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Sunday, Sep 26, 2004

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Once sour milk hits the morning coffee, it cannot be strained out

D. Murali

THIS is a world that looks for quick returns because few have the patience to wait. It is rare, therefore, to find people who have the courage to trust in enterprises that are not yet off the ground.

Thus, if you are an entrepreneur with a great idea thumbing on the finance highway, it is quite probable that you don't come in the field of vision of institutional investors and creditors. But angels will spot you as blips on their radar screens! To guide them to you, here is The Angel Investor's Handbook, by Gerald A. Benjamin and Joel Margulis, published by Vision Books (

There is "much money pinballing around," but the problem is "it might not be handled judiciously." We are in the pre-IPO arena where there are enormous risks, and to add to those are too rapid decisions "using only executive summaries to determine whether to invest", sacrificing due diligence. Winners may appear to "nonchalantly hit the home run", but behind that superficiality is the homework they do: "Investigation, negotiation, valuation, deal structuring, and exit planning." To fly, therefore, like angels, without such preparation would only resemble the folly of Icarus.

The authors announce that there are more than a million US households having "the capability through discretionary net worth to invest directly in early-stage companies or ventures."

Ninety per cent of the US millionaires are self-made, not inheritors of wealth, you'd learn from the book. They're not egg-sitters but "know firsthand that profits can be derived from successful start-up ventures."

Very little info is available about this `esoteric and idiosyncratic' private investors. Once an angel is spotted, entrepreneurs inundate him/her with deals, most of which may fall flat on investment criteria. "At a party, a meeting, a professional event — it doesn't matter; someone will approach them, slide out the old guitar, and start singing the song." That may sound, loud and clear like the Abba song, Money, money, money! "The investor who surfaces has to be ready for what follows." Money Must be funny in the rich man's world...

Venture investment takes many forms: "from riskier seed, R&D, and start-up funding at the earlier stages through bridge, acquisition, merger, and turnaround investments at later stages in the development of the venture." Seed, as the name implies, is the idea stage. Financing R&D helps product development, and start-up support takes care of initial marketing too. You bridge to help in short-term capital "to reach stability". M&A, is matchmaking. And turnaround is about turning from red to black.

Since there's a lot of money available, won't all needs be satisfied fully? No, because there are "inefficiencies in the market for early-stage company equity". There is no ready information about sources of funds or venture opportunities.

Another vacuum is that no secondary market exists to provide the angels with exit routes. "Further, restrictive securities regulations limit the flow of information." As a study by International Capital Resources shows, "more than 50 per cent of private investors' deal flow comes through family, friends, associates, and colleagues." If that's not woe enough, "professional assistance and advisory counsel is extremely expensive."

Another finding is that 65 per cent of angel investors like to invest in deals "within 300 to 500 miles" off their residence. Average hold time is eight years, and ROI objective is "a minimum of 30 per cent". But how long do they take to decide: "As little as three weeks." It would be nave to look at angel investors as only deep pockets because they wish to be "high-worth investors not just high-net-worth investors".

`Deal-flow development' or the surfacing of angel investment opportunities happens in three ways: 57 per cent got the inputs from personal contacts; 31 per cent received referrals from attorneys, accountants, brokers and so on; and 12 per cent received "an unsolicited contact from a non-family representative of the firm seeking financing."

When explaining due diligence, the book advises: "Avoid investing in people about whom you cannot make a valid judgment." What is important is what you do before investing. "Once the sour milk hits the morning coffee, it cannot be strained out. Neither can sour deals."

A chapter that should interest professionals is `the preinvestment audit' with many checklists. Thereafter is negotiation and deal structuring, where you should avoid mistakes such as misinterpreting the entrepreneur's poker face as `hostility or apathy'.

On `valuation', you'd learn that it is not a precise form of financial analysis, but "more akin to an art form or, at times, even horse-trading" because "subjective factors eclipse objective ones" and intangibles can be overwhelming.

If you're ready to fly with angel wings, tuck in this book between the feathers.

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