What start-ups need to know to speak the language of the angels

Angel investors fund more companies than any other source of capital for start-up ventures, except for entrepreneurs themselves and their friends and families.

Investing in start-up ventures is a risky business with only one in 10 start-up investments providing all the return on investment for angel portfolios.

Angels tend to invest in new ventures in business sectors they understand.

While angel investments cover the spectrum of start-ups, most specialise in a single or narrow set of business verticals, such as software, energy, medical devices or others.

Other angels choose to fund low-tech ventures, such as retail, growth services and manufacturing. As a class of investors, angels cover all sectors.

What are the common characteristics of angel-funded start-up companies? Here are the criteria for investment used by most angels:

* Angels bet on the jockey, not the horse. A qualified, coachable entrepreneur and management team are the first consideration. It is said that a B team is unlikely to be successful in commercialising an A product, while an A team will quickly upgrade a C product into a viable business.

* Angels invest in start-ups that can ramp revenues to US$25 million ($34 million) or more in five years. Rapid scalability is important. If one in 10 angel-funded start-ups must provide all the portfolio return on investment, then angels should bet only on potential home runs.

* Angels fund ventures with customer-ready products or services. Investors want to talk to customers or potential customers to confirm that the product or service meets an important need - a "must have" for users. Angels invest in painkillers, not vitamin pills. Entrepreneurs with products that are not quite customer-ready should be self-funded with the help of their friends and family.

* A competitive advantage is important to angel investors. This could be a patent, trade secret or huge head start. Investors do not fund companies with products that can be easily duplicated by more mature companies with deep pockets.

* Angels seek companies with solid sales and marketing plans. Too many entrepreneurs assume that products or services will sell themselves, which is never true. Angels want to fund entrepreneurs who understand the channels to be used for reaching customers with their products.

* Angels prefer to invest in local companies. Why? Angels want to be able to kick the tyres before investing and then coach, mentor and serve on boards of directors of portfolio companies. Considering that most angels are part-time investors with multiple interests, investing in companies near home just makes sense. Furthermore, many angels are motivated to give-back to their communities by investing in local entrepreneurs.

* Angels tend to invest US$200,000 to US$1 million in the first outside round of funding for new ventures at a valuation of $1 to $2 million and hold equity stakes of 20-40 per cent after this first round of financing. Angels are not lenders, like banks, who expect to be paid back with interest. Angels are equity investors who buy shares (or ownership) in start-up companies.

* Angels expect entrepreneurs to have an exit strategy that will enable both the entrepreneur and investors to sell the start-up within five to 10 years to a larger public company, providing all shareholders with a substantial return.

* And, for all their trouble and risk-taking, there is good evidence that patient angels can earn about a 25 per cent internal rate of return when measured over a 10-year period.

Bill Payne is the BNZ University of Auckland Entrepreneur-in-Residence 2010, located at The ICEHOUSE business growth centre.
Visit www.theicehouse.co.nz and www.billpayne.com