Credit: jelene

Run a farm. Join a Mafia family. Become a vampire, play poker, or open a restaurant.

Seems like you can do just about anything you want in the vast universe of social gaming.

Social gaming, those simulated games populating social networking sites such as Facebook and MySpace, are everywhere, and their popularity is growing every day. Despite their critics who liken developers to virtual scam artists, social gaming startups are becoming immensely attractive to angel investors seeking new frontiers.

Growing Audience

What’s compelling about social gaming is these aren’t just adolescent boys addicted to Grand Theft Auto. Social games are designed for the casual user, people who want to fritter away a few hours playing with friend. That opens up the window for unlimited growth. According to VentureBeat, social gaming is attracting a new and much more far-flung demographic than traditional video games: Women, older users and people who don’t consider themselves gamers.

And they grow fast, spreading like wild fire, racking up new users almost overnight.

Farmville launched on a Friday, and by Monday had 500,000 users. Playfish was able to get 5 million players to join its Restaurant City game in just 5 weeks. Zynga says more than 25 million people are now playing Mafia Wars, its game of crime families and mob warfare – that’s more than the population of Texas.

Zynga, which along with Playdom and Playfish comprise the Big 3 of social gaming. Launched 3 years ago this winter, the company boasts 50 million regular users and is profitable – some reports estimate it could turn US $100 million in revenue this year. Zynga has raised US $40 million and Playdom just got US $43 million in its first round.

Devil in Disguise?

But it’s not all fun and games, some say. Critics charge these social gaming outfits, especially the larger ones, amount to little more than elaborate scams aimed at getting users to cash in on “free” virtual goodies. A typical scam asks users to fill out a survey — in exchange for virtual currency to purchase make-believe geegaws and a surprise subscription fee tacked onto their cell phone bill.

Angel Backing

Social games still represent just a tiny segment of the US$50 billion international video gaming. But it’s a very successful segment: Social gaming is adding employees, adding users, and turning a profit. It’s an industry that’s not just surviving, but thriving in a difficult tech landscape.

Jeff Bezos apparently sees the opportunities. He’s pumped money into social gaming startups, including an undisclosed amount to Social Gaming Network and US $3 million to Kongregate through his personal investment vehicle.

The Right Mix

Social gaming may just be the right mix for some angels. “They’re really good at using the right mix of ingredients … not just for profitability, but for growing your user base,” says Tim Chang, principal at Norwest Venture Partners. Viral marketing and cross-promotion aid in driving traffic – and profitability.

Ultimately, social gaming offers more exit strategies than the traditional video game industry – the sphere of interest is so much larger. Earlier this week, in fact, there was a grand exit when Electronic Arts snapped up Playfish for a reported US $400 million.

That alone might be enough to sow your seeds in FarmVille.

But angels, ask yourself: Is this entrepreneur willing to flip a few burgers? Or at least willing to make some sales calls or write a few product specs? You know … do the dirty work?

Flip a Few Burgers

Sometimes, that’s what it will take. Smart startup founders should be willing to take a hands-on approach, says entrepreneur-turned-investor Mark Suster. That’s right – they should flip burgers.

Suster did it both ways – hands-off and hands-on. In his first tech startup, Suster and his partner landed US$16.5 million in capital before they were even working it full-time; they hired a team of executives and a corral of developers. This was in 2000 – as market valuations fell, the fledgling startup had to cut its staff by more than half in one day. Then, Suster says, he was forced to do the hands-on stuff – make sales calls, make decisions about technical operations. He was flipping the burgers and getting an education in how his company worked.

Grill Marks

The second time around, Suster stayed closer to the flame. This time, his startup raised only US$500,000 – and had a shoestring staff as a result. Suster did more of the down-and-dirty work himself, including marketing, sales, even designing the company logo.

“I did the grunt work. And this is how it should be in startups,” he says.

Just don’t confuse a willingness to take a hands-on approach with the steamrolling Know-It-Alls. The latter, the Armies of One, think they can do it better than anyone else. So they do. And usually, it becomes quite apparent they can’t do everything they think they can. It can be a fine line, but an important distinction.

Lean Times

Often, flipping burgers is a simple matter of survival. Face it: Angels are investing less. A study just released by the Center for Venture Research shows investments were down 27%, to US$9.1 billion, in 2009. The average deal size shrank considerably — by 31% — as well.

That’s not to say angels have shut Heaven’s gate. Angels are investing less, but they’re spreading the wealth thinner and farther afield – they’re spending less on more startups. With less venture capital upfront, the playing field has changed. As a result, the Do-It-Yourself approach is becoming one of the new rules of angel investing.

“Entrepreneurs should find ways to finance their own growth: working without salary, moonlighting, seeking grants, running lean operations, and focusing on an aspect of the business that can generate revenue,” the New York Times wrote last week.

Red Flags

Angels, consider the burger litmus test when as part of the pitch. As the competition heats up, which entrepreneurs are best equipped to withstand the grilling?

As Suster says, if the “CEO can’t drive the demo or the financial model themselves it is a big red flag.”

The interesting finding from this analysis is that while overall investment dollars are down, the total number of ventures that received funding in the same period increased 6% over last year. The number of active investors in the first half of 2009 was virtually unchanged from 2008.

A Change in Focus

One very obvious change between 2009 and 2008 is the number of investments in the seed and startup stage for angels. In the first half of 2009, 27% of angel investments focused on this area. While this appears to be a strong number, it is actually a 19% decrease from the year prior and the smallest percentage focused on this area in several years.

“This change in investment behavior is likely an indication of both a need to increase investments in existing portfolio companies and a change in angel’s risk tolerance,” said Jeffrey Sohl, director of the UNH Center for Venture Research at the Whittemore School of Business and Economics.

Trend Recognized Early On

Investors and others watching the market are likely not surprised at the UNH finding as this lower spending trend was identified earlier in the year. The Charlotte Business Journal reported in March that the dollar amount of angel investments had declined 26% nationwide versus 2007, although the volume of deals had remained largely unchanged.

This trend is interesting in that angel investors appear to still want to invest their money, but the number of dollars per opportunity has changed. While these cautious individuals are striving to spread the risk, startups are finding that their valuations are no longer the bloated approximations of a booming economy and instead more realistic and achievable.

Predictions Challenged

In late 2008, a number of industry participants were attempting to predict what 2009 would hold for the angel investing market. Alexander Muse of the Texas Startup Blog wrote the following:

I predict that the turmoil on Wall Street will actually improve the ability of startups to access investments from angels…More and more angels I know have been moving more and more funds out of their brokerage accounts and into their bank accounts. This flight to safety will continue for a time, but soon the specter of inflation will rise and investors will look to invest their money.  The lack of professional private equity will only increase the opportunities for angels to make great investments and their access to greater percentages of their own capital will mean startups will get more.

Others like Murphy believed the economic recession lowered the wealth of many current and would be angel investors. At the same time, acquisitions were being driven through market consolidation instead of strategic advantage, thereby lowering prices and value. At the same time, angel investors do have the luxury of taking a “wait and see” approach.

Looking Back to Prepare for What Is Ahead

In hindsight, it appears both Muse and Murphy were correct, but maybe not in the ways they originally intended. The UNH report suggests that while angels have not taken a backseat to investing this year, they have treaded very lightly and with much caution. Will that change for 2010? What’s your take?

Sound advice for anyone, for just about any situation. For entrepreneurs, keeping it simple can mean the difference between boom and bust. For angels, investing in something simple and easy to understand can mean the difference between a home run and a dead horse.

“Your idea doesn’t have to be big. It has to be simple,” Lisa Barone advises entrepreneurs in a recent post at Smallbiztrends.com.

MISS the Point

Even with a simple brilliant idea, the odds are against any new startup making it big – in fact, 55% of new ventures fail within the first 5 years. So how do you pick a winner?

Angel investors eyeing a new startup should remember the KISS Principle, but they may want to adopt a new mantra as well. Let’s call it the MISS Strategy – Make It Simpler, Stupid. An idea can be simple, sure. But the key to success is making it simpler for the customer.

Think about ideas based on making life simpler that grew into household names. Amazon.com made it simpler to buy books online. Google gave us an easy search engine in a plain white wrapper. And Diapers.com, one of the fastest growing e-retailer out there, made it simple to buy diapers online and have them delivered to your doorstep.

Back to Basics

New Jersey dads Marc Lore and Vinit Bharara applied the MISS strategy when they started Diapers.com in 2005. The idea was born of their own frustration: They were tired of late-night runs to the store for diapers and figured there must be an easier way. After discovering the Internet was surprisingly void of diaper offerings, they set up their own online store with just the essentials: diapers, formula, and wipes.

“Having my second kid and seeing my wife having to keep us in stock with diapers and formula and stuff – it wasn’t easy for her. I thought, if we could make this an easy experience for Mom, offer premium service and speedy delivery, we could extend into the other high-margin baby products,” Lore said in a recent interview with Inc.

Cleaning Up

Other frustrated parents soon flocked to the site to order diapering supplies. Diapers.com grew exponentially, adding more baby supplies as it grew. Today, Diapers.com offers a full menu of products ranging from jars of baby food to nursery furniture. But the focus remains on making life simpler for its 500,000 customers.

The dollars have followed. Diapers.com tallied web sales of US$89 million last year, making it the 5th fastest growing e-retailer in the Internet Retailer Top 500 Guide 2009 edition – that’s an increase of 147% from its sales of US$36 million in 2007. It just raised US$30 million in funding from several venture firms and Lore says the e-retailer is on track for another blockbuster year.

A simple idea that made life simpler for the customer. It was a sure MISS from the get-go.

Credit: The 5th Ape

Do women have the guts to wear a halo? The stereotype says no: Women want to play it safe with their money. They just aren’t as adventurous as men when it comes to investing – and that means most will shy away from becoming angels.

It’s true women are still underrepresented in angel investing: Just 8% of the 225,000 active angels in 2005 were female, according to the Kauffman Foundation.

But a female serial entrepreneur who has ridden the “rollercoaster ride” of angel investing shatters that old stereotype and offers inspiration for women interested in getting started.

Gender Gap

Francine Hardaway, founder of Stealthmode Partners in Phoenix, understands why women aren’t interested in the game – at least initially.

“Women aren’t as risk tolerant and they hit singles rather than swing for the fences. I’d call my own first business either a single or a bunt,” she writes in a guest post.

One Step At A Time

So how does a woman go from timid spectator to bold angel? For Hardaway, an early success paved the way to more, with a few lessons learned along the way.

Hardaway took her first foray into angel investing by putting up US$5,000 for a former student. She ended up making US$50,000 when the company went public – a sizeable enough return in the 1970s to hook her.

She went on to more success (a FFF — Friends, Family, Fools — investment helped 2 friends start a “rag” that is now Village Voice Media) and she was on her way.

Roller Coaster To Success

Of course, through the years, Hardaway has had ups and downs. She lost a million in 1990 in real estate, but “made a ton of money” by flipping houses in the mid-2000s.

All told, she estimates she’s been in about 50 real estate deals and 15 tech deals. She calls herself a “deal junkie” – an image that blows up the notion that women aren’t interested in high risk, high yield investments.

In fact, women like Hardaway are particularly well-suited for angel investing.

“Most of the men I talk to don’t have my stomach for roller coaster rides,” she says.

Pay Off Worth It

If you’re standing there at the gate, wanting to get on the ride, you’re probably ready to become an angel investor. But it’s important to understand the basics and your own tolerance for risk. If you want a little help along the way, consider joining an angel group. An angel group will pool your resources with other investors  — spreading the risk while maximizing your potential for success. You can also learn the ropes and pick up some invaluable advice.

Be prepared for a few bumps. For most investors, including Hardaway, a few twists and turns along the way are worth it.

“I’ve never lost everything, and I have had a fabulous time,” she says. “I will obviously do this until I completely lose my senses.”

When examining the activities of angels investing in new startups, age should be considered a significant asset. Business founders who bring industry experience and expertise to the table have a much greater chance of success than the young pup with the “next big thing.” This is not to say that young entrepreneurs have never succeeded. In fact, many have done much better than most anticipated – think eBay and Google. As most can assume, however, these companies are the exception and not the rule.

Challenging the Assumptions

In a recent TechCrunch article, the “young is better” assumption is challenged by those who firmly believe youth is wasted on the young. The author, Vivek Wadhwa, is an entrepreneur turned academic. A visiting scholar at UC-Berkley, Senior Research Associate at Harvard Law School and Executive in Residence at Duke University, Wadhwa reported on research recently completed by his academic team.

Based on a survey of 549 entrepreneurs in high-growth industries, the average founder of a high-growth company launched his or her venture at the age of 40. In addition, these founders are likely to be married and have two or more kids. These individuals are hardly the innovative 20-somethings with passion and no family distractions that Silicon Valley VCs tend to favor. Wadhwa suggested perhaps there is a connection between this habit and high VC failure rates.

The age assumption tends to run rampant throughout the investment arena, whether the investor is an angel or a VC. In following these assumptions, anyone over 40 might as well set out for retirement or plan to be merely an advisor, not a CEO or Founder. Is the assumption that if the individual was worth their salt they would have already launched a successful company? Or, is the individual too set in their ways to drive success and innovation?

Why Older Is Better

For those who happen to fall in the over 40 – or even over 30 – age range, there are some valuable arguments for trusting in the more seasoned entrepreneur. As Matt Mullenweg so perfectly stated, a good portion of those entrepreneurs in this age range succeed for a number of reasons:

•    They offer a lot of experience
•    They are more cautious
•    They are likely to have their own funding
•    They have nothing better to do
•    They have credibility with bankers and customers.

A Kauffman study showed that people age 35 and older actually have higher entrepreneurship activity rates. These “older” professionals have often actually worked in an area or sector where they developed an idea or simply got tired of working for someone else. With the economic crisis, many Baby Boomers may be seeking alternative employment opportunities. Not all will land the perfect startup, but the success and health of the economy will rely on these risk takers to lead the recovery.

As an angel investor, you know there is no magic number when it comes to the ideal age for an entrepreneur, although it is likely to be a consideration. Think about your own background and experience. Do you bring more to the table now than you did in your 20s? It is very likely the 40-something entrepreneur can offer much of the same.

PerfectBusiness.com (which bills itself as “the path to entrepreneurship”) is holding its “Perfect Pitch” contest to help get the right business ideas in front of the right investors. Contest entries are business pitches that include a written description, pictures, and video. These entries will be reviewed by a panel of noted judges who are popular, humorous, and extremely good looking. (Venture Hype is one of the judges.)

The panel of judges will select the top 10 pitches and request more information from those businesses. Then, with the additional information in hand, 3 winners will be awarded airfare, accommodations, and the chance to pitch their idea to Virgin’s Richard Branson and a roomful of investors at The Perfect Pitch 2009 Entrepreneur and Investor Conference on Oct 26 at the beautiful Marina del Ray California.

So, if you’re an entrepreneur and you have an amazing idea for a better mousetrap or the next best thing since sliced bread, and you’re just bursting with excitement because you know this idea will make bazillions of dollars, you’re running out of time to enter your pitch. The submission deadline is Sept 8 21, before midnight. (In fact, if you’re reading this and it’s too late, you might want to invent a time machine then go back in time to submit your idea).

Or, if you’re an angel investor, you can still participate. Chances are, you know a whole bunch of entrepreneurs who’d love to pitch their ideas. Maybe they’re not in your industry but they have a good idea, or maybe it’s your cousin Frank and you think his idea should reach a broader audience. Whatever. You can spread the words and encourage entrepreneurs you know to submit their pitches. They’ll appreciate another chance to have their pitch heard. Don’t forget to tell your fellow angel friends about the upcoming conference too!

Link:

• The Perfect Pitch 2009

In one of his blog posts, Segal describes a technique he uses to push startup founders to express themselves succinctly and competently. He calls it “The Stop Watch Test” and it works like this: Segal gets a stopwatch and then asks the founder to tell him in less than a minute what he or she does. The result is surprising: Segal reports from his unofficial “poll” that founders get it right only 35% of the time. [1]

Lesson learned for entrepreneurs? Talk fast and take out every other word.

No, of course that’s not the lesson learned! Instead, new entrepreneurs should create a well-crafted, compelling description of what they do and be able to deliver it flawlessly in less than 60 seconds. They need to cover the problem, solution, and where the money is.

And investors in early-stage businesses would do well to ask their prospective investments to perform a similar exercise: Pay attention to how the company is described by the owner/founder. Work with these prospects to fine-tune their “elevator pitch” so they can present to anyone, anywhere, without boring their audience, when asked what their new company does. Brevity, it seems, is more than just the soul of wit.

In a follow-up post, Segal talks about paying attention to how people describe their roles. Although he doesn’t intentionally draw a link between this post and the previous one, the connections are thought-provoking. In this post, Segal talks about how some of the more successful companies he’s worked with are able to tie their employee’s roles directly to a business result. [2]

Those are powerful tips! The stopwatch test will help you to know how well a founder understands what their marketplace wants and how focused they are; and the second tip will help you to know how efficient, results-focused, and even potentially profitable the startup could be.

So the next time you get a startup founder in your office, give them the stopwatch test and see how long it takes them to describe what their company does. Then ask what they do, along with any other key roles in their startup, and see if they’re able to tie each role to a business result.

Notes:

[1] The Stop Watch Test
[2] Geeks Linked to Business = Success

The current state of the global economy has changed the landscape for all investors. While some see the current environment as a great time to invest, others have tightened their wallets to wait for greener pastures. VCs tend to fall into the latter category as many have opted to wait out the storm rather than dive right in on even the most promising of opportunities.

For VCs, the current activity has delivered some promise, although overall power as a player merely shadows what VCs once were. According to MidwestBusiness.com, VC investments were up for the quarter by 15 percent, while the actual number of deals completed was up 1 percent. Even with this positive movement, the full first six months of 2009 were still down 55 percent over the same period in 2008. [1]

This performance demonstrates that perhaps a few too many VCs got used to the prosperous growth of the first part of the decade and didn’t plan for a change in the climate. This poor planning has left many VCs out in the cold while angel investors are taking advantage of the opportunities waiting.

Case in point, the Oregon Angel Fund just closed its largest fund ever at $3 million. At only three years old, this fund gets half of its cash from individual angel investors. The remaining funding is provided by the Oregon Growth Account, which invests a portion of state lottery proceeds in Oregon-committed venture funds. [2]

Similar success has reached the southern portion of the United States as the Central Texas Angel Network (CTAN) is set to surpass its entire 2008 investment level this quarter. This group typically backs early-stage companies with small investments. With the five deals closed so far this year, the group has equaled the amount invested in nine deals in 2008. Randall Crowder, CTAN Executive Director says the volatile public market combined with lower valuations for nascent companies is generating greater deal flow. [3]

Why are angels still actively investing while VCs have become a shadow of their former self? It could have something to do with expectations. Most successful angels tend to be relatively realistic about the type of money they can earn on a deal. They also understand the ups and downs involved in a startup and how important it is to know the deal inside and out before signing on the bottom line. [4]

As the global economy inches toward a recovery, angels will continue to play a crucial role in ensuring markets achieve stability and new companies are set to breath new life into ailing segments.

Notes:

[1] VC Investments Improve in Second Quarter, But a Shadow of Former Self
[2] Angel fund closes largest round ever
[3] Angel investors pick up pace
[4] Fool’s Gold?

These shrinking investments have not left angel investors unscathed and some are shying away from making investments. Not only is the status of growth in the market a problem, but some may view now as the wrong time to launch a startup – no matter how promising the opportunity.

For those startups that are seeking seed money, angels are still a primary source for consideration due to low entry barrier, simple and quick decision process, low return rate requirement and flexible time limitation relative to venture capital. In the Chinese market especially, angel investing is taking a more dominant position, especially in high-technology firms.

In reality, now is the perfect time to invest. Valuation is low, helping to produce a better overall return. In addition, this is a great time for angels to invest in syndication. Thanks to the free-flow of exchange of information and deals between angel groups, companies are better prepared with their presentations and angels are more educated about the industry.

Angel syndicates are enjoying strong growth as angels are seeking increasing opportunities to spread the risk through pooling their money. Not only is this good for investment-shy angels, it also benefits those companies seeking investments as syndicates are investing much higher amounts than stand-alone angel investors. According to a survey of Angel Capital Association members, the average pooled investment in 2008 was US$281,000. Individual angel investment ranged from US$10,000 to US$200,000 per startup.

Remember that old saying that you are always safer in pairs? The same is definitely true in investing. It can be scary to go in on a deal all by yourself. It can be especially intense if you are a new angel and the opportunities seem to outweigh the amount of time you have to evaluate each one. In working with others, you have the opportunity to share the burden, even if you do have to share the spoils.

Often dubbed “Smart Money”, syndicate investing allows for not only the pooling of financial resources, but also expertise and skills. By combining incisive business knowledge together with cash, angels of all backgrounds can benefit from working together. This creation of Smart Money is causing the number of angel syndicates to experience strong growth.

If you’re not sure how to get stared with a syndicate, you haven’t been asking the right questions. Use your networking skills already in place to identify opportunities in your field of investments. Others are looking, too and enough of the right conversations will create for you the right connections.