Showing You the Money

Guest Contributor Matt Dunbar is managing director of the Upstate Carolina Angel Network.

A peek inside UCAN’s investing process

According to Paul Graham, founder of the prominent startup accelerator Y-Combinator, “The hardest part of starting a startup is making something people want.” But he says the second-hardest part is raising capital.

While coming up with something people want (and will pay for) is certainly no small task, it seems that many aspiring entrepreneurs are much more daunted by the process of raising funds than by the process of identifying a marketable product or service. With that challenge in mind, we’d like to use this month’s column to help demystify the fundraising process for startups to help them get the answer they want to that ubiquitous startup request: “Show me the money!”

For starters, let’s admit that raising capital is indeed a very difficult thing to do. There are typically about 600,000 employer firms started every year in the United States, but only about 60,000 successfully attract capital from private angel investors, while a scant 3,000 or so convince institutional venture capitalists to invest. UCAN’s investment rate is similar to most VCs, with 3 percent of the incoming candidates receiving an investment.

Given the scarcity of available funding for startups, the aspiring entrepreneur needs to do his homework to fully understand the process investors follow when considering an investment. Of course, each investor will develop his own unique approach, but in broad strokes, most investors follow a similar process. Let me pull back the curtain a bit on the UCAN process to reveal some insights on how our group evaluates opportunities.

Investors’ time is usually even scarcer than their money, so the best way to get their attention is through the voice of a trusted colleague. Investors often view the initial introduction as a test of the entrepreneur’s resourcefulness – in today’s connected world, they expect you’ll be able to find a way to get introduced – and UCAN is no different.

Once you get the introduction, you should have a two- or three-sentence pithy summary that explains at a high level what your company does. It should provide a compelling hook to pique the investor’s interest, whether it is delivered in a short email or during a proverbial “elevator pitch.”

As part of an email introduction (or shortly after getting the investor’s card during an face-to-face intro), the entrepreneur should send the investor a one- or two-page executive summary (in PDF format) outlining the basics of the business – including the market problem, the company’s solution, the market dynamics, the team profile, the business model and the summary financials. It should also include a brief summary of the target capital raise, detailing the amount sought and the proposed use of funds, as well as the exit strategy for generating returns for the investor.

If the introduction and executive summary prove intriguing to the investor, the next step in many cases is an invitation to a meeting or presentation. In the case of UCAN, that first meeting will likely be a 30-minute conversation with the managing director or one of our investors. If the opportunity sounds like a good fit, the next step would be an invitation to present at a monthly screening meeting. During these sessions, three or four candidate companies make a presentation to a subset of UCAN’s members, and typically one or two of those candidates are selected to move forward in the process.

The next step for approved companies is to make a presentation to the full UCAN membership (which meets monthly). If at least 60 percent of the attending members approve, UCAN will put together a team of three or four members and staff to conduct due diligence on the company over a four- to six-week period. Research on angel group investment returns suggest that investors who spend more than 20 collective hours in diligence realize significantly better returns than those who conduct less diligence – so be prepared for a thorough detailing of all the aspects of your business during that process. (Side note for investors – research reveals that angels who invest through groups realize blended rates of returns north of 20 percent).

Finally, if the investors like what they’ve found, they will likely offer a term sheet outlining the structure of their proposed investment – including the valuation, or price they are willing to pay. Of course deal terms are a topic worthy of entire books, so we’ll tackle that subject another time in this space.

For now, we hope this brief summary provides a bit of insight on how early-stage investors typically approach their investment process. The final, key takeaway for entrepreneurs is simply to do your homework. Just as investors will conduct due diligence on you, you should conduct diligence on them. Leverage the Web and your personal networks to gain an understanding of the investor’s target investments, evaluation process, typical investments – and most importantly, their relationship with entrepreneurs and ability to add value.

If you do your homework – and demonstrate that you’re making something people want to buy – you’ll have a much better chance of being one of those fortunate entrepreneurs who is able to convince investors to show you the money.