SMART ANSWERS
By Karen E. Klein
FEBRUARY 3, 2000


To Angels, There's Nothing Heavenly about an Unprepared Entrepreneur

Get your management team lined up before you try to lure them

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Q:  I am planning to launch an online magazine and have been advised to submit a "strategic memorandum" to an angel investor for my first round of funding. What kind of information do I include, besides a detailed description of the magazine, and an idea of the competition? What do I write about business infrastructure and my management team if I have none?
—G.C., Los Angeles

A:  Unless you've approached a number of talented individuals who are committed to joining your fledgling company upon funding, you probably aren't ready to seek outside investors. Without a strong management team waiting in the wings, most angels won't risk their money on you. "A lot of funding is about people, and a lot depends on whether you can get the right people on board," says Janis Machala, a managing partner at Paladin Partners, a venture catalyst firm based in Kirkland, Wash. Try raising seed money from your own resources or go the "friends and family" route while you develop your concept to the point where it will attract some experienced partners.

Once you do that and have a team to present to investors, you can start circulating a "pitch document" — a three-page executive summary that showcases your idea and hits all the key points in your business model. Append financial documents, management team résumés, and perhaps a mock-up of your magazine. If this material is compelling enough, you may get some initial interest, says Jon Goodman, executive director of the EC2@USC high-tech incubator, who's been an angel investor herself for 15 years. The market is hot, she says: "In California, we are seeing deals funded without full-fledged business plans. Nobody has time to read them, and most of [the investing] is idle speculation anyhow because the market is changing so fast." Include a timetable and a projected exit strategy for investors, Goodman says, preferably an initial public offering or explain what might make the company a likely candidate for acquisition.

OPENING GAMBIT. Another, more formal document sometimes circulated among angel investors is called a "private-placement memorandum," Machala says. It discloses the risks associated with funding your company, includes a six-page (maximum) executive summary of your business plan, and concludes with the financing details. The executive summary should contain an overview of the market you're entering including key competitors, the potential of your idea to capture market share, any intellectual property that you own, a list of management-team members with credentials, a summary of your sales and marketing strategy, and details of how you will use the funding. If an angel is interested, he or she may send you a "term sheet" — the opening gambit in deal negotiations. The offer will include a valuation of your company. If an angel proposes investing $100,000 in return for 10% of the company's stock, that values the company at $1 million.

A term sheet is likely to be very complicated. Don't try to decipher it alone, Goodman says. Investors may demand preferred stock, an automatic buyout in the event of an acquisition, and a seat on your board of directors. They may make their investment contingent on your raising additional money by a certain date, and they may want the option to cash out at a particular price when your second funding round comes up. All of these possibilities could have serious consequences for your company.

"The first thing to do — without stopping at go — is to retain an attorney who has represented entrepreneurs in negotiations with angel investors before," Goodman says. The terms you accept determine how future investors will value your company. "A term sheet in the hands of an unsophisticated attorney or entrepreneur can prevent them from raising another dime." A qualified attorney who makes sure that you protect your idea is a must, Goodman says. "Entrepreneurs feel like their new company is their child. They're madly in love with it, and they see the money and convince themselves to go for it without being prudent about the terms and conditions that being put on that money. An unhappy result is not uncommon," she says.


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