Week 2: Sourcing

Every business needs money, not only to pay operating expenses like electric bills and salaries, but also to keep developing the products and services that fuel the business. This amount of money can often surpass the individual resources of one person.

When entrepreneurs and business owners need money, a frequent pattern emerges: first they ask their friends and family for money, then angel investors, and then venture capitalists.

This series of posts will focus on angel investing.

Angel investing is in many ways venture capitalism writ small. Most investments lose money – often all money invested. The winners usually do well enough that they more than compensate for those losses. As a result, the angel hedges his bets, investing in numerous companies, with the expectation that most investments will fail and maybe one or two will knock it out of the park.

Some have argued that angels and venture capitalists don’t actually make money.

Profitable or not, an integral part of angel investing is access: access to learn about and invest in quality companies before the masses. The first section in David Amis’ book Winning Angels deals with this challenge and proposes varying ways to try and overcome this barrier. Some suggestions are better than others, but the meat of it is that successful angel investing comes down to getting referrals.

Just to state the obvious, the problem isn’t finding people to take your money to fund their dreams – the world is full of them – but finding businesses that possess a (seemingly) solid idea and are already on the launchpad with the fuse (seemingly) lit. When these businesses need money and seek it out through a second party, will you hear about it?

Geography is a big factor in this dynamic – perhaps the factor. It is no coincidence that angel investors often cluster in places like Silicon Valley and other urban hubs. One of the curious things about living in the age of the Information Super-Highway is that you need to live in a city to have this inside line. The number of angel investors potentially willing to invest in your business likely decrease as you move further away from those urban centers.

The internet has brought angel investing across wider expanses of territory though, and these have some potential. Angel List offers the ability to join investing syndicates or as a professional investor. I believe you need to meet the qualifications of an accredited investor to gain access to the professional investing port of the site.

The last couple of years has also introduced equity crowdfunding, but this is an extremely young industry and still developing from a legal standpoint. There are enough stories about pump-and-dump fraud in this area to give one pause about investing hard-earned cash into those ventures.

It really goes back to relationships. Angel investing is relationship-based, just like publishing and politics. It certainly isn’t impossible to enter into it, but there are definite barriers (financial and personal) to entry that must be overcome if you want to become an angel investor.

Perhaps the best way to become an angel investor (if that is really your ambition) is to first start your own business, make that a success, and along the way pick up the skills and wealth that can eventually be used for angel investing on your own terms.

Much of Amis’ advice for angel investors could be examined from the perspective of the entrepreneur. Just as there are bad entrepreneurs, there are bad angel investors: people who always think they know better or who can’t extrapolate beyond their individual life experiences to the situation at hand.

Also, angel investors are not always content to be ATMs, and the funding should be thought of as a wedding of sorts. Conflicting visions and priorities will not serve either party.

Similarly, entrepreneurs can seek out the same parties that would eventually provide referrals to those high-quality angel investors.

We’ll examine this topic in more detail in the weeks to come.