In researching for other blogs to connect to that serve insights and information to angel investors, I found Jesse Rasch’s blog. His blog entry from March 07: UnVenture Capital: An Alternative Approach to Startup Investing; contained timeless insights regarding the difference between angel investors and venture capitalists. Further, Jesse shares his criteria for making investments. Since we work with a lot of angel investors who are new to the process, his experience and insight is invaluable.

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Check out these investment websites: www.kugarandholdings.com, www.nbai.net, www.kyrmedia.com, and www.entrepreneurblogspace.com

I was finally catching up on old magazines and came across a September issue of Business 2.0 and an interesting article “The Facebook Economy.”   We hear so much about web 2.0 social communities, so how does an angel investor determine the hype from the substance?  Do they watch this trend flame out or do they jump on the wave?  The danger of the hype of the web 2.0 companies is that we can get caught up in the same groundswell of exciting yet non-commercial concepts as we saw happen in 1998 with the flood of dot-com investment opportunities.  It is important to understand that “web 2.0″ isn’t a new technology platform or a new World Wide Web, rather it references the changes in how software developers and end users use the web.  It is kind of like the difference in 2-D and 3-D video.   It is still video but in changing the way it is used, you create a whole new experience.  Visit http://en.wikipedia.org/wiki/Web_2.0 to get more insight into the start and evolution web 2.0.

The west coast angel investors seem to “get” the web 2.0 social community concept and invest seed and early stage capital.  The shock of the market value on such early market makers such as Myspace and YouTube got the attention of angel investors seeking the excitement of jumping in and being at the forefront of another trend.    The east coast private equity investors and venture capitalists seem to be much more hesitant for two very valid reasons: 

1.  It is hard to identify the shining golden apple from a whole bushel of apples…..   so many of them are popping up all over how does one know which one is the one that will make it when you don’t want to be the one that bet on Pets.com (the one with the sock puppet) , a pure Internet play, rather than the investment in a hybrid that made it like PetSmart.  

2.  Similarly to the dot.com bubble, the revenue models for the “social community” companies is often ill defined.   Therefore, individual investors have a difficult time understanding how the company will scale and produce an expected return on investment.   Wise early stage investors are wary of an exit strategy that is solely based on attracting enough users (eyeballs) to the become an attractive acquisition candidate, but lacks a strategy to create positive cash-flow.  Fundamentals of business should still apply regardless of whether or not a company is part of a hot trend or not.

 So here are 4 revenues streams that a web 2.0 “social community company” ought to address….either because it is included in their revenue stream or because it is not, and therefore why it is nota valid revenue stream for them….what is now being called the “facebook economy”:

1. Sell Ads:  obvious and the most documented source of revenue for web 2.0 communities.   The problem is that it depends on the volume it drives.   The very nature of web 2.0 social communities is that they have a viral appeal that causes one friend to tell another friend and so on and so on.  That is very “trend” centric and anyone who has paid attention to trends know that the come and go and the Internet speeds up that process of fire to flame out significantly.    The whole world of pay per click and screen real estate selling is changing more rapidly than one can even forecast therefore it is an extremely unreliable source of revenue for a start up/ early stage company to build a whole company on.
   Take away:   if  a web 2.0’s company’s primary source of revenue is advertising they are a turtle with their head in their shell.
2. Attract Sponsors:   This is a viable alternative to advertising in that the “sponsor” is advertising but to a very targeted group and often it is related to a symbiotic product or event.  It is similar to product placement in a movie or show.   When you see the stars of your favorite show drinking Budweiser instead of some unknown foreign beer or no name, you connect with that image. 
   Take away:   If a company has some focus group that it has been successful in targeting, sponsoring because a valid alternative to advertising….it is like the “infomercial” for an online alternative.  It takes longer to develop the validation of a sticky community, but can be much more effective because the community doesn’t realize they are being “sold to”.
3. Sell services:  This is  as a result of the large onslaught of ancillary applications (widgets and plug-ins) that avid users of social communities use to enrich their experience.   Usually there is a “free” version to get started with and then a for fee version for an enhanced functionality.   
   Take away:  This is a very viable business model because a compelling application or service will gain a loyal user community.  Awareness often comes from others seeing the functionality or the use of that app/service and with built in click appeal, that company has a new user.   As an investor, you need to make sure the management team really understands the viral marketing strategy and knows what their target market will bear.   You don’t reach users and paying customers with a Google adwords campaign for this type of business model.
4. Sell Products:    Typically, this is affiliate products being sold for pennies on the dollar.   The idea is “now that I have eyeballs at my site, let’s sell them something”.   It gets very compelling when the products are actually originated and centric to the community.   The products become popular in the same viral way the web community gets known and embraced.
   Take Away:  This is much more like an old school business model that has a new twist because the “store” and the target market is all virtual and none of the old rules and methods apply.   But given a management team with insight and knowledge on how this can be done, in part because they are part of the “facebook” economy as users, this can be very solid.

The article only listed the 4 revenue sources, and I’d like to add a 5th: Subscriptions.   We are seeing a trend where users are willing to pay a monthly subscription to get better or more services.   They can participate a long as they want for free for basic service or usability, but at some point their hunger for more will drive them to upgrade.   This revenue model has the greatest scalability and brings together both worlds:   Cash-flow and the hype of a large user community.   The other revenue streams (advertising, products etc) can add onto the foundation of subscription revenues.

Bottom line:  An early stage investment opportunity needs to have a plan to reach cash flow positive in the foreseeable future.   It doesn’t take a lot of money to launch a web 2.0 community and to make it known if the company knows how viral marketing in social communities works.   Often, the company will grow organic and have minimum friends and family seed investors involved and only seek significant capital when they are ready for the real push into the market and their platform needs to be enhanced to make it more robust to handle volume and incorporate new features.   This is a good time to get involved for an angel investor because the valuation is still low, but the basic market appeal and business model has been proven.

I welcome any insights you may have as investor who has invested in web 2.0 communities, the decision process you went through, or other insights you have gained regarding investing in this sector.

Karen Rands of Kugarand Holdings LLC. shares her insights about Angel Investing in this interesting podcast interview. Karen has raised millions of dollars for entrepreneurs! When Karen speaks, people listen to what she has to say about raising money! Launch Funding Network and The Network for Business Angels and Investors are successfully bringing entrepreneurs and investors together!

Listen and find out what it takes to raise the money that your company needs. Do you have what it takes to close the deal?

Check out Karen’s podcast page: www.kugarand.podOmatic.com

Listen, Learn, Enjoy and Share!

In addition, she is giving an offer for a free eBook! Visit:  http://www.LearnToBeAnAngelInvestor.com for the free ebook and excerpts.   Or get access to the final public version at www.kyrmedia.com/index.php

Check out Karen’s podcast page: www.kugarand.podOmatic.com

A recent article on the Fortune Small Business addressed this very topic: 

Angel investors operating in organized groups are seeing average returns on investment similar to those enjoyed by venture capitalists, according to a new study. 

The Article went on to say:

Kauffman Foundation and the Angel Capital Education Foundation, the “Returns of Angel Investors in Groups” study claims to be the largest of its kind. The study shows that organized angel investor groups in North America have seen average returns of as much as 2.6 times their initial investment over three and a half years from investment to exit. 

Therefore….

That’s an average internal rate of return (IRR) of 27%, similar to the average IRRs seen by private equity investors such as venture capitalists, who usually get involved in a business at a later stage of growth and are therefore commonly thought to take on less risk.

For the wealthy person, thinking about creating a greater yield from his or her portfolio, this is great news.  Yes there is great risk with angel investing, and it inherently it is unpredictable, but there are certain things that can be done to mitigate risk and you can set up criteria that helps you reduce the emotional element that causes some investors to invest when deep down they know they shouldn’t.

This also speaks to the value of having access to due diligence documents and access to groups of angels or other angels that can help mitigate risk, either because of their knowledge or just the collaboration that comes from multiple investors going in on an investment.

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:

1. 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.
2. Has protected the product and offering with patents, copyrights, or at the very least explored it and determined trade secrets are best.
3. 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.
4. 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.
5. 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.

Early Stage:

1. 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.
2. The money that comes in at this round should get them to cash flow positive.  
3. 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.
4. 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.

Expansion Stage

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.     

I was at an investor conference, the Progressive Investor Network, where Morgan Stanley’s Wealth Management group was the sponsor.   Their representative made a comment in his opening remarks….  “We have clients that come to me asking for a greater yield than the 4% they get in the bond market or the unpredictable, lack luster performance of the stock market these days.   They see Angel Investing as a way to potentially create a greater yield for a portion of their portfolio.”  

If that is the case, then why don’t more high net worth people jump in and do angel investing? 

It could be answered by the philosophy of the guy that we met later that day at the Buckhead Club.  This gentlemen was the founder and operating partner of a financial wealth management firm operating for decades in Atlanta managing trusts and large estates.   He called himself a “technician”.  The attraction of a greater “yield” was of little interest to him.   The idea of making 10 or 20 X your money wasn’t as appealing as having a steady predictable return.    He did concede that if he was to start a company because he had a great idea, he would put his own money in then go to his buddy Fred, and Fred might go to his buddy John, and they all invest to get the thing done and make money.   But Hey….isn’t that angel investing?    And wouldn’t Fred and John invest because they thought they would get a GREATER YIELD?

So the answer to the Million Dollar Question:   Can Angel Investing Create a Greater Yield?   Yes, absolutely, and great wealth has come from it.   The wealthiest invest privately in companies to get a greater yield.   Sometimes it comes from a friend of a friend.  Sometimes it comes from meeting a company at an investor event.   Their is Risk involved in all of it.  Fortunes have been lost in real estate that was bought with high interest at the wrong time….didn’t Trump almost lose it all from a real estate and credit slump about 20 years ago?   The stock market has robbed people of their retirement and their livelihood too.     It all comes down to this:    mitigate risk and diversify.

I’m working on book 6 of the Learn to Be an Angel Investor Series….and it will explore this topic in much more greater detail with bunches of stats and historic perspective. 

Angel Investors are the start up company’s best friend.  Some say they are called “angels” because they are an answer to the entrepreneur’s prayer for money to get their business launched.  

Angels are the financial fuel of the economy.  Before Venture Capitalists get involved, before banks will loan a company an unsecured note; Angel Investors provide the capital that fuels the entrepreneurial spirit and helps inventions become products and ideas become reality. 

 Angels are wealthy individuals who provide seed capital and growth capital to companies in start up and early stage of their company’s lifecycle.  Their capital can be offered in exchange for equity in the company or as some specialized form of debt facility.  Investing in this stage of company is the most risky, but it can also be the most rewarding.  Rewards come not just from the financial returns, but also from experiencing the purest form of capitalism…bringing value to the market by supplying a product or service to satisfy a market demand.   There is a definite sense of pride and accomplishment from being able to say you were an early investor in a block buster like MicroSoft or Starbucks,  and surprisingly, there is little regret from the early stage investors in the near misses like WebVAN and PETS.com because they got their sizeable returns.   That is how it works for the wise angel investor.

Investing or buying Private Equity of early stage companies is one of the secrets the wealthy use to create more wealth.  As Robert Kiyosaki says in his book,  Rich Dad’s Retire Young, Retire Rich on page 127, “the rich invest in shares of a company when the company is still a private company”  This course (www.howtobeanangelinvestor.com) will teach you how to identify and screen opportunities for early stage private equity investing so that you have potential to reap the rewards of those early investors who took the risk and invested in MicroSoft or Home Depot.

An individual is considered an “accredited investor” when they have sufficient income ($350,000 combined household income) and/or accumulated wealth of over $1 Million.

Angel Investing is the industry term used to describe when a private individual invests money into a start up or early stage company before that company is public.   High net-worth men and women provide needed capital to entrepreneurs that cannot go to a bank to get because their company is still unproven.   Just about every company that ever went public, had at one point in time attracted the investment growth capital from individual investors.   And even in the case of flame out companies like WebVan, the angel investors in that deal made their money because they bought their shares at a lower valuation, say $1.00 a share, so that when the company went public, at say $25 a share, that investor made 25X their investment.   A $100,000 investment in a company such in that example, became $2,500,000.   That is how the rich get richer.   But it is never a sure thing so an angel investor must also be prepared to lose the full $100,000 if the company fails to execute on their strategy and go out of business before a liquidity event happens.   This is partly why the SEC regulates private equity investing in non-public companies and tries to ensure that only accredited investors make that type of investment.   Accredited investors have enough income or accumulated wealth that the government assumes they should know if an investment is good or not.