What Makes Dumb Money Smart?

Some time ago I decided to write a series on how to raise funding from angel investors. It is a broad topic. I start with this lengthy blog post where I explore the ways an angel investor can add value to a startup beyond mere money.

So, please grab a cup of coffee and let us begin.

What a business angel invests and expects?

An angel investor can invest dumb money, relevant knowledge or both. The combination of money and knowledge is called smart money.

  • Money. This is the easiest element to evaluate and compare alternative offers against each other. How much? What’s the funding structured (equity vs. convertible)? What is the valuation and other key terms?
  • Knowledge. A relevant knowledge is rare. Almost any investor will claim to be investing smart money. Smart knowledge applied at a pivotal point can either accelerate success or prevent a failure. Knowledge matters!

An angel investor doesn’t offer a free lunch but expects to get something back also. 

  • Return on Investment. The investor expects to get paid if a startup gets off the ground and later on gets either acquired or IPOs.
  • Control. Traditionally investors have wanted a degree of control in the companies they have invested. The latest trend is less contractual control or no control at all. The control, or ability to influence, comes through mutual relationship between the founders and the investor.

In spring time 2012, I was asked to keynote in a local startup event. I decided then to talk broadly about business angels; where do they come from, how they differ from each other, and most importantly, how to evaluate and measure their value add. Here I will present and discuss the distinct contribution dimensions and angel profiles I quickly generated back then.

I acknowledge this is not an absolutely coherent presentation of the topic but I do hope you will still be able to derive some value and gain fresh insight from this.

What are the typical angel investor profiles?

  • Super Angel. These are highly influential and rare creatures. They are mostly based in the Silicon Valley. They are prominent and deeply networked individuals with access to proprietary information through their relationships. Super angels have deep pockets and they have a diversified investment portfolio, and they like to co-invest with other super angels, and double down when initial bet turns out to be successful. Super angels are super busy and thus their contribution beyond money focuses on creating access and increasing credibility. We don’t have a single super angel in Finland. The best super angles have highly proprietary deal flow and they have a very detailed picture on what happens in the market. Their failure tolerance is high because they are the players and know the rules of the game.
  • Startup Specialist. That’s me. This is a hard position to be at. You fight against people with money and reputation. You have to be better or work harder in areas that require considerable use of non-scalable sweat i.e. time. Startup specialists have in-depth understanding how startups are built. They have been there. Preferably in the role of a CEO as nothing replaces CEO experience – nothing. The key contribution takes place in defining the product, helping the team identify and prioritize tactical steps, and being a close leadership mentor to the CEO of a startup. Good startup specialists with product sense and nuts’n bolts level understanding of the business and technology are rare.
  • Professional Manager. There are large corporation executives most of whom are taking their first baby steps with startups. Oh boy, different world! Very few professional managers have been able to cross from large corporation to a small startup without doing major damage to startup(s) in this process. They just don’t get it easily what hands-on and being lean means. A prominent CEO of a public company will always increase credibility of a startup but do be careful to follow their tactical and/or strategy advice.
  • SME Founder. If you have successfully founded a small company and made an exit, that must count for something. You probably know how to be hands-on. Having said this, most SME founders who have gotten rich but do not have background in high technology, they may be nice persons but their money is dumb as building a fast food chain don’t qualify you as a savvy tech investor. The same rule applies to successful technology entrepreneurs who were successful because they were in the right place at the right time. Luck plays a major role!

When evaluating the value add of an angel investor, please do look beyond the track record and celebrity status. Try to understand what are the specific areas he excels at and what are the basis for his claimed particular competence.

What are the key value contribution areas?

Time Usage

Most contribution areas require considerable investment of time. This is the underlying reason why sweat equity investing doesn’t scale at all. If as an entrepreneur you are looking for a strong contribution in areas that clearly require heavy usage of time (like helping you to build a go-to-market plan, or refining the core product), do ensure your angel investor is ready to spend the time needed. Measure output but be aware that certain type of output require enough time spent as input. Being smart, experienced and knowledgeable is only the prerequisite.

Failure Tolerance

Guess what happens in a startup where things go south and the future doesn’t look that bright anymore? People, including investors, panic. The more experienced ones armed with better failure tolerance panic less. An angel investor, with fear of failure and lack of failure tolerance, can become an incredible pain in the ass for a startup.

Angels who fear – both losing their money and more importantly losing their face – stop doing intros, may become hostile, and in worst cases start talking behind your back to kill your reputation while saving their own face. This is just a normal human behavior yet it shows how so few angels in practice understand the true nature of early stage investing; most will fail and there is nothing wrong with that, it’s part of the game.

Luckily, there are exceptions. Those few angels who understand the rules of the game. The ones who continue to back you up even when you are facing a certain death. My advice is never to take any angel onboard who fears failure. It is contagious and makes your life miserable.

In addition, it might be a good idea to request all angel investors to sign a memorandum of understanding in which they acknowledge that most likely outcome of the venture is that they lose their investment in full. Should this be an issue a question should be raised about their suitability of being an angel investor in the first place.

Corporate Governance

The in-depth understanding of startup legal is absolutely critical. If you are building your first startup, you don’t know what you don’t know and that’s a big problem. One of the areas where this shows is legal. An angel investor with tons of experience in startup legal is a great asset. Most angel investors, however, don’t know well enough this stuff. It is so specific with all nuances and details. Even most lawyers don’t understand this area well enough and their advice is oftentimes not good at all.

Credibility

Any new startup without proven founders and market traction has a credibility issue that prevents it from either closing early customers or raising funding. Increasing credibility means increased chance of success. Thanks to social psychology, you can enhance the perception of your company’s credibility via social proof. A prominent, important, distinguished person joining to the company as a director to its board or an advisory director. This must mean something! If you bring in a brigade general or almost any prominent person who is appreciated by your target market, tech press or your prospective customers, the credibility goes up – even if there would be no real basis for his reputation or value add to your startup. It is about the perception. Perception matters.

A prominent angel investor with good track record and reputation always increases the credibility of a startup. For an angel, this value add dimension is the most scalable way to invest knowledge (or reputation) as it doesn’t necessitate any use of time.

Network

Some angels are taken onboard because they claim or are known to have a vast network with breadth and depth. This network is further expected to translate into meaningful meetings and business opportunities through introductions. It all depends. It is not a done deal. Very few people, in fact, have a good cross-industry international networks to top decision makers in large platform companies (e.g. Facebook, Apple, Twitter, Google etc.), startups, and venture capitalists.

If you are building a mobile app or a Facebook app in Finland, if someone can introduce you to a right person in a platform company it can be very valuable. A typical Finnish angel can’t do that, as his reach stops at the border.

Influence

The network alone has almost zero value. You are looking for introductions that have impact. Introductions that will get you the meeting or a quick phone / Skype call with a decision maker right now. Many people have large networks, very few people have great influence at the highest echelons. Seek angels with influence!

It takes a lot of time (10-15 min) to write or call a good introduction. It doesn’t sound much but if you  are known for your network, the queue of introduction requests is endless. The more prominent you are, the more people ask introductions from you. Luckily, this is an area where increasing influence greatly decreases the need to write lengthy introductions.

I mainly do introductions to my inner circle, which means I can cut off the nonsense and just write “Qintro” standing for quick introduction to the email subject line. I never do an introduction if I don’t see there a fit and trust on the integrity of the participants, and neither should you.

Funding

The best angels not only know a lot of other angels but they also have experience and track record on how to raise angel and venture capital. They know what are the milestones you need to achieve to become fundable. Trying to raise capital when a venture is non-fundable is waste of everyone’s time yet companies do it all the time.

Lean Startup Strategy

Helping the founders to put together an executable plan is very valid and important value add. Things like:

  • Understanding the big picture and helping the team to define a competitive business strategy.
  • Defining meaningful customer and product development steps that are reachable yet stretchy and well aligned with the funding requirements.
  • Changing strategy in case the existing assumptions are tested and shown invalid.

Product

Startups die or fly with the product they build and launch. Adding value to product means working hands-on with the team on all aspects of a product be that its design, feature set, positioning, launch plan, choice of technologies etc.

Product contribution is the highest value adding area but it is also very complex.  An investor must spend a lot of time to truly grasp the intended product concept. The product visions of the in-house product person and investor must be in good alignment. Otherwise influencing the product vision and engineering decisions is not possible or becomes inefficient.

In addition to the above value add areas, leadership development and related contributions can be very valuable. Especially so if the founding team and its CEO are doing their first startup.

I don’t know why but spelling this stuff out from my mind felt like a big effort this time and I am not completely satisfied with the result. Anyways, I decided to get it done and publish it today no matter what.

Let me know what you think about this, and if you think I have missed or ignored something that I should have said here, please do let me know, and I will make this even better.

4 thoughts on “What Makes Dumb Money Smart?

  1. André Medeiros (@andrestaltz)

    I felt like this article needed a conclusion, because it ended so suddenly. In particular, I would be interested in methods that startup founders can use to assess if an angel investor has those contribution skills. For instance, I find it really valuable to see recommendations from startup founders and their experience with the angel. As you said, anyone can claim to have those skills, but they become proven once others confirm it.

    And good informative text. From my perspective of a humble first time entrepreneur, I consider Influence, Corporate Governance, and Startup Strategy the most beneficial value contribution areas. But then, as you said, I might not even know what I don’t know, and other areas could become crucial.

    Thanks

    Reply
    1. mikamarjalaakso Post author

      Hello Andre,

      Thanks for your comments! And great to see you here. I think recommendations and social proof have very little value in evaluating a potential angel’s capabilities. Yet people use them a a lot.

      The only way to really test whether a certain sweat equity investor is good for or not is to do a small project together. Anything from one day workshop to a smallish one or two week project. This way you can figure out whether you can efficiently work together, share the product vision (at least at that point) and how good you think is the angel’s beyond money contribution.

      I actually have built sets of questions to gauge a candidate’s capabilities in each area. Asking those questions is better than nothing but I would advise to do a small project together.

      BR,
      ,,Mika

      Reply
      1. André Medeiros (@andrestaltz)

        Hi Mika,
        Thanks for the quick response.
        The method you recommend is good indeed, but then it basically applies only to Startup Specialists or angles with enough time. So for all the other kinds of angel investors, what methods apply? Recommendations plus questions?

  2. mikamarjalaakso Post author

    Hi Andre,

    Well … if you get a chance to get a real super angel onboard, naturally you probably don’t ask too many questions but offer your hand and welcome that lucky person.

    Keep control to yourself and accept money and don’t ask too many questions as long as you get along well. Make sure that the angel understands he can lose everything. Get the papers signed and take the money. 🙂

    ,,MIka

    Reply

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