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Plenty of athletes have raw talent. But the ones who really succeed are those who are also coachable.  Without that quality, even the most gifted potential star may be more trouble than he is worth. That is particularly true when it comes to the startup entrepreneurs you back.

Great things happen when veteran angels pair up with coachable entrepreneurs. Mistakes are minimized, networks are leveraged, and opportunities are created. Experienced angel investors realize that just because an entrepreneur possesses extraordinary technological vision or genius, for example, it doesn’t mean that he’s going to be good at management or marketing. They favor founders who are willing to listen, take advice, and follow guidance.

Don’t become enamored by the entrepreneur’s fancy product. It is always the people behind it who make a business succeed. You want to back smart entrepreneurs who recognize their own limitations and understand the importance of leveraging synergistic relationships to build marketable strength. You want to back entrepreneurs who can humbly accept that they can’t make it by themselves and they’d have a much greater shot at success if they are open to other points of view.

Entrepreneurs who are too stubborn to be coached often wind up sitting on the sidelines, while their more coachable competitors move up to the big leagues as celebrated champs.

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What has personality, compassion, experience, know-how, contacts, great advice, money to boot and a set of wings?

An angel investor of course!

We’ve been reading up on the latest Dow Jones Venture Wire insight into the growing influence of angel investors penned by Tomio Geron.

Geron draws upon some anecdotes to show that modern day angel investors are filling the vacuous void left by venture capitalists in more ways than one.

Super Angels

Just when we thought the latest flurry of superhero flicks had finally left the box office alone for a while, the so-called “Super Angels” fly in.

These guys are the likes of Silicon Valley’s greatest Ron Conway and other networked-to-the-hilt success stories who are willing to get their hands dirty as well as open their checkbooks.

Mike Maples – who runs a US$35 million angel pool called Floodgate and who’s pumped some cash into Twitter, Digg, and Chegg in their early days — is of course another worthy mention.

“Many super angels define themselves as more closely aligned to the interests of entrepreneurs than venture capitalists,” Geron said.

Consistent with the findings in HBS’ working paper.

Dynamic Duo

The dynamics of the venture capitalist and angel investor market does appear to be shifting.

VC funds have grown much bigger over the decade. Few are interested in making the small seed investments that many startups need. Placing small bets just doesn’t worth their time and effort — the payoff is simply too small given the size of their fund.

Affluent enough to spread little bits of money across lots of different startups, Super Angels are becoming the target of many entrepreneurs because they offer at least 1 of the 3 values – Geron says through the mouth of Y Combinator partner Paul Graham:

1. A networking mastermind
2. Geniuses ability – usually in the tech arena
3. Deep expertise in certain field that would simply takes years to acquire

Those are pretty tough shoes to fill.

But it seems the so-called Super Angels have just the assets, knowledge, experience and connections to step in.

Rapper will.i.am and Ron Conway | Image: Maria J. Avila Lopez, Mercury News

Ron Conway is the Robert Pattinson of angel investors.

Hell, if Conway had a gig on Twilight he’d turn all the bad vampires into good ones!

So how did the angel investor who endowed Google and PayPal become so very successful?

Conway is often referred to as the messiah of angel investors worldwide, and according to an article by Chris O’Brien, Conway walked the hard road with poise to take the title as Silicon Valley’s most influential startup investor.

O’Brien states that, while most VCs are best known for the money they’ve made, Conway is best known for the people he knows and the way he treats them – which is well.

Genuine Interest in People

O’Brien’s article delves into an interview he had with 59-year-old Conway in early April at a Twitter developers conference in San Francisco and refers to the invariable “nice guy” Conway as “the Internet” due to his uncanny ability to connect people and re-connect people for their own benefit.

Apparently even Black Eyed Peas rapper “will.i.am” has Conway’s digits saved in his cell phone as “The Coolest.”

According to O’Brien, despite the hectic schedule Conway keeps, the ridiculous amount of people he meets at conferences, and the hefty number of successful startups he has to his name, the guy is clever and polite enough to remember not just everybody’s name, “but also their conversations, what they’re working on, and whom he’d like them to meet”!

It’s no doubt he has a constant buzz around him as fans and fanatics join the crush to worship his every step.

Fall of an Angel

But it wasn’t always beer and skittles for Conway, and in 2001 it even seemed as if he’d entirely fallen off the wagon.

Moving into the realm of startup investing on the cusp of the dot-com boom, Conway started out as an angel by betting on a varied range of startups in the hope that they’d turn over big dividends via his 2 funds – Angel-I and Angel-II.

But O’Brien’s article takes us back to a dark period in 2001; when it appeared that Conway had backed one dog after another and his 2 funds lay in ruin.

Conway recalled the time as “painful” but thankfully his early investments in funds-transfer giant PayPal and search engine stalwart Google went public in 2002 and 2004, respectively, which turned the whole thing around.

Bet on the Jockey

Thanks to his staying power and ability to “keep the faith,” Conway was back in the money.

Many angels might not have stuck around to see it through, but it was Conway’s commitment to the craft and belief in people like Ev Williams, founder of Odeo, that sets Conway apart from many angel investor hopefuls.

Conway’s faith in Williams became unwavering, especially after Williams re-paid investors swiftly when Odeo failed – an extremely unusual gesture from any entrepreneur.

“I decided to set that money aside and invest in whatever Ev did next” – Conway told O’Brien.

And the thing Williams did next was none other than (the almighty) Twitter!

What Have You Learned?

Ron Conway is an angel who’s driven by his heart, and his faith and his belief in other people.

As an up-and-coming angel investor, what have you learned from Conway?

From what we see, nice guys don’t always finish last. Drop your conceit and believe in mutual respect. Be helpful to entrepreneurs — they’re the ones who’ll make you money. Don’t you agree?

William R. Kerr

Startup businesses need more than just cash in their kitty to achieve success and business longevity, according to a Harvard Business School paper into entrepreneurial funding.

While it is important that seed businesses receive the necessary funding to get their operations up and running, sometimes the psychological support they receive is just as important as the financial leg up.

Only an archangel can make this happen!

Angels vs. VCs and Friends & Family

Where a venture capitalist may swill some cash around in their managed fund and occasionally flick some in the general direction of promising startups, angel investors give new businesses their proverbial set of wings – give yourselves a pat on your cherubic backs for that one!

Angels are oftentimes seen to provide the same type of support that friends and family might.

But just like the merciless honesty we expect to receive from friends and family, angel investors don’t back a venture they don’t believe in – and this point of distinction appears to make all of the difference.

Angel-Backed Companies Less Likely to Kick the Bucket

The Harvard report penned by William R. Kerr, Josh Lerner, and Antoinette Schoar tables evidence that angel-funded firms are less likely to kick the bucket than firms that rely on other forms of initial financing.

This is good news for you angels out there who have invested your hard-earned cash in a venture and look forward to continued pay days!

While venture capitalists might be intent to keep flogging the dead horse that still promises to win a race, angel investors are proven to seek out companies that are committed to the growth of more than just their bank accounts.

According to Kerr, Lerner and Schoar, the improvements that can be seen within businesses funded by sophisticated angel investors can be logged at between 30% and 50% – more than the improvements noted in businesses using other types of initial financing.

Kerr, Lerner and Schoar go on to say that these statistics can be attributed to:

• the use of networking that is initiated by most angel investors;
• the dedicated due diligence they put into researching each new venture before signing on the dotted line;
• the personal assessment undertaken to weigh up the chances of recovering their outgoings; and
• the way that angel firms survive and thrive by upping the ante on diversifying their portfolio and maintaining a personalised approach to their business backing.

It is okay to initiate a “Give me an A, N, G, E, L” cheer here punters!

More Than Money

The concept comes back to the nature vs. nurture school of thought.

Josh Lerner

Does a new baby require only milk to satisfy her growth and development needs?

Unlikely.

Just like an infant, startup businesses are usually seeking added value from an angel financier.

Adding value means helping out and being there when the
company needs you (e.g. providing helpful advice and critical connections), not stepping on the founder’s toes when your help isn’t needed.

The overall vibe of the Kerr, Lerner and Schoar report is that angel investors should embrace the fact that they are expected to give more to their investments than just the funds.

Take Away

You’re all acutely aware of the fact that the success of your investments is balanced greatly on the success of those you invest in, so take away some key points of thought from the Kerr, Lerner and Schoar paper.

• Due diligence, due diligence, due diligence – Look beyond the business plan and executive summary. Intensively evaluate every member on the startup team. Listen carefully as they present their ideas to you. Do they believe in themselves as much as they expect you to?
• Document, document, document – The Kerr, Lerner and Schoar report details information about how much effort Tech Coast Angels put into maintaining their database of companies not funded by them, but should be! Food for thought…
• Score it – Take a ballot on a new venture detailing your interest level in a pitch delivered by a startup, your overall confidence in the facts and figures that back them up, and your belief in their commitment to drop their egos and put in the hard yards to make success happen.

This is the second in a two-part series.

In Part 1, we took a look at how ABC’s reality show “Shark Tank” gets some key angel investment concepts wrong. In the second and final installment, we’ll offer five things the show gets right.

A Japanese import, “Shark Tank” has helped thrust angel investing and entrepreneurial spirit into the spotlight. The show throws hungry small business owners before a panel of self-made millionaires.

Entrepreneurs pitch their investment proposals and look for a specific dollar amount from the sharks. In return, the investors seek a percentage of ownership stake. The real-time negotiations play out in an ultra-public setting that, at times, makes for combustible debate — passionate entrepreneurs who’ve poured their lives into a startup rarely take defeat well.

Some of the show is closer to make-believe than anything resembling “reality” television. Valuations, time frames and negotiations are all warped or misconstrued for the benefit of the neat TV package.

But “Shark Tank” doesn’t get it all wrong. In fact, here are five things the show gets right about angel investing:

1. Points for Presentation

The Sharks don’t shy away from ripping an entrepreneur for a lackluster investment proposal. While some of the bluster is no doubt for the TV audience, there’s definitely a pragmatic foundation there. It’s seemingly common sense but needs to be reiterated: Presentation matters. One that’s cobbled together or that reflects a certain degree of seriousness, professionalism or general knowledge isn’t likely to inspire confidence or investment.

2. Smart Money

Entrepreneurs should seek smart money. The investor should hopefully be able to add value more than just the dollar investment. Small business leaders solely in search of dollars are almost always doing themselves a significant disservice. Some of the smart entrepreneurs target particular Sharks because of their past experience with similar ventures. Likewise, the Sharks often pursue a venture where they feel they can add significant value or will pass on deals where they have little to offer.

3. Smart People

Ideas without great management are not worth much. Talent is key and so is the ability to execute. Having IP may be the only other thing that helps make an idea valuable, but the IP is partly a result of execution and management. The Sharks are often wary of companies that lack a strong, visionary leadership who can generate results with the funding dollars. The general investor should be, too.

4. Valuations Vacillate

Valuations fluctuate wildly and there is no standard method. This can be seen in the wild fluctuations proposed between the sharks and the entrepreneurs. Entrepreneurs looking for a plug-and-play formula for valuations need to prepare for uncertainty.

5. The Elevator Pitch

There’s a duality inherent in “Shark Tank” when it comes to the pitch itself. In the real world, the thought of investors making a decision after reading a plan and listening to a few minutes of presentation is hard to fathom. At the same time, the show offers entrepreneurs solid examples of why cultivating a sharp “elevator pitch” is extremely important. It also illustrates how key it is for entrepreneurs to craft a compelling story for their vision.

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Dixon has founded 2 successful Internet companies in New York over the last 4 years. Dissatisfied with the venture capital market, however, he has now teamed up with friends and fellow angel investors, Eric Paley and David Frankel, to create Founder Collective, which aims to fund startup tech firms.

Tech Startups Are Underfunded

Dixon says that he wants to do what he wished was available when he started out as an entrepreneur. The tech segment, he believes, is highly under-funded, an oversight that Dixon hopes to correct. Unlike firms filled with VCs with zero real-life operational experience, this new venture among capitalists is run by people who have themselves been entrepreneurs and know exactly what is needed by startups.

The problem, as Founder Collective sees it, is that there has been a trend towards bigger and bigger funds over the past decade. This has consequently led to multimillion dollar funds that need to make huge investments. This, in turn, means that VCs can focus only on the more well-established companies.

Founder Collective Focuses on Seed

What Dixon and his friends decided to do, as a result, was to raise a small fund of US$40 million that would focus on technology startups. Based in Cambridge, Founder Collective has 2 full-time managing directors — Paley and Frankel. Dixon and his other partners, Mark Gerson, Zach Klein, Bill Trenchard and Micah Rosenbloom, will continue as the CEOs of their own firms and come in as sponsors on specific deals.

Founder Collective aims to specifically focus on seed-stage funding. This means that rigorous checks on the entrepreneur will be crucial, although Dixon acknowledges that one really cannot predict the future after all.

What holds all the partners together is their common interest in companies at the early stages. The phase of team building, product development, and financing can be the most exciting time in the life of a company. Oh well, some people bungee jump…whatever gets the adrenalin going.

“We get to work with energetic, passionate, thoughtful young entrepreneurs, who just need a little guidance,” Dixon says. “We all enjoy the process of building companies ourselves — or helping other people to do it.”

Founder Collective has so far made 9 investments between US$50,000 and US$700,000, including New York-based Hot Potato and art gallery and website 20×200.

The reader writes -

How do you prevent being washed out as you keep pro-rata and the numbers get increasingly bigger?

Suppose you invest $200k for 25%. The venture then raises $5m, so to keep pro rata you do $1.25m of that round. Then it raises $15m. Eventually it gets hard to follow you money and you get diluted down significantly.

We’ve covered dilution in an up round in Part 1 and examined dilution in a down round in Part 2. Here, we’ll go over some of measures you can take to lessen the impact and/or likelihood of getting burned by dilution. If this topic is new to you, you may want to read the basics in Part 1 and Part 2 before proceeding.

Note: Not all of the measures below can be taken simultaneously. Sometimes it’s either A or B, but not both. Talk with a lawyer who’s very experienced with startups and angel financing to gain a better understanding of the terms and deal structures.

Aligned Interest. Align your interests and objectives with the founders’. Paul Graham of Y Combinator writes:

Dilution is normal. What saves you from being mistreated in future rounds, usually, is that you’re in the same boat as the founders. They can’t dilute you without diluting themselves just as much. And they won’t dilute themselves unless they end up net ahead.

One way to do this is to offer entrepreneur-friendly terms, such as opting for common shares instead of preferred shares. The tradeoff is that common shares offer you very little protection.

Another way is to agree on an exit strategy early on. Basil Peters — an angel investor, prolific speaker, and author of Early Exits: Exit Strategies for Entrepreneurs and Angel Investors (But Maybe Not Venture Capitalists) — believes that “angels, and entrepreneurs, would have fewer dilution surprises if companies had good alignment on an exit strategy before the first investment went in.”

Angel-Only. Focus on angel-only deals to prevent follow-on financing from VCs (which can be very dilutive), notes Peters. The companies should require only US$0.5 million to US$3 million to prove its business model.

Early Exit. Big corps like Google are increasingly buying pre-revenue ventures as their growth strategy, says Peters. Help the company exit early (e.g. look for an attractive acquirer before it becomes sustainable or profitable) once it’s proven its business model. Exiting early allows you to cash out and helps avoid raising dilutive rounds.

Anti-Dilution Provision. Include anti-dilution provision in the term sheet, which allows you to re-price your stock if subsequent funding rounds are down rounds. In general, this comes in 2 forms, full ratchet and weighted average ratchet. More on anti-dilution protection in a future post.

Even if you’re protected by this provision, later investors can force you to waive or remove it. It’s really a matter of bargaining power. If the company needs the cash to survive, but potential investors refuse to invest if you don’t waive your right, then the company could die.

Board. “Negotiate for permanent board status or at least observer status,” advises Jeffrey Leavitt, partner of DLA Piper. This way, you can “learn of pending company activity that could affect [your] interests.”

But don’t take this as you-should-stick-your-nose-into-every-little-detail. Y Combinator, for example, interferes as little as possible. The seed firm realizes that independence is one of the reasons startups succeed. “Investors who try to control the companies they fund often end up destroying them.”

Though we should mention, the amount Y Combinator invests is relatively small — usually around US$11,000 + US$3,000 per founder. Which means US$17,000 for 2 founders, US$20,000 for 3, and etc.

Capital Efficient. Invest in companies that don’t need a lot of capital to reach breakeven or profitability. These companies have better odds to become self-sustainable; they’re less likely to be desperate for cash or funding from outside investors.

“[Capital efficient] means go-to-market (funding) is right around [US]$2 million, and maybe up to $4 million to get to cash-flow break-even and that’s got to be it,” stated James Geshwiler, managing director of Lexington’s CommonAngels and past chairman of the Angel Capital Association.

Deal Structure. Avoid unnecessary dilution by acquiring preferred shares or convertible debt, which converts to shares at a later date when the venture is properly valued by professional investors, Leavitt further suggests.

Follow-On. Reserve funds for follow-on investment. John Huston of Ohio Tech Angels Fund said, “The angels’ best protection against a ‘down round’ is to have adequate dry powder to preclude the need to seek new outside investors.”

Milestones. Before you invest, make sure the company has set, and will likely hit, milestones that will increase its valuation before raising the next round. Increasing valuation in the next round means there’ll be no down round. As mentioned in Part 2, down round can be very dilutive and can decrease the value of your holdings significantly.

One angel says, “[Significant milestones include] licensing of a critical piece of technology, completing a prototype, entering into an important partnership, entering beta testing, completion of FDA I testing, achieving first revenues, etc.”

Valuation. Value the company reasonably from the start. New angels frequently pay too much at the early stage, placing too high a value on the startup. Over valuation is more prone to down round if the company needs to raise more money from outside investors in order to get the business going. Again, down rounds can significantly dilute the value and size of your holdings.

Final Words

Dilution is inevitable in both good times and bad. When it comes down to it, you ought to be confident that the company’s valuation will exceed the impact of dilution before opening your checkbook; otherwise you may want to pass on the opportunity and look for one that has such potential.

If you want to be more than a one-trick pony – that is, if you want to bring more than just cash to the startup – you might be needed in some of the following areas to assist the business:

THE OUTSIDER: An angel investor brings an outsider’s viewpoint to the business. Many startups are run by passionate people who have a lot of skin in the game. Your point of view – as someone who arrives on the scene a little later – can bring sanity and perspective. Of course you’ll be “bought in” when you invest in the organization, but be sure to keep one foot outside of the business – on firm ground – to make sure that your outsider’s perspective adds value.

THE GUIDE: Taking a journey through the unknown is full of false starts and missteps. Having someone there who has made that journey in the past (perhaps more than once) can help to bring a startup to profitability sooner, and more efficiently, than without your help. You already know that you don’t simply drop off a check and consider your job done; active research and networking with this step in mind will increase your ROI.

BINOCULARS: Entrepreneurs can become so focused on their project that they can sell themselves on its value. Ever had a startup tell you that their product “sells itself”? They need your skill to point out that no product truly sells itself, but rather that marketing and sales will play a part. In a sense, you’ll help them to look up from the small picture of their microscope and look through binoculars at the panoramic view. At every conversation, get the subject matter away from the product’s features and put their focus on the full business.

THE ORGANIZER: One of the first hires of any rapidly growing business is an organizer – someone who can see the chaotic pieces and assemble them into an efficient whole. COO’s or CFO’s often play this role when they’re brought on board. However, introducing some organization earlier into the process will mesh nicely with your role as the angel investor. Granted, an organizational chart (and other organizing tools) might best be written in pencil, but you can bring value to the startup by corralling the team and bringing order.

THE OPPORTUNIST: When a product developer starts a business, their focus is on their product, and often on its tried-and-true uses. You bring greater value to the team by broadening their horizons beyond that initial purpose to show them that there are other opportunities or markets for their product.

A word of caution is important here: Make sure you can back up your contribution with expertise. If you’re an angel with money, just be the money and avoid foisting your grand (but inexperienced) ideas on the company. But, if you’re an angel with cash AND with decades of business wisdom then you’ll be a welcome addition to the team.

As an angel investor, you probably will bring money to the table. But you have a bigger role to play and you’ll make the startup more successful, faster, when you bring your entire toolbox of value to the agreement. This is a great way for you to actively contribute to the growth of your financial investment with a little “elbow grease”.

Image: Hugh MacLeod

You and a group of other angel investors have placed your trust — and your money — in a startup venture. Now what? What can you and your fellow investors do to help your portfolio company live up to its potential?

The previous articles (Challenges #1, #2, #3, #4) in this series focused on choosing an investment and making sure that you’re getting your money’s worth. But successful angel investors don’t stop when money changes hands. The next step in the process is monitoring the performance of your investment. This is actually something you should consider early in the game. How much involvement do you want to have in the company, and what will that involvement look like?

As an investor of a startup, you need to think about who’ll speak for you. If one seat on the board is reserved for an angel, you need to think about who’ll be able to accomplish the most in that position. And that may not be the person who made the largest investment. The angel who serves on the board should be someone who knows the business thoroughly and is skilled at interacting with others.

Oftentimes, angels also act as mentors and coaches to management. Many startups are headed by young, inexperienced managers who have wonderful ideas but little knowledge of how to make them work. You can provide the sort of expertise and business savvy these novices need. You can also put managers in touch with your network of valuable contacts in the business world.

Even before the investment is made, you need to think about how you’ll communicate with management. You don’t want managers to feel like you’re breathing down their necks, but you do want to establish regular channels of communication. At a minimum, you should request quarterly reports on the company’s progress.

You also need to think about how you want to measure the company’s performance. Are you mainly interested in tracking revenue, profits or technical progress?

And what happens if problems emerge? If, for example, the company badly misses milestones? In these cases, you should initiate closer contact with the company and more frequent communications. You may also offer additional coaching and advice to get the company back on track – but don’t breathe down management’s necks.