How To Be An Angel Investor

Assessing Plans For Growth

With benchmark metrics in hand, you can measure a business' plan for growth.

• Growth Strategy:  The business should be able to concisely describe how it plans to drive growth. I would almost always trust a small list of big drivers over a long list of little ones.
  
  

• Target Metrics:  As you assess the plan through metrics, a company’s aggressiveness will reveal itself. Be mindful that the law of diminishing returns will make some metrics less efficient over time. My lead investor would never tolerate a plan that didn’t plan for ad spend to increase as a % of revenue over time, and experienced teams will know this.
  
  

• Prior Experience:  You may find the most comfort in a plan that builds upon success the company is already experiencing. In an ideal world, growth mechanisms can be quickly proven before being amplified.
  
  

Investors try as hard as they can to project whether a team can achieve its plan. However, as I’ve seen experienced investors do this, they’ve also done something else: look for how a team will respond when things go off the rails.
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Sensitivity Analysis

Modeling alternate scenarios accounting for when targets might not be achieved is called a sensitivity analysis. Experienced investors require it.

• Sensitivity Model:  We perform sensitivity analysis by creating a carbon copy of our pro forma model that projects our entire business based on an alternate level of sales, fundraising, etc. to produce a projection of profitability and cash.
  
  

• Contingency Plans:  I prefer sensitivities that do not consume every last contingency to survive. It’s OK to adjust the business under new circumstances. But it must retain additional resources in case the new plan is off too.
   
  

Driving growth is hard. While there is merit in swinging big, I am uncomfortable with founders who cannot distance themselves enough to see their own business with a clear eye. 

Financial Levers

With targets set, you need to understand how your capital will make a positive impact to grow the business. We call these opportunities levers.

• Documented Levers:  The levers should be simple and clear. In the case of Bluffworks, we are raising funds to purchase inventory and increase paid advertising.
  
  

• Quantify Their Impact:  The levers should be backed by metrics, such that the application of capital is correlated with a specific desired result. In the case of Bluffworks, our advertising ROAS is too good, such that we are missing opportunity by underspending to acquire new customers.

The team should be able to model the impact of your capital. And, you should be able to discount the growth or effectiveness in that model to see if it still pencils out with slightly altered results.

Cash Flow And Future Financing

For a startup, cash is like oxygen such that without it even promising businesses close. Due to the cycle of inventory purchases versus revenue, the disconnect between cash and profit can be significant.

• Cash Flow Plan:  Every business needs a framework to manage how their business operation consumes and replenishes cash. This should be part of the pro forma model, and is sometimes repeated again at a more detailed level, possibly weekly. Before investing in any business, I would look at how they manage cash.
  
  

• Long-Term Capital Need:  It is unlikely you’ll invest in a business that doesn’t need follow-on capital. In fact, for many businesses, the further they go the more capital they’ll need to hire staff, open locations or purchase inventory. Capital doesn’t always have to be secured via equity fundraising. It’s possible to utilize debt. But, you have to understand how much capital will be required at various phases of growth.
  
  

• Short-Term Capital Runway:  The period between the current raise and the next time the company needs more capital is its runway. Most investors look for 18 months to two years between raises, with 12 months being the minimum. It’s important to ask, “What happens if you don’t raise more capital?"
  
  

• Capital Threshold:  Imagine you invested $100K in a business that needed $1M to proceed. If the company couldn't raise the full amount, your investment would essentially burn. One way to combat this is via a threshold that must be reached before your capital is deployed.
  
  

Understanding the ups and downs of cash flow for the business you are investing is in critical. We've had our hard knocks with cash. A lender once remarked,  “you are the best company we’ve ever seen at managing cash.” To which my CFO responded, “That's because we don't have any.” 

Exit Strategy

Financially, all of this is for naught if the company doesn't achieve an exit. Typically, a juicy return on investment is unlikely to be achieved by the payment of periodic dividends. The brand has to sell.

• Acquisition Patterns:  Investors look for an acquisition strategy, that must be connected to the realities of the industry. With apparel, companies are purchased by an acquirer to gain access to a new consumer base, expand their product line or broaden opportunities for customer acquisition. The best scenarios achieve synergy, like a footwear brand buying an apparel company to leverage their shared customer base.
  
  

• Exit Multiples:  While it’s difficult to access benchmarks of multiples from private transactions, every industry has standard multiples that experienced operators will know. Expectations for your exit multiples need to be industry appropriate.
  
  

• Structural Hurdles:  How likely is an exit to occur? A company often must meet certain milestones before even being considered. For example, in apparel it's rare to exit a company that is only a few million dollars in size. It needs to be closer to $20M or more.
  

It’s worth going deep into discussion of exit scenarios with a founder to understand how they think about exiting. I'd want to know their personal goals in terms of financial reward, would they be comfortable letting go, and more. 

Investment Terms

Should an exit (or liquidation) occur, details of the investment vehicle will drive how capital is distributed. This is intricate stuff that needs to be reviewed by an attorney, but I can share a little bit of what investors look for when assessing the instrument.

• Investment Vehicle:  For experienced investors, the valuation isn't enough. They dig into how the price per share is calculated (pre or post-money), liquidation preference, shareholder rights in terms of voting, authorization of a sale, etc.
  
  

• Corporate Control:  A combination of the corporate bylaws and the capital table defines who has decision making power over the company. It is important to understand what that company can and cannot do without your approval; mainly in terms of fundraising and approving future transactions.
  

Contractual terms feel like the opposite of the optimism of startup investing. Which makes it one of the best places to gain outside counsel. 

The Founder(s) And Team

If there's one way this can be more simple it is:  do you believe in the company and the team?

Because every business eventually faces challenges is why many investors focus so much on the capabilities of the founder and team.
 

• Founder Capabilities:  Every founder comes with their own strengths and weaknesses. But the feedback I’ve received suggests there is a subset of skills experienced investors find non-negotiable, which are: transparency, objectivity, commitment, and resilience.
  
  

• Solo Versus a Team:  People debate whether it's a good idea to only invest in companies run by at least a pair of founders. But, then a contrarian comes along and lists all the successful companies that were started by one person. Although cofounder relationships can cause tension, I would be open to starting Bluffworks with a partner if I was to do it all over again.
  
  

In the beginning, when things are good It's hard to anticipate how intimate a relationship can get should things become tense. I suggest you attempt to imagine how a founder will respond under pressure.

I think the driving force of why our investors support Bluffworks isn't that they expect it to be the next Tesla. It began because they love our products, and concluded with the fact that they trust me.

Your Personal Investment Approach

Where so much focus is typically placed on the merits of an investment, it’s impossible to know if an investment is “good” versus “bad” without understanding an investor’s criteria.

• Tolerance For Risk:  It is unconventional to make a high risk / high return investment without diversifying via a “basket”. A professional will make 10-15 angel investments expecting a subset of them to deliver outsized returns while the others fizzle and the portfolio wins overall. An alternate approach is to have a high risk tolerance for a company you love, realizing you are supporting something great and that your life won't change if you lose the capital.
  
  

• Anticipating Future Capital Raises:  Imagine you invested in a company, and you're now sitting back and waiting for a return, right? Uh oh… The most experienced investors know that when a company needs follow-on capital, they will be the first ones asked; especially in the face of adversity. For Bluffworks, this may be the last of our small angel rounds as we move on to larger sources of capital. But when asked to make follow-on investments, experienced investors often participate first because they were planning for it, and second because they calculate the new ROI on their entire investment.
  
  

• Return On Investment:  To calculate a potential return on investment, you need to model how the current valuation is paid at an exit event, minus the effect of dilution. This is done based on a capital table that documents the % ownership of all shareholders. You should review plans for how much future capital a company expects to need, and can ask the founder to present their dilution math, as I do for my investors.
   
  

The perspective with which you enter an investment will have a lot to do with how you'll feel at the end. 

Closing

I hope this guide is helpful, and I encourage you to contact me if it needs clarification.

Without the many angel investors who have supported us, there would be no Bluffworks, and so many other great companies.

In the end, investing is tricky. If for some reason Bluffworks was to never achieve an exit, I think most investors would be glad they supported a committed and resilient founder, and proud they brought a company they love to life.

Good luck!