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Shannon Henry's The Download Live
Discussion with John May, Angel Investor

Thursday, December 2, 1999 at 1 p.m.

Shannon Henry
Shannon Henry
Welcome to The Download Live. I'm your host, Shannon Henry. Today's guest is John May, an expert in "angel" investing. May is the executive director of the Private Investors Network and co-manager of The Dinner Club and the eMedia Club, all locally-based networks of individual angel investors. The groups meet regularly, hear from technology companies who pitch their companies, and then choose which ones to fund.

As the Washington area has become home to many cashed-out technology entrepreneurs and high net worth individuals, those people are more and more looking to invest in other start-ups. And May has become the area's chief angel networker.

Send your questions now on the difference between angels and venture capitalists, how to find an angel and when companies should seek angel funding.

Shannon Henry: Hi, Welcome John! Could you start off by explaining what this kind of earthbound angel is? How's an angel different from a venture capitalist and how long have people been using the term angel?

John May: The main difference between angels and mainstream VC's is that the former are individuals, writing checks from their own accounts, and the later are institutionally raised funds run by professionals. Angel originally came from the broadway producers who backed speculative new plays and took the financial risk - some flopped some soared. Today angels are business investors into early stage private companies.

Shannon Henry: Why are there so many angels all of a sudden? It seems like they're coming out of the woodwork. How long will this period last?

John May: The good news for entrepreneurs is that the 90's have seen an explosion of new wealth being created in the public equity markets and internet generated wealth has meant that more individuals are willing to put a little of their net cash aside for riskier, but potentially more lucrative, venture investments. This increase - almost exponential over the last few years - in funds for this asset class should only increase in the near term as angels and VC's get more comfortable with the New Economy.

Bethesda, MD: Typically, what percentage of a company do you look to hold onto when making an angel investment?

John May: The amount you have to give up to an angel is as varied as with professional VC's. In fact, the forms of investment are more varied - debt, debt with royalty kickers, common stock, preferred stock, etc. - so the ways of sharing the upside of ventures can be more varied as well. In general the key is the perceived pre-money value of what the entrepreneur brings compared to the amount of risk equity capital that you are seeking. Remember, the investor may lose all - the entrepreneur gets to use the money in the growth attempt before the angel sees any kind of return.

Gaithersburg, MD: I often see references to that one must be an "active, accredited investor" to participate in some of the Angel investments groups. Would you please define this and explain how one becomes an "accredited investor"?

John May: The SEC definition of accredited is roughly $1.0 million of net investment liquidity, or $200,000 per year income - so the bar is pretty high. Having the self identified label of accredited helps to encourage future investors to play with you because you have a supposedly sophisticated background support network.

Shannon Henry: Who are some of the super-angels in the area?

John May: A super angel in my terminology is someone who is in his or her own right a venture capital fund. They do larger transactions, they have deeper pockets, they have staff support, and they play with the VC's. We have a growing number of them in our region - many are banded together in the capital Investors Group, like Steve Case, Jim Kimsey and Mario Morino, and others have cashed out of Yuri, UUNet, and DIGEX so have the funds to become serious multi million dollar transaction "super angels". Washington is fortunate to have a growing number of sophisticated, active super angels.

Gaithersburg, MD: We have just completed the sale of my company; I am too young to retire -although a vacation is in order-. I have a strong technology background although I have often found myself in marketing positions. I am intrigued by the concept of angel investing and the possibility helping some young companies grow.

Where is the best place for someone like myself to start and learn more about becoming an angel investor?

John May: Emerging angels have several ways to learn and syndicate. We have the mid atlantic venture association sponsored Private Investors Network to join - only accredited angels are members - which meets once a month. Active angels like yourself - don't want to retire to the golf course and have a strong mentoring streak - can connect with university business school mentoring networks. You can also join a local angel investment club, like the Dinner Club or emedia club, or invest in a angel venture fund like Next Generation Fund. We look forward to your joining the ranks of active local angels.

Alexandria, Virginia: If you are interested in a venture capital firm due to their contacts in your industry, but the vc firm wants a first round of financing to come from an angel, will a vc firm put you in with a "friendly" or "approved" angel and then look to help the company along with the possibility of getting involved on a second round of financing? Or are you out there on your own?

John May: Usually, if they really want to track you, they can give you leads from their own limited partnership pool. Otherwise, they should refer you to Private Investors Network or to investment bankers, securities lawyers, or other intermediaries who have long rolldexes of clients. Remember to honor the referral when the time comes for future rounds of finance or hiring service providers - what goes around comes around. It is a small world here still.

North Potomac, MD: Let's say that my 2 partners and I have a great idea, have done some research and are midway through business plan development. Is that the right time to pitch the idea to an angel? And if so, where do we find them?

Mike Freeman

John May: Yes - but there will be fewer takers than when you have a full business plan and full management team. The good news is that there are so many angels - compared to vc'c - that you can always find someone at any stage and type of business - just hard to find them easily. You will probably need an angel from your industry niche to deal with such an early play.

Washington, DC: What is the best course of action on finding an Angel Investor without the fear of giving up my intellectual property?

John May: peel the onion slowly - give an outline of the business, an executive summary - and meet with the prospect before giving the whole plan or proprietary info away. Each side of the investment table needs to get comfortable with the other - investors don't want to sign confidentiality forms unless they really need to, and you should not disclose the essence of your "black box" before you have serious interest and you have checked out the prospect. Go slow.

Shannon Henry: Tell us a little about the angel dinner club model. How does it work? Who decides what to invest in? And what are the other benefits to these groups than the obvious one of making money?

John May: We have developed this new investment model in response to needs from both investors and entrepreneurs. The angels get to stay active and use their brains as well as their money. They interview companies, vote on whether to track them, and are led by the manager to research and a group vote to go or no go into the deal. They get community building as well as pieces of high upside private equity deals. The entrepreneurs get dozens of angels involved in their deal but only one check, one tax ID, one meeting. We have 60 in the www.thedinnerclub.com and 75 in the www.emediaclub.com and so far a lot of completed deals and active involvement.

Alexandria, Virginia: My husband and I have an idea for an internet company. We've budgeted for $1 million for the first year of operation. We have appox. $300,000 in personal cash assets. At what point should we seek angel funding? At the onset of development, or after revenues have started coming in?

John May: I believe that "every business needs an angel". Whether you entice them with an advisory board seat, or let them make a seed investment in you, if you get a mentoring, active angel who wants your business to be a long term capital investment that yields some psychic reward, you will be better off than if you reinvent the wheel at each stage of your growth.

Newington , CT: When seeking investors, how can we best protect ourselves from having our business plans and concepts stolen out from under us?

John May: First, know who you are dealing with - via referrals or references. Second, only send enough information out to determine real interest in your project. third, only deal with investors who know your space or who have experience in your field - passive investments from those who don't understand the risks and competitiveness in your field may come back to bite you later. and last, get non-compete, non-disclosure signed when you completely open the kimona.

Shannon Henry: What are the risks of angel investing? How are the risks different from those of an individual investor in a venture fund?

John May: Investors should only provide equity into early stage private with funds they can easily afford to lose. The rule of thumb is to allocate 5-10% into alternate assets - real estate, oil and gas, venture, once you have substantial assets to play with. VC investments provide no near term tax benefits, no dividends usually, so the high long term upside should offset the risk of total loss. A good angel investor is one who has had some losses and is sadder but wiser.

402 Maple Ave West: How would one contact an angel if one didn't know any?

John May: Third party referrals, like service providers or venture trade associations, are good starting places for contacts. Remember angels like to be private and informal - there are no directories of angels - so contacting early stage venture funds, angel dinner clubs like ours, or the Private Investors Network or Grubstake Breakfast are good starting places. Part of the challenge for entrepreneurs is to show how good they are at solving hard problems - like finding the right angel.

Shannon Henry: How are other regions of the country linking up angels? What's different about the Washington area compared with say, Silicon Valley or Boston?

John May: Structure angels are forming all around the country. I did a study for the Center for innovative Technology about the angel infrastructure and it is amazing how every state, and locality, is developing venture forums, fairs, angel networks and now clubs and funds. Silicon valley has been a little ahead for years - but usually at the high end. The average business angel has only recently received the attention they deserve through investor networks and new funds. I even spent a week in europe recently talking to angel groups forming in Holland and Switzerland - and they think the DC area is light years ahead of them!!

Shannon Henry: What do you mean by "psychic reward?" Sounds like something you don't get from stock market investing.

John May: One of the best rewards of individual investing by an angel is the "warm and fuzzy" feeling they get from helping younger or newer entrepreneurs to navigate the tough world of leading your own company on a high growth path. You can't put a price tag on the social or mental benefits.So don't think the average angel gives up some financial expectation because they get other dividends - the best ones get both, as opposed to being a passive investor in a fund managed by someone else.

DC: When a company gets angel or VC investment, is that considered corporate income for tax purposes?

John May: No equity investments are not counted as taxable income when received - they go on the balance sheet not on the income statement that year.

Alexandria, Virginia: If you are in the early stages of obtaining financing and several angels and vc firms are looking at your business plan, should you wait to get a response from these entities before sending the plan around to additional angels and vc firms? If so, how long should you wait? At what level do you cut off the distribution of your plan?

John May: There is a thin line between shopping your plan too much and having the finance world think you are non-discriminating and desperate and not circulating your plan to enough sources. Remember, most plans take months to fund and evolve dozens of contacts to find just the right mix of money, talent, valuation, and timing.

Shannon Henry: What are the benefits to bringing angels together to invest?

John May: Increased intelligence and experience, deeper pockets, and good old fashion wisdom. Syndicating a deal is usual for the professional money managers - grouping brainpower and resources of individual investors also makes sense. It is important for the entrepreneur to know if a group of angels is established and experienced as a unit - is this their first deal? their only deal? Is the group a "pledge fund" and you don't know if any or all of the group will really poney up, or is it a pool of capital - like our clubs or a fund - that you know has money in the bank to follow up their term sheet. Structured angel groups is the wave of the future, here and throughout the US.

DC: Is there a preferred entity for angel investors? For example, right now we are operating as a sole propietorship but will be incorporating soon. Should we go C-sorp, S.Corp, etc. or does it matter to an angel?


John May: At a minimum your outside investors will need a corporate organization, whether S, C corp or LLC. If further rounds of finance are likely, eventually a C corp may be required. But early on you can raise funds and operate as a LLC with a good operating agreement - just be aware that shares, stock agreements, stock options, and the like will demand a normal Delaware stock corp as you grow.

Alexandria, Virginia: How do I go about finding an angel investor? Are there round tables in the area where angels and new business ventures can meet?

John May:
Try the Baltimore Washington Venture Group, the High Tech councils in the area events, the Netpreneur program of the Morino Institute, the Private Investors network, and the newly organized MIt-PIN problem solving sessions that began last week. Lots more is in the wings - incubators, accelerators, clubs - so you are in the right environment at the right time.

Baltimore, MD: From media accounts and this discussion, I have the impression that angels are only interested in tech startups. Is that the case, or do they invest in more "old-line" industries as well?

John May: The good news is that angels are of all types and are more likely to be interested in any form of high growth business - the business must be "
investible" that is has room for the investor to grow value as well as owner to have good lifestyle. Angels look at all types of deals - IT is hot now but not the only arena.

Shannon Henry: On a personal note, how did you get to be the go-to person in Washington on all things angel? Not something you study in college, I'd guess.

John May: I guess I have always enjoyed early stage private investing - which has fewer institutional players and more room for "principal to principal" deals.I have run early stage venture funds, like Calvert Social Venture Fund, and helped angel networks like PIN get started. In my expanded role in joining Art Bushkin to form Stargazer Group, a venture catalyst, I will be expanding the establishment of angel clubs, "give back funds" and funds of funds to continue to service the expanding pool of active angels in the region. It is consulting, economic development, personal investing and "psychic reward" all rolled into one!

Shannon Henry: How involved does an angel usually get in the company? Joining boards, advising, etc.

John May: Expect advisory role - whether formal board or informal kitchen cabinet - to be a minimum. Sometimes, angels roll up their sleeves and take a part time officer role - sometimes they do a lot of email or phone assistance. Finding new money, advisory firms, searching for key hires - these are the services that active angels bring.

Silver Spring, MD: What is the best way to submit proposals to groups like yours? Intro letter, e-mail, attend a meeting...

John May: email is a great, non intrusive first step - always keep initial packages small and to the point - then peel the onion as a fit appears and interest is sparked. Don't overload the first time.

Herndon, VA: I founded an e-commerce site which we recently just launched. Revenues are there but small. At this stage, what do investors look for in a company? Are we selling the concept and vision? The site is for a relatively unexplored niche so there's not a lot of data...other than what we can extrapolate from our own research.

What is the best way to proceed?

John May: management, management management is key. They hold the vision and the energy to wind through the ups and downs. The market has to be there - or the hint of a big opportunity to entice risk capital that has so many options today. Look for an investor with realistic expectations!

Shannon Henry: At what stage do most high net worth individuals get interested in angel investing? Is it usually about the same time they get involved in philanthropy?

John May: As we wind down today, it is good to know that as individual investors feel comfortable with their net worth, so they can risk some capital on early stage deals, they do start to come out of the woodwork. The more time or investment capital they have the easier it is to get them hooked on mentoring and joining their fellow investors. They should definitely separate their philanthropy side and their venture side - or at least have clear goals for return on their spending - and many are establishing foundations as they establish pools of venture capital. Both are good for our community - stay tuned for advances in progressive philanthropy in our community in the coming year!

Shannon Henry: Thanks to John and all our angel-curious readers for a great discussion. Bye!

© Copyright 1999 The Washington Post Company

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