Negotiating an Angel Deal in your PJ's

Well, not exactly...I was part of a Dow Jones VentureWire webinar last week titled Negotiating An Angel Deal: What Angels, Entrepreneurs & VCs Need to Know. I prefer the traditional face to face where you can interact with the other panelists and audience, but was the first panel I did wearing my favorite flannel penguin pajamas...

It had a good mix of viewpoints with east (James Geshwiler, Common Angels) and west coast (yours truly) angels, early stage venture capitalist (Jason Mendelson, Foundry Group), and a couple of attorneys (Dan Hansen and Mario Rosati). It is obviously too late to dial-in to the call, but you can still order a CD of the session. If you don't want to spring for that or spend 90 minutes listening for that one nugget you are looking for, I'll share a few of the topics I found interesting.

• Dumb Money - Are we as dumb as we look? One comment made by Jason was that angels tend to be less sensitive than VC's on valuation and can potentially make it difficult to get a venture financing done at acceptable valuation. While this may certainly be the case with unsophisticated angels (much less of these now) or in cases with no lead investor, I'd argue the opposite. We are typically looking at either smaller exits or require a lower valuation to get a reasonable step-up to a venture round. In my experience, venture investors are more focused on percentage ownership, which obviously requires a trade-off with the amount invested and valuation.
  

• KISS - No, not one of the guys on the left. The old Keep It Simple Stupid Principle. I had a discussion with another angel investor a few months ago and he was bragging about the deal he just struck that included a 3X participating liquidation preference. I let him know that he just accomplished two things - left a bad taste with the entrepreneur and opened the door for the next investor to ask for a multiple preference that is senior to yours. While upstream investors can certainly ask for more in any financing (The Golden Rule), it will be much easier to get simple terms if the precedent has been set from the beginning.

• A related topic is the standardization of terms. There has been a lot of discussion and publishing of standard term sheets, including Y Combinator, TechStars and SeriesSeed. A good comparison of the various "standard" term sheets can be found at Start-up Company Lawyer. Mario's firm, Wilson, Sonsini, even has a term sheet generator on their site. You answer a few questions and similar to TurboTax, out pops a term sheet instead of your tax return. Not quite as much fun to play with as the Dilbert Mission Statement Generator, but probably more useful. Consensus seemed to be that all of these "standard" terms are a bit different and while not possible to completely standardize (no company or financing is exactly the same), the guiding principle should be to keep it simple (see above) and minimize legal fees.

One other topic discussed was the recent legislation introduced by Sen. Dodd that could have a big impact on angel investing and job creation. A couple of items buried in the 1300 page bill include changing the definition of an accredited investor and moving regulatory roles on private3 placements from federal to stage level. This will both reduce the number of angel investors and make it more difficult to syndicate across stage lines. Lobbying is ongoing by both the National Venture Capital Association and Angel Capital Association and James Geshwiler on the panel wrote a recent post on the ramification.

I will be speaking on a related topic next week at an SVASE event in Palo Alto, "Founders vs. Investors - Are we all on the same page" Hope to see some of you there and promise I won't show up in my pajamas.

Watch Out for the Red W(h)ine

I have been following the rallying cry of entrepreneurs with some amusement over the past couple of weeks in response to a blog post by Jason Calacanis, "Why Start-ups Shouldn't have to pay to pitch angel investors." In fact, I was cornered by a member of this camp at our recent Sand Hill Angels annual social event at the Wine Room in Palo Alto (great place, by the way). I was afraid if I didn't answer the question of whether Sand Hill charges entrepreneurs to pitch properly, I might be wearing a very nice pinot.

I've written about the practice of charging entrepreneurs in earlier blog posts and it is not something we would ever do at SHA. However, the individual above was adamant that we should have a PR campaign to let the entrepreneurial community know that we don't participate or support this practice. I laughed and said that our web site made this clear and we may have even put a brief posting to this effect on our twitter feed. I'm also a strong believer that your track record and reputation are your most valuable assets in the venture community. This is not something that can happen overnight by putting a press release on the wire.

However, this is a great question to ask at the front of the process. I have put together a list of questions to ask your angel investor group contact:

• Do you charge any fees to present or during the due diligence process?
• How many investments have you made this year? Last year? Average size?
• How many of those investments are initial investments? Follow-on?
• In how many of those were you a lead investor?
  
• How many do you have a board seat?
  
• What percentage of your members have made an investment in the past 12 months?
• What percentage of your members are not active angel investors (i.e. service providers)?
• Do you invest as a fund, single purpose entity or as individuals?
  

This is not a comprehensive list of questions, but certainly a good start? At Sand Hill, we are very active and often lead investor and Series A board representative. We made 12 investments last year (5 new and 7 follow-on) and are on the same pace in 2009.

For those who do charge, should you avoid them like the plague or burn at the stake? I wouldn't go that far, but certainly fair to determine what you are getting for your limited amount of cash. Here is a list of questions I'd ask:

• How much is the fee?
• When are we obligated to pay?
• What do we get?
• Are you a broker-dealer? (Note: Finders fees are illegal in California for non broker-dealers, not sure about other states)
• Do you have any service provider members? Do you charge them a fee?
• If you do charge, why are you you charging me for the privilege of being added to a telemarketing list? Shouldn't you be paying me?
• How many companies have paid fees in the last year?
• How many of these have received investment for your group?
  

I don't think it's time to hang all angel investors in effigy, but remember that due diligence goes two ways...