Administration and governance in a start-up is not very complicated but the same laws and regulations, which the large companies follow, are to be followed. There is certain paperwork, which needs to be up to date all the time and this usually is the responsibility of the CEO, as start-ups do not normally have a finance and/or administration department in the beginning.
- Advisory boards
In addition to a competent board a start-up can sometimes benefit from an active and well organized advisory board. They might be people who do not want to sit on the company board because of the risks, their main occupation or other duties or personal reasons.
- Business angel
It is often thought that you have to be very wealthy to be a Business Angel, but in fact many start with investments from around 10.000 €. But remember that your money likely will be tied up for several years so it must be money outside your normal financial needs. Business Angels invest in more than one company to give a spread of opportunities to diversify their risks. In fact, it is recommended that you invest in at least ten companies to avoid too much risk.
As well as investing money, Business Angels also bring valuable know-how, contacts and experience to the businesses in which they invest. We talk about “smart money” when referring to Business Angels and other active and professional investors. Personal investment strategy Business Angels need to be active in looking for good cases. In order to be able to look efficiently from the start, a clear focus should be defined. It is a good idea for a Business Angel to clarify his/her personal investment strategy in the very beginning.
Also take into account that in most cases the business plan will not happen as expected and the surprises tend to be negative ones. Therefore an additional round (or several) of financing with similar valuation than the initial one is very normal, even though not anticipated in the business plan. You should reserve some of your planned investment for the target company to these later rounds.
The degree of Business Angels’ engagement can vary according to their personal availability and liking, ranging from being a lead investor down to a more passive role.
All entrepreneurs are optimistic; otherwise they would not be entrepreneurs. Some are also nervous, poor, uninformed or naive. That can be accepted, but you need to sort out the big liars, the cheaters and the incompetent.
Check at least the following:
A) Business plan checklist
B) Strategic plan checklist
C) The new business road test
D) Top Ten Lies of Entrepreneurs
- Collecting information
The entrepreneurs will of course provide you with a business plan and other information, but it is a recommended to collect information also from independent sources before engaging in close negotiations with the company. The more information you get from different sources, the better off you are. And the more informed you are when talking to the entrepreneurs, the better questions you can ask them. Get references – if the company already has customers, ask to meet some of them.
- Company board
A well-functioning and competent board is essential to the success of any start-up. As the law states the board is responsible for the management of the company. It is also important to remember that an investor is not in the board to look after his/her money, but to provide as much added value as possible.
- Due diligence
Due diligence refers to all the examination, fact finding and investigation of the target company, its business plan and markets that you do before actually doing the investment.
The exit is the point, at which the investment and any profit are returned to the investor, and therefore is a very important event and deserves a lot of planning and preparation. It is wise to consider different exit scenarios and avoid being locked-up in only one option. The most common case is a sale of the total company or all of the shares of the company.
- Finding investment opportunities
Opportunities for Business Angel investments are usually presented in so called pitching events, where startups and already operating companies present their ideas for potential investors. FiBAN continuously maintains a list of potential investment opportunities.
- Go-to-market strategy
The sequence with which a company enters various markets should depend on two factors; a) the strategic importance of the market and b) the company’s ability to exploit that market. The importance of a market should be estimated through the current and future market size, as well as the learning opportunities offered by that market. A company can rely on traditional export, distribution networks or licensing. There are different types of ownership control modes. Choosing the right mode of entry is critical.
- Good exit
A common rule of thumb in Business Angel investing is that approximately half of your investments will return little or nothing, 30-40 % will give you your money back (perhaps with a small profit, often just covering the “interest” for the time it took) and approximately one in ten will give you a real gain. One case should in other words compensate for the half that became nothing and give the upside for the whole investing activity, meaning a return of ten times the investment or more.
It is advisable that private investors seek expert advice to understand the outcome both financially and in the tax perspective.
- Increasing and managing the value
You need to “get out of the building”, meaning that a hands-on Business Angel will visit production facilities, clients and partners. Just going to the board meetings is rarely enough.
- Investor cooperation
Typically some, but not all of the investors will be members of the board (or have a representative). Normally the shareholders agreement guarantees the right to information about the company to every investor at any time, but there is normally no easy system for spreading this information. The best practice proposal is to organize a shared file.
- Lifecycle of the investment
Although the business plan may indicate that the initial investment will be sufficient to carry the company to a position of strength, there are nearly always negative surprises on the way. Most likely a second-round investment or many additional investments will be necessary. Always expect to invest at least the same amount as in the first round during the next two years following the initial investment.
- Lifeline of a company
We know that it usually takes five years or so in “the valley of death” for the start-up to become a profitable business. It is likely that the “cash burning rate” will increase during the second or third year of operations, due to the need of personnel and marketing. It is essential to imagine the whole lifeline (and all money needs) of a business before jumping on board.
- Making an angel investment
No deal is good at any price (there is always a maximum price worth paying even for the best of the best), but many deals will be good at some price. It is highly recommended that you get legal advice for assessing documentation, structuring the deal and drawing up agreements.
- Managing the management
There should be some rules agreed upon with the CEO immediately when the new board starts working after the investment. It is much easier to decide these things upfront than to try to get them in place later on. It is also worth thinking about demanding the chairman’s signature on all payments to the CEO.
- Need to go international
Find your competitive edge in global competition, starting by analyzing what your strengths are on the home market. Knowledge, skills and experience regarding how to navigate in a global environment will increasingly become a core requirement for leaders. It is suggested that you choose a CEO especially for the purpose of going global when the time is right.
- Preparing for exit
Preparation for exit starts at the very beginning of the investment process, with the signing of the shareholders agreement, where the main rules about the exit need to be described. It is particularly important to provide a mechanism to enable efficient decision making in cases where all investors do not agree. The company should at all times be ready for exit related due diligence.
- Role of a private investor
There is a general expectation that a Business Angel will bring value to the company in addition to the investment itself. It should be noted that investors should not disturb the CEO with frequent phone calls or other contacts to enquire about “how is it going” – it is up to the board to organize regular and sufficient information for all shareholders.
- Screening and analyzing
The purpose of screening and analyzing is to understand the potential and the risks in the offered opportunities and determine if further continuation of the investment process is justified.
The team is of essential importance. Does the team have the required technical and commercial skills, mindset and commitment to build up and scale the business?
- Shareholders’ agreement
When investing in start-ups it is important to agree on several things and document these in a shareholders agreement.
Let a lawyer at least check the agreement before closing. We strongly advice not to make too complicated shareholders’ agreements.
- Strategy process
At the time of the investment the strategy of the company is outlined in the business plan. The immediate focus for the board (generally newly elected after the investment) is to make sure that the company is putting actions in place to execute this strategy. It is good practice to agree in advance that strategy review takes place a certain month every year.
- Structuring the exit deal
We talk about an exit also when the investor exits a company for no money or if the company goes bankrupt. Unfortunately it is a form of exit an active Business Angel almost certainly will come across. Our only advice is that an inevitable rundown should be done as soon and clean as possible. Also remember to make sure your own name is safeguarded in the event of insolvency.
- Sweat equity
Sweat equity refers to an investor contributing to a project in the form of effort besides financial equity, which is a contribution in the form of capital. Other terms used are: “stocks for services” or “equity compensation”. It is very important to have a clear agreement and documentation regarding the expectations from the sweat equity and how it is compensated. There might be need for an employer agreement even if the salary is zero.
- Syndication and Lead Investor
Syndication means that there are several Business Angels participating in the investment. This is the norm, not the exception.
- Term Sheet
Provided that analyzing and screening has convinced you to continue the investment process, it makes sense to sign a term sheet between investor(s) and entrepreneur(s). The term sheet includes the most important terms and conditions, which the parties agree that will be the basis of the proposed agreement to invest. The term sheet is a document of engagement while the actual investment is the marriage.
Valuation refers to the total value of the equity of the company. We speak of either pre-money or post-money valuation. Pre-money valuation is the value of the company before the investment, calculated with the share price offered to the investors. Post-money similarly is the total value after the investment has been made.