Angel to (potential) Angel: Investing in Startups

I am often asked by friends and colleagues – “Tell me about Angel investing – how does it work, what are the risks, and how do you pick the next Facebook????”. As we embark on the 4^th Seattle Angel Conference in September, I thought I would share my answers more broadly here.

A little over a year ago, I got involved in Angel investing after running a startup focused on data security called Newline Software. I wanted to better understand what investors look for, so I jumped in with both feet, joined Alliance of Angels as well as the Seattle Angel Conference. I took 7 months off between jobs and spent my time driving around Seattle listening to pitches, attending demo days, taking part in due diligence, and meeting with entrepreneurs and other investors. I drank a lot of coffee and learned a ton. At this point, I have now heard somewhere north of 150 startup pitches. There are a lot of very interesting ideas out there.

What have I learned? A lot. Trained as a technologist, after being an engineering leader for 20 years at Microsoft, I tended to think more about the technology, and not about the value proposition for the customer and the problems being solved for the customer. As my friend and former Microsoft colleague @CharlieKindel likes to say, I had some things to unlearn from my great experiences at Microsoft.

Writing a check is something everyone knows how to do, but the hard part of making an investment is to determine if the startup you are looking at, has a good opportunity to succeed. Unfortunately many do not make it, and as I explain to potential investors, you should be investing a small % of your portfolio into startups and you should do your homework. When I think about my first angel investment, at which time I did not know what I do now, the business plan and pitch I reviewed as great in and of itself - but I failed to compare it to anything else in the industry, and I didn’t talk to any other investors. I was uneducated as an Angel investor, but I did know how to write a check.

There are many different ways to look at startups and through my experience interacting with lots of investors, listenting to pitches and talking to entrepreneurs, I have developed my own priority list. Talk to other investors, and they may view things differently. Part of what we do at Seattle Angel Conference is to teach you to come up with your own approach to investing. What I look for, in order of importance, is:

-          Team - Great ideas don’t execute on their own. You need a team, preferably with some startup experience, that knows how to execute on a good idea, preferably understands and follows the Lean Startup model, and knows when to pivot. The sooner a startup realizes its idea(s) are not right and can pivot, the less amount of money is burned.

-          Market Opportunity – It needs to be a big enough market, and enough product differentiation that the product can achieve success. Who is the competition? How will the startup differentiate? If the startup is creating the next great search engine, I would decline as that is a pretty saturated market with entrenched competition. If they have figured out a way to do searches by scanning your brain waves, that might be more interesting.

-          Value Proposition – A great question to ask of a startup, is what is the customer value prop? Great technology solutions don’t always translate into customer value. If someone can clearly articulate the value proposition of their product, it usually means they understand the customer needs, the problems they are solving, and how to bring value to the customer. Think about yourself as a customer of many things – the last time you bought a vehicle was it because it met the needs you had or did you buy it based on an innovation in the engine and the exhaust pipe?

-          Sales Strategy – If it’s an addressable market and has a value prop, how are they going to sell it? Ideally they have someone with sales experience on staff. Sales is a lot about connections, building relationships, being able to close a deal. Lacking sales staff doesn’t mean they can’t be successful, however cold calling is hard. Engineers are great at engineering, but not always at sales. If someone tells you the solution is direct sales to small business that is a red flag. That is a sales strategy that is very hard to scale.

-          Product – I tend to invest in products that I understand, because it’s easier for me to understand if someone would buy it, easier to determine if it’s a good user experience, etc. I have seen what I think are great products, but in industries that I don’t know. In cases where I know people in those industries, I have reached out and asked them what they thought. I have learned a lot this way.

Lastly, do you homework. Ask other investors. The great thing about being a part of Angel groups, is the opportunity to network with other investors. Through the Seattle Angel Conference and Alliance of Angels I have had the chance to expand my investor colleague network. The opportunity to ask them what they think about a particular deal, what they know about a particular company, and what sorts of investments they are making.