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:
- 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.
- Has protected the product and offering with patents, copyrights, or at the very least explored it and determined trade secrets are best.
- 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.
- 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.
- 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.
- 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.
- The money that comes in at this round should get them to cash flow positive.
- 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.
- 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.
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.