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The biggest question for angel investors in the last decade is: “How do I get a return on my investment?” Without financial returns, most angels aren’t able to keep plowing money into new startups.
So, what does an angel need to do to get their money back, or better yet, make great returns? Here is the best advice I’ve gotten on getting to liquidity or exits from some of my favorite angels and experts over the years. Interestingly, the advice covers before, during, and after you invest.
Align with the entrepreneur on exit plans by asking good questions when you’re first evaluating a company
John O. Huston, a founding member of the Angel Capital Association, suggests that great exits start with three entrance questions, including “Is there exit goal congruence between the investors and the entrepreneur?”
To determine if there is exit goal congruence with entrepreneurs you are considering investing in, Huston suggests sharing data on recent exits in their industry and region. The data discussion opens eyes and builds understanding, as many entrepreneurs plan on an unusually large exit such as Facebook’s $19 billion acquisition of WhatsApp but a $50 million to $200 million is more likely.
Then ask: "If we decide to invest in your company we will work really hard with you over the next three to five years so that we can sell your venture and put X-many millions of dollars in your pocket, is that an adequate outcome for you and your family in light of all the hard work ahead?” If the answer is yes, proceed with due diligence.
Flip the 75-25 percent rule on due diligence to focus on supporting exits
Dusan Stojanovic diverges from the traditional practice of spending 75 percent of the time on due diligence and 25 percent on an exit. He flips the ratio and spends only 25 percent of the time on due diligence and 75 percent of the time working on the exit. How does this work? He's already well-versed in his industry, so he can quickly weed out startups he feels won't have a chance of succeeding. He also spends a tremendous amount of time in one-on-one networking meetings with company merger and acquisition representatives, employees who work on corporate ventures, and chief innovation officers to understand what they think and to create strong relationships. He understands who the potential customers are and what companies might be interested in an eventual acquisition.
Know what you want for a return and stick to it when you’re helping a company during the acquisition process
Peter Rosenblum of Foley Hoag LLP provides three basic rules for sellers--before beginning a sale:
- Remember the goal. Establish how much money sellers are going to have in their pockets after taxes and payments of deal liabilities. Know what is going to be left to you.
- Always walk away from the sale with at least the minimum amount you would accept for the entire company.
- Start early in preparing for the transaction. If you envision a sale transaction in the foreseeable future, start preparing.
Selling a business is not an easy process. Executives of angel-backed companies need patience and expertise to face the many steps involved. Startup executives benefit further when they have a knowledgeable angel director on the team to provide strategy, insight and connections throughout the process.
Consider “structured exits” that don’t involve acquisitions or IPOs
David Gitlin, who co-leads the Emerging Technology Practice at Greenberg Traurig LP is a passionate voice for one liquidity alternative, “structured exits,” which are investment structures designed to achieve a desired investment return without reliance on a traditional exit. The Philadelphia-based attorney told me, “It’s very hard for companies and investors to get into a new mode of thinking, but the concept of structured exits is really a win-win for so many.”
The main difference with a structured exit is that it allows you to structure your deal risk. You don’t gamble on whether or not there will be an exit and instead, you can start getting back your investment fairly quickly. Often these deals line up around getting a return around the income portfolio companies have and providing a portion of that to the investors.
If you have “zombie” companies in your portfolio, consider ways to “exit the unexitables”
Parker MacDonell, managing director, and Michael Kindrat-Pratt, director, of the Ohio TechAngel Funds (OTAF) have experienced three types of exits (positive negative, and stalled). About a third of their portfolio companies have been in the “stall” or zombie situation. OTAF calls these companies “unexitables.” MacDonell and Kindrat-Pratt shared some tips with me last year.
Before diving into the tips, it’s important to address some smart questions most angels might ask: Why is it better for angels to find a way to exit these companies versus leaving your money there? Or, aren’t angels just going to lose their money anyway in their unexitables?
Getting out of these companies may result in a return that is less than the investment, but there may be some potential upside to the scenario. At least you can take advantage of tax losses and there won’t be a requirement to invest in future rounds of the company or being further diluted. Also, in some cases it is possible to make a positive return. In one case, OTAF got a 2x return by selling their stock to a shareholder who was more bullish on the company than they were.
Creativity, combined with good investing practices and luck can lead to great results. All these angels and experts have found ways to get great returns. Consider these ideas for your own portfolio.
