Thursday, January 12, 2012

Beware the Angel of Death!

Angels investors are great.  Some are better than others, but the vast majority are good for companies and can help the company when no one else can.  They will offer reasonable terms and will be quick to close. The best are the ones who come from industry; they tend to have an understanding of the required patience and can also guide you and introduce you to other investors and experts.  I don't want to discuss them in this post.

I want to discuss the small group of angel investors that you need to beware of.  They come in different shapes and colors, but you can usually identify them in advance.   They usually don't come from the industry, although there are exceptions. The terms that they will offer will be aggressive and one-sided, and sometimes they will require personal liability of the founders.  The valuation will be extremely low and they will want to have control plus direct or back door veto rights in the next round.  The terms will often be more aggressive than VCs, but without the added value or the big bucks.

Angel investment, at least the way I see it, is a leap of faith.  You usually have only a vague idea and a lot of question marks.  This should be reflected in the valuation, but you should not take an investment that almost pushes you out at the seed stage.  Getting to the first VC round after being substantially diluted in the seed round is bad for you and also bad for the company.  Founders with small stakes are not as effective as founders with big or normal stakes and will start thinking about their next start-up.  Investors that don't understand that should not join your company.  The professional angels understand that completely, and will try to make you feel happy and comfortable.

The other things that sometimes happens with the second type of angel investors, is that they will ask for full blown representations.  Not only is this bad for the company, but it is also bad for the angels. People sometimes think that they can give up on reps in the seed round, because it is a small round, the risk is low, and the angels will never sue them.  This would be the correct approach if the impact was only on that seed round.  The issue is simple, the rule of thumb is that next round will piggy back on the representations of the previous round.  So if you agree to aggressive representations in the seed round, there is a good chance that you will meet them again when the big money comes.  And it is bad for the angels as well, because in the next round they will be on the same side as you.

Finally, be careful of any angels that tell you that their agenda is to get to an exit without a VC or major investments.  This cannot be an agenda, even if the angel tells you that it worked for him with his start-up. If you end up building a company bootstrapping all the way, that's great, but it cannot be a strategy.  Keeping 100% of the pie is not a path to success, and most companies need substantial resources and the expertise that VCs have.  I am not saying that you have to take investment from VCs, but make sure that at least after the seed round, you are still in control of the decision making and not the angel.