Boulder Startup Week Kicks Off With Look at Angel Investing Pitfalls

5/13/14Follow @MichaelXBD

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of problems with the founders, he said. Deciding which teams will be winners requires a judgment call, he said.

“A lot of angel investing really is trusting your gut, trusting your instincts. It doesn’t mean you won’t be wrong, but if you have a portfolio of investments, you only need to be right once or twice.

—Look at a lot of deals

Of course, not all guts are created equal. Kraus pointed out that Levine has seen hundreds if not thousands of potential deals as an angel investor and venture capitalist, but that for beginners, there’s a steep learning curve.

“I’ve only been doing this for about three-and-a-half years. Three-and-a-half years ago, I couldn’t have gone with my gut,” she said.

Kraus said she thinks it takes looking at 200 or so deals before someone really develops a sense of what deals might work.

—Ask smart questions

Badgering entrepreneurs isn’t the same as asking good questions that could reveal valuable information about team dynamics and their commitment, Batten said. She believes the focus should be on the strength and quality of the team.

Levine said he likes to ask entrepreneurs how they came up with their idea and their startup’s origin story.

“I want to understand the path they took to come up with the idea they’re passionate about,” he said.

Vernon takes a different tack. He likes to ask entrepreneurs pitching him why no one else has built a successful company around their idea.

For entrepreneurs:

—Avoid “smart rich guy” syndrome

Entrepreneurs desperate for capital could be excused for thinking a huge check from a single investor might be much better than raising money one $25,000 check at a time.

But it’s not, Vernon said, especially when it comes from someone who’s not used to angel investing, doesn’t know the industry the startup is in, and demands too much control.

“What happens is, an entrepreneur becomes very invested in the business they want to start, they get very excited about it, they look for money, they do all the classic things, and they end up finding a smart rich guy who doesn’t know anything about the business,” Vernon said. “This can be a successful contractor who builds houses, or a successful restaurant owner that just has a lot of free income and fancies himself an investor.”

The investor is willing to put up a lot of money—maybe even all the founders need in their angel round—and they take it. Then the trouble starts, Vernon said. The investor has too much control, his or her interests might not be aligned with the entrepreneurs, and he or she could refuse to allow them to raise more money and diminish the investor’s stake in the company.

“It’s the perfect example of getting mixed up in a total shit show because you can’t go get new money because he won’t allow it and he’s the number one shareholder, and he’d actually ride it to zero before he’ll let you go get another investor,” Vernon said.

It seems hard to believe an investor would be so short-sighted, but Vernon has seen it multiple times.

“I’ve seen it happen three times with three different people. That is a recipe for disaster,” he said.

Vernon wasn’t alone, as Levine said he has had experience with similar problem investors.

—Don’t try to hide the risks

When making a pitch, it might be tempting for an entrepreneur to try to minimize the risks his or her company faces. That’s a bad idea, according to the panelists.

First, savvy angel investors know the odds, so trying to hide them doesn’t make sense.

“The most probable outcome is we’ll fail. Statistically, that’s the truth,” Vernon said.

Plus, being upfront about risks and challenges tells a prospective investor something valuable about an entrepreneur.

“I always own the risks,” Batten said. “As an entrepreneur I’m flat out about it. I’m showing I know what’s coming, [and that] I know how to manage it.”

Finally, keep in mind good angels are more focused on the upside.

“I don’t think your job is to frame the risks,” Levine said of entrepreneurs. “Your job is to frame the opportunity and/or yourself in a way that’s compelling. The risk is the risk.”

Michael Davidson is the editor of Xconomy Boulder/Denver. He covers startups, venture capital, clean tech, energy, aerospace, telecoms, and whatever else happens above 5,280 feet. Contact him at mdavidson@xconomy.com. Follow @MichaelXBD

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