Angel Investors

Investment lexicon for entrepreneurs, angel investors and venture capitalists

Isn’t it interesting how words can creep into our business vocabulary and have completely different meanings from their etymological roots?

 Here are a few words that bear little resemblance to their original meaning:

 Traction – defined as the act of drawing something over a surface.  Today in business it relates to a company’s ability to generate revenue or acquire customers. For example, “the company was able to gain traction in the mobile app sector by acquiring customers”.

 Runway – defined as a specially prepared surface along which an aircraft takes off and lands or a raised gangway in a fashion display. Today it means a company’s longevity to sustain revenue or cash flow. For example, “the company has enough cash in the bank for a runway of three years before the next capital raise is necessary”. 

 Don’t you miss Andy Rooney?

 He would have had something brainy to say about our business vocabulary.    You have to love his sarcastic wit. He once quipped – “The dullest Olympic sport is curling, whatever ‘curling’ means”.  How true! Sorry curlers.

 Well, I came across another word that is being embraced in the investment world and it is – “curation”. Curation is the new due diligence aimed at delivering high quality deal flow or investment prospects to investors and backers. It refers to the process of vetting deals to scrutinize losers from winners. 

Although this seems to make sense on the surface, the way I see it the problem resides with those doing the curating. Why? Because if they are not very good at using their curation crystal ball to pick winners then the process is flawed. These gatekeepers to capital have to be really good at screening the good deals from the bad ones to generate positive investment outcomes.

 Due diligence or curation, although a practice that provides a certain level of comfort to investors as a hedge in risk mitigation, cannot be relied upon entirely. The statistics on start-up failures are a testament to how terrible existing practices are in delivering on the promise. We know these top picks eventually result in a whopping 80% plus in business failures. 

 I see interesting differences between the curation processes for Crowdfunding and the more traditional practises used by Angels and Venture Capital Funds.

 In my mind Angels and VCs represent the few that make decisions for the many about who will get funded and who will not. A lot rides on their curation prowess, and the stats prove it is not efficient.

 Crowdfunding takes out the middleman or the gatekeepers and replaces them with the wisdom and the hearts of the Crowd to make better predictions as to the winners that get funded.  Let me explain.

 In James Surowiecki’s book “The Wisdom of Crowds” he maintained that large groups of people, even non-expert people, are very often smarter than an elite few no matter how brilliant those few may be. The author provides numerous examples of when groups have proven better than individuals at solving problems, fostering innovation, coming to wise decisions and most notably, predicting future outcomes. Intriguingly, group members don’t need to be particularly smart on an individual basis in order to be very smart on a collective basis.

 Here are some interesting trading platforms that use the power of the crowd as prediction markets. 

 Hollywood Stock Exchange (HSX) 

 The HSX is a virtual, online stock exchange where traders buy and sell virtual shares in upcoming movies. The HSX sells the data collected from their exchange as market research to entertainment, consumer product and financial institutions.

 Since 1996, the HSX has accurately predicted the box office receipts of thousands of movies. According to a study the correlation between the HSX’s predictions and actual opening box office receipts was calculated at 0.93 – not bad since a perfect correlation is 1.0.  The HSX has also been used to predict Oscar winners, and so far they’re averaging about 92% accuracy.

 Wouldn’t this number be refreshing when it comes to predicting positive start-up outcomes?  

 Although people self-select to be involved, meaning they choose to be involved. There is no screening mechanism to ensure these “traders” should be ardent movie or entertainment experts. This crowd is large and represents over 1.6 million traders. Such a large sample can be said to be statistically correlated.   

 Iowa Electronic Market (IEM)

 The faculty at the University of Iowa developed the IEM to be an Internet-based teaching and research tool. It allows students to invest real money ($5.00-$500.00) and to trade in a variety of contracts. The use of the IEM is best known for the prediction of political election outcomes.  

 The University of Iowa has found that even 100 days before an election, the market price predicts the winning candidate about 75% of the time.  Political polls predict only slightly more than 50% of the time, and political pundit predictions are way worse. A 12-year analysis of IEM trading indicated that the IEM consistently out-performs political polls in terms of not only choosing the right candidate, but also predicting the margin by which he or she will win. 

 These examples demonstrate the power of the crowd to make predictions. They do not just indicate the capability to identify winners and losers, but also the overall statistics provide evidence of their accuracy in doing so.

 Crowdfunding works on the same principle. Backers vote for their project and they will use their own money to do so. They will back a project if they feel it is aligned with their interests, needs and beliefs. The collective demonstration of social proof is more powerful than any process of curation can ever be, as it elevates winners by using the collective shoulders of the crowd.

 Crowdfunding backers, like customers, vote with their wisdom and heart. The current reward based platforms are showing that curation or due diligence does not have to get in the way of positive capital raising outcomes. Although some platforms do vet projects, this is more on the basis of suitability rather than financial metrics. In the end it is the people with compelling projects who motivate crowds to get on their side and provide them the needed capital, which is proving the disintermediation of due diligence.

What I mean is, due diligence is not necessary in predicting winners, and one has to contemplate whether it is necessary at all given the track record of the capital gatekeepers in the traditional investment arena to produce winners. Tapping into the wisdom of the Crowd may be much better.

Over half of all startups are dead in the water within 2 to 5 years. This certainly may help explain the exponentially popular appeal of business incubators and accelerators, which promise to boost the chances of individual startups to raise capital, get to a positive revenue stream and provide community benefits like higher regional employment.

There were about 12 incubators in 1980 and today they number in the thousands in the USA alone. Some of the most famous ones are Y Combinator or TechStars. Even governments are getting into the act: the Obama administration in White House has launched Startup America to facilitate public and private partners investing in American entrepreneurs.

In different ways, incubators and accelerators aim to leverage high-quality mentorship and access to funders to produce dramatically different results; but do these methods actually work? (more…)

Even entrepreneurs who know how to raise capital may still not be taking full advantage of the relationships they’ve built with investors. Particularly with angel investors and venture capitalists, there’s an expectation, if not an obligation, to make use of their expert advice to help drive your business to success. Your backers may have crucial expertise as valuable as the financial investment they make in your enterprise.

Types of Angel Investor Expertise

Here are some examples:

Mentoring

Entrepreneurs or CEOs can gain much by asking experienced investors to act as mentors. They can provide great insights into finance, among other things. In early-stage companies, some lead investors or VC firms might provide the assistance of entrepreneur-in-residence, an experienced person who acts as a mentor.

Hiring

As we briefly mentioned above, experienced investors have wide-ranging industry contacts and are better than any executive search agency, not to mention much faster. You can be fairly confident that they can help you with hiring for almost all senior positions, either in engineering or management.

Strategic Alliances

Experienced investors can offer great ideas with regard to forging strategic alliances in the market and also provide you access to the right people in case you do not have your own network of contacts. They can help in providing sales leads, too.

Suitors

You can be assured that experienced investors have considered potential acquisition, or merger, partners before you have. Chances are they even have analyzed the prospective companies for the “best fit” with your company’s offerings. You should seek their assistance in forming a liquidity event strategy as this, in many cases, has been how your investors have made their money. They will also be interested in supporting you as they are interested in getting their money out one day when the time is ripe.

Entrepreneurs have to be on the lookout for a range of accelerators for their business, not just capital although raising capital is critical. Mentors, strategic alliances and other opportunities can come up at any stage and should be leveraged. Make sure you’ve got a strategy in place to take advantage of them.

Do Canadian entrepreneurs need to up their game? That’s the conclusion from a recent Vancouver Sun article that caught my attention, though I disagree with the premise; it’s more accurate to say that we still need to work on building a business environment that helps entrepreneurs thrive.

Here’s an excerpt:

“Then it becomes interesting. I’m a big supporter of the Vancouver tech community and I feel like we have a really good base here. But in the end, the only thing we can do to accelerate the development is attracting better entrepreneurs and more entrepreneurs to Vancouver. The more talented entrepreneurs we can get into town, the better.” Senia Rapisarda shares that sentiment.

The vice -president for strategic initiatives and investments at Business Development Bank of Canada, Rapisarda said that while Canadians have the technology and skill to compete in the high-tech market they are “a bit behind” when it comes to fostering development of what she described as “serial entrepreneurs.”

“Doing something, being successful and coming back for more, or doing something, failing, and coming back for more. We don’t have a lot of those, and we need them.”

I don’t think the problem is a lack of entrepreneurial spirit in Canada or even parts of the USA outside of traditional business hubs. If somebody tries to make it as an entrepreneur, fails and keeps failing, they still have to put food on the table. No one wants to keep banging their heads against the wall, so would-be entrepreneurs go back to working for others. The main stumbling block to creating serial entrepreneurs is how to provide an environment that supports entrepreneurship.

How to Develop an Entrepreneur-Friendly Business Environment

How do we develop an environment that creates more entrepreneurs and give these aspiring entrepreneurs (and serial entrepreneurs) an  edge? Here are a few ideas:

• Get people thinking about entrepreneurship earlier. Think back to high school or your childhood and when someone asked you what you were going to be when you grew up. How many of us listed a type of job rather than “starting a business”?
• Educate entrepreneurs about the resources that are available, such as government grants like SRED that help companies get the most out of limited budgets. All entrepreneurs understand the concept of bootstrapping, but not all understand that they can apply for funding even before they are ready to raise capital.
• Promote mentoring. The knowledge and wisdom of a board of advisors can be as critical to success as the raising of capital. There are some avenues for startups to take advantage of these knowledge resources through organizations like New Ventures BC, but these opportunities have plenty of room for expansion.
• Fail Fast; but fail cheaply. Entrepreneurs need to know the benefits of doing market research and how it can avoid costly mistakes. Make this business analysis tool set a fundamental part of any new and existing enterprise to minimize risks and increase value propositions. We know entrepreneurs rarely consider it an important element of business success.  Companies should be encouraged by funders and advisers to do market assessments, market validations, new product development research, customer segmentation and other research activities to make better decisions.

What else can we do to provide a more supportive environment for entrepreneurs? Leave a comment

Investment lexicon for entrepreneurs, angel investors and venture capitalists

What’s “burn rate”? What’s the difference between a “venture capitalist” and a “vulture capitalist”? What do “ROI” and “NDA” stand for? The arcane lexicon of venture financing can leave some entrepreneurs scratching their heads – which is not a great thing to be doing in front of a roomful of potential investors.

• The YCE Investment Lexicon is FREE to download!

Entrepreneurs are usually experts in their field. Plenty of CEOs of technology firms started out as programmers or engineers. Successful chain restaurant CEOs started out as chefs in their family’s kitchen. They know their business well – but they often don’t have the formal training in investment terminology.

Let’s go over a few of the common terms:

• Burn rate. The amount of money the company consistently spends each month on salaries, rent, general expenditures and administration.

• Hockey Stick Forecast. A five-year forecast with year-over-year revenue growth. In chart form, it looks like a hockey stick.

• Valuation. The monetary value placed on a company and agreed to between the investor and entrepreneur. It forms the basis of the investment. 

• NDA (Non-Disclosure Agreement). A legal document to protect the company’s confidential information.

Learn more the Your Capital Edge’s Investment Lexicon which is FREE to download. Get familiar with the language of investing

Listen to how venture capitalists and CEOs use this kind of language themselves in a discussion about How Venture Capital Works

Your Capital Edge is the successful entrepreneur’s secret toolkit that helps you raise capital, create investor presentations, formulate an HR plan, secure financing, locate Angel Investors, make accurate cash-flow projections and more.

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