Start-up Wealth - Book Summary

Unlock the potential: Become a savvy investor and make wise choices in start-ups.

In the vibrant world of start-ups, the role of angel investors has been evolving rapidly. These financial catalysts, though not as flush with cash as their venture capital counterparts, are instrumental in propelling entrepreneurs towards realizing their dreams. But what does it take to snare an angel investor? Or, if you're on the other side of the coin, pondering on foraying into the realm of start-up investments, where should you begin?

To answer these questions, it's best to turn towards the experts — successful angel investors who've honed their strategies over the years.

In our journey, we'll uncover

why a momentum investor values passion and drive above all else;

how the initial test market for a start-up often comprises the investor's own social circle; and

why the importance of a swift exit strategy is mutual for both investor and entrepreneur.

Meet the trio: The three kinds of angel investors and their unique motivations.

As we embark on this journey to dissect the world of angel investors, let's first understand who these influential players are. Predominantly affluent individuals, angel investors are the financial backbone of start-up companies. They emerge in three distinct forms: momentum investors, value investors, and alternative investors.

Momentum investors are defined by their faith in their intuition and foresight. They don't hinge their decisions on hard facts or detailed specifics. Instead, if a start-up sparks a deep connection or kindles an interest, a momentum investor is likely to lend his support. One such influential investor is Brad Feld, a managing director at Foundry Group. Feld has a unique methodology for gauging his instinctual response towards a business proposition, which we will delve into in the following section.

Value investors, on the other hand, gravitate towards start-ups with robust financial backing. Renowned value investor David Verrill, founder and managing director at Hub Angels Investment Group, is well-known for scrutinizing a company's revenue sheet before deciding to invest. To assess the future viability of a business idea, he usually prefers examining data spanning the past one to two years.

Lastly, the alternative investors seek to make more than just a monetary investment; they aim to leave a lasting imprint. Instead of investing in typical assets such as stocks or bonds, these investors target specific business niches — from healthcare to antiques, or even wine — with the intention to create a significant ripple effect.

Catherine Mott, the founder of BlueTree Capital Group and BlueTree Allied Angels, epitomizes the alternative investor. Through her organizations, she aids entrepreneurs in establishing solid businesses and emphasizes private equity investments to ensure local start-ups are adequately funded.

With a basic understanding of the three investor types, let's examine the first category, the momentum investor, in greater depth.

Momentum investors: Attracted to invigorating ideas and captivating entrepreneurs.

Ever pondered why the world isn't teeming with individuals like Bill Gates? The explanation is straightforward — not all business concepts possess the magic spark. This is a conundrum every fledgling investor has to grapple with. How can you differentiate the next big thing from the run-of-the-mill?

Renowned angel investor and momentum investor extraordinaire, Brad Feld, offers some practical insights. According to him, a potential investment proposition must present three essential elements — a zealous entrepreneur, promising early product feedback, and the prospect of a lasting relationship.

Feld is of the firm belief that the entrepreneur's passion for the idea is a paramount indicator of potential. After all, if the entrepreneur themselves isn't excited about the product, how can they infuse a sense of excitement in their customers? But, equally importantly, the product must stoke excitement in Feld himself before he considers investing.

But no matter how invigorating the product might seem, its potential for failure always lurks. To counter this uncertainty, Feld ensures that the product is thoroughly vetted with its target demographic. Suppose he's considering an investment in a start-up peddling organic candies — he would first share the sweets with his close circle of family and friends to appraise its market potential. If their feedback is upbeat, affirming a gap in the market for such a product, Feld would most likely consider investing.

But before making his final decision, Feld has another hurdle for the start-up to leap over. He introspects — would he be willing to invest in the company over the long haul, even if his role were minimal? For Feld, the entrepreneurs' experience or past laurels aren't significant determinants. What truly matters is the sense of kinship between him and the business. Once the start-up ticks these boxes — the solid connection, exciting product, and passionate entrepreneur — only then will Feld give the green light to invest.

Value investors: Crunching numbers to pinpoint promising start-ups.

Meet David Verrill — a value investor who cut his teeth in corporate fundraising at the Massachusetts Institute of Technology before joining a collective of investors to establish Hub Angels Investment Group.

The collective primarily zeroes in on capital-efficient start-ups in the local area. In essence, businesses that operate with modest capital expenditures, yet deliver substantial outputs. Hub Angels isn't drawn to grandiloquent visions. Instead, they delve into a start-up's finances to assess if it demonstrates a promising growth trajectory.

Given that most of the founders of Hub Angels come from a life sciences background, their investments naturally lean towards fields like health-information technology and diagnostic tools. They consciously steer clear of pharmaceutical companies, a decision born from Verrill's past experiences. According to him, pharma companies, often seeking hefty funding in the range of 20 to 40 million dollars, haven't proved to be sound investments.

Given its relatively small size, Hub Angels could find themselves overwhelmed when pitted against other investors in the high-stakes pharmaceutical domain. So, they prudently adapted their strategy to their scale and opted to invest only in start-ups with less onerous capital requirements.

One aspect that sets Hub Angels apart from other angel investors is their approach towards repeat investments. While most investors provide a one-time infusion to a start-up and then bow out, Hub Angels believes in continual engagement. They closely monitor their investments and seize opportune moments to reinvest, thereby amplifying their returns.

Take the company Localytics as an example. This company, which enables apps to analyze user behavior on mobile phones and craft targeted in-app ads, benefitted from two investment rounds by Hub Angels. Buoyed by its initial success, Localytics went on to raise 16 million dollars from other venture capital firms.

Like all successful start-ups, Localytics is expected to soon reach a stage where it no longer requires Hub Angels' backing. And when that moment arrives — the angel investor's mission is accomplished!

Short-term investment relationships: A win-win for both investors and founders.

Meet David Bangs — an angel investor since 2007 who joined the Northwest Energy Angels investment group and carved a niche as a characteristic alternative investor. A clean technology enthusiast, Bangs has some firm beliefs about what constitutes a wise investment.

For Bangs, a smart investor's strategy must encompass a quick exit plan for both themselves and their capital. But how do you deal with a situation where the company isn't primed for such a scenario? That's where Bangs' alternative approach comes into play. He often proposes buying a portion of the company's shares, but with a stipulation — if he decides to disengage, the company owners must repurchase his shares at an agreed price.

So, if Bangs wishes to withdraw from an ongoing engagement to funnel his funds into another start-up, his pre-agreed clause enables him to reclaim his money promptly — a far quicker process than seeking out a new buyer for his shares.

This nimble strategy is immensely beneficial for investors and founders alike. You might wonder, though — why would any entrepreneur agree to this arrangement?

Contrary to what you might expect, many companies welcome the chance to buy back a certain percentage of shares, provided this percentage is less than their margin. This agreement gifts them an increased ownership stake and the prospect of a more significant exit should they choose to sell their company.

To bring this concept to life, picture a start-up with a 40-percent margin. If the company directs five percent of its returns towards repurchasing shares, it would be left with an effective margin of 35 percent. This outcome is a tantalizing prospect for the shareholders!

Embrace collective wisdom: Partner with fellow angel investors to stay grounded.

By now, we've gained insights into how an angel investor sifts through potential investments to funnel their resources into an intriguing start-up. The investor's unique principles and strategies guide their decision-making process.

However, there are instances when going solo isn't the best approach. In such moments, the counsel of fellow investors proves invaluable.

Meet Catherine Mott — an alternative investor who is part of an angel investment group. Here's her rationale:

Picture being swept away by an entrepreneur's groundbreaking idea. You are brimming with anticipation to aid their market entry and are enthralled by the golden opportunity you've stumbled upon. But, how groundbreaking is this idea, honestly? In your fervor, you may have overlooked potential hiccups.

This is where your fellow angel investors can be lifesavers. They can provide you with constructive feedback that can ground your enthusiasm and enable you to make a more balanced and informed decision.

Mott places substantial importance on the managerial capabilities of start-ups. She ensures that start-up founders practice due diligence and are genuinely primed for market entry.

As part of her evaluation process, Mott scrutinizes the team leader's skills. Is the person aptly suited for the role? Can they handle criticism constructively? Do they foster smooth team collaboration? If the answers to these questions are affirmative, the team is deemed ready for the market.

But Mott's assessment doesn't stop here. She goes on to analyze the target market in relation to the business model or product. This evaluation phase can span between four and six weeks, contingent on the team's caliber.

Though this phase might seem time-consuming, it is crucial in mitigating failure risks. And it's not just Mott who benefits; the start-up also stands to gain, as she consistently ensures the company's financial strategy is robust and sustainable.

In conclusion

The primary lesson from this book is clear:

Successful angel investing calls for a blend of thorough due diligence, deliberate testing of potential investments, and seeking insights from peer investors for astute, profitable decision-making. Momentum investors, guided by instinct and their network, rely less on hard data. In contrast, value investors ground their decisions in rigorous financial analysis to choose the most promising start-up to invest in. And then we have alternative investors, who invest with their hearts, pouring their resources into a cause they genuinely care about, thereby making a significant positive impact.