New Angel Fund Under Development

I am delighted to report that a new angel fund, to be known as the Treasure Valley Angel Fund is in formation and seeking investors.  The purpose of the Fund is to support economic development efforts by providing capital and advice to local entrepreneurs while providing an opportunity for the investors to make a return on their investment.

The CORE, an economic development group based in Meridian and focused on creating a CORE competency in the state in Health and Research sponsored the initiation of the fund. Leadership of the Core worked extensively with the Department of Finance to develop offering parameters that ensure that sales of interests in the Fund are properly qualified under the Idaho Uniform Securities Act.

Over the past few years both the Boise Angel Fund and Highway 12 have been potential sources of early stage capital for local entrepreneurs.   However, Highway 12 is no longer accepting applications for new investments and the Boise Angel Fund is nearly out of capital.  So a new source of capital interested in supporting valley entrepreneurs will be a welcome addition to the entrepreneurial ecosystem.

The Fund will be a “member-managed” LLC.  That means the investors (called “members”) in the fund will make the investment decisions. Once capitalized, the Fund members will appoint a screening committee to consider initial applications from entrepreneurs.  When the screening committee recommends an investment, a due diligence committee will be formed to thoroughly investigate the entrepreneur and his or her business plan, and if warranted, to negotiate the terms of a possible investment.  The recommended investment will then be brought to all the members for a vote.

Whether or not the Fund members agree to make an investment, members will be encouraged to help the entrepreneur by providing advice, access to their contacts, and such other assistance as may be appropriate.  Individual Fund members will be  free to make an investment in the company whether or not the Fund members decide to make an investment of Fund capital.

Before the Fund can make any investments, it must first raise capital to invest.  The Treasure Valley Fund is raising between $750,000 and $2 million.  Units of $50,000 each are being offered to qualified Idaho residents.

The offering to form the new fund is subject to a number of restrictions, the most important of which are:

1.  Only accredited investors (who generally must have a net worth greater than $1 million, excluding the equity in the investor’s primary resident or income greater than $200,000 per year) can participate in the Fund.

2.  Investors must be residents of the State of Idaho

3.  Any investment must not exceed 10% of the net worth of the investor excluding the value of the equity in the investor’s principle residence, furnishings and automobiles. 

Of course, such an investment is very risky and no one should invest in the Fund unless they can afford to lose their entire investment.

If you meet the above criteria and would like to know more, additional information and a copy of the Fund’s Confidential Placement Memorandum can be requested through the Fund’s web site at www.treasurevalleyangelfund.com.

I hope to chronicle the formation of the Treasure Valley Angel Fund over the coming months so that others interested in forming such capital pools might learn from the experience of the Fund.

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. Loon Creek Capital provides consulting services to the Treasure Valley Angel Fund. He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875. 

Improve your Chances of Receiving Angel Funding

I recently attended a seminar on Trends in Raising Capital in Palo Alto sponsored by the Angel Capital Association (ACA).  The ACA is an association of about 300 angel groups throughout the US and Canada.  Those 300 groups collectively represent about 10,000 active angel investors.

The seminar provided information to leaders of angel groups on the current state of the angel capital market.  One section I found particularly interesting was titled “Meeting Investor Expectations.”  The information, which I summarize below, was based upon a membership survey by the ACA.  58 groups participated representing more than 3,400 individual angels.  Those angels participated in more than 200 deals in 2010, and invested more than $45 million.  

Generally only one out of ten or twenty applications receives funding. According to this survey, there are things the entrepreneur can do to improve the chances of favorable action. While the survey was of member groups of the Angel Capital Association, I believe the findings can inform entrepreneurs approaching individual angels as well.

Get a Referral.  The typical group receives 15-30 applications a month, which is more than they can thoughtfully respond to. A referral to a group by a trusted party (e.g. another angel group, a respected individual angel or VC, an entrepreneur in which the group has invested) may help move the application to the top of the pile.  Referrals from economic development organizations and websites are viewed as having little value.  The perception is that the interests of these organizations are not aligned with those of the angels and therefore their referrals cannot be trusted. 

The Importance of the Executive Summary. The executive summary is like a resume.  The purpose is to get a interview.  Likewise, the purpose of the executive summary is to get a meeting with the angels. In the case of the Boise Angel Fund, over four years we received 214 applications.  Only 66 were invited to a meeting. So two thirds of the executive summaries did not capture sufficient interest to result in a meeting.

Good executive summaries are hard to write. In my experience entrepreneurs often spend weeks on their business plans and minutes on their executive summary, when in fact they should devote a great deal of effort to the executive summary.  In the ACA survey, only 38% of the executive summaries were rated as good.

Writing the Executive Summary. Compelling executive summaries are not more than two pages in length.  They are well written and without grammatical and typographical errors. They are delivered in PDF format so there are no accidental changes or formatting problems.

They cover the following both “POST” and “STORM.”

P-the Problem

O-the Opportunity or market size

S-your Solution (your product or service)

T-your Technology

S-your go to market Strategy

T-your Team

O-Others in the market (the competition)

R-Resources needed by your business

M-Milestones you intend to reach with the resources

Obtaining a referral to a group or an individual angel and preparing a thoughtful executive summary will improve your odds that you will be invited to a meeting with angels, which is the first step in the funding process. 

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. Loon Creek Capital is working with The Core to help create the new Treasure Valley Angel Fund (www.treasurevalleyangelfund.com). He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875. 

State Small Corporation Offering Registration (SCOR)

Federal securities law requires that securities issued by companies to their investors must be registered with the Securities and Exchange Commission unless the offering qualifies for an exemption from registration. Registration is a complicated and expensive process, generally prohibitive for smaller companies.

One exemption from registration is available if the company offers securities only to accredited investors in a private offering.   An accredited investor must meet certain criteria, the most important of which is that he or she, including the spouse if one, has a net worth of more than $1 million, excluding the value of the person’s primary residence.  A private transaction means that there can be no advertising or publicity about the offering, including no mention of the offering on the company’s web pages.

This type of offering is problematic for many entrepreneurs.  If they don’t have deep networks of accredited investors, it may be virtually impossible for them to raise capital, given that they can’t talk publically about their offering.

There is an alternative.  An entrepreneur can chose to register its company’s offering with its state securities regulator.  This offering is known as a Small Corporation Offering Registration or SCOR.  A SCOR offering allows a company to raise up to $1 million from an unlimited number of investors resident in the state using public advertising. The investors do not have to be accredited.

A SCOR offering is not simple, but it is doable. Boise entrepreneur Doug Joseph is currently conducting a SCOR offering for his company Locate Express as a means of raising capital to expand his business.  Doug reports that he was able to do most of the work of registering his offering himself.

In Idaho our regulator is the Securities Bureau of the Idaho Department of Finance.  The Bureau has published a SCOR manual and other useful documents on its web site. Click on “SCOR/U-7 Filings” under “Forms Available Online” in the upper right of their home page.

I’ve summarized the basics of a SCOR offering below.  But there are technical details that are important and anyone contemplating such an offering must engage legal counsel to advise the company and to give an opinion regarding the securities.

According to the SCOR manual the company must be a corporation or limited liability company.  This offering cannot be used for companies engaged in petroleum exploration and production, mining or other extractive industries.  And the company must not be a development-stage company with no specific business plan or purpose other than a merger.

The stock price must be $1 per share or more.  Financial statements must be provided.  If the company is raising less than $500,000 the statements must be reviewed by a CPA; for offerings between $500,000 and $1 million, the statements are generally required to be audited.

To register your offering with the State, you file a disclosure document known as a U-7 and other documents along with a filing fee of $300.  The purpose of the filing is to disclose all material information about the Company that a typical investor would want to know before making an investment in the company. 

The Idaho Securities Bureau is willing to talk on the phone or meet with an entrepreneur considering making a SCOR offering to review the requirements before the entrepreneur submits the documents.  You can reach the Bureau at 888-346-3378. 

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu.

New Data on Pre-Money Valuations

I thought my previous article was going to be my last for a while on the topic of valuation. But some germane new research has just been published.

In previous articles I discussed the concept of pre- and post-money valuation. Pre-money valuation is the value the entrepreneur and the angels negotiate before the angels invest. Post-money valuation is the pre-money value plus the amount of the investment, and it used for computing the percentage of stock the founders will retain after the investment by the angels.

In the second article on valuation I noted that one of the factors in setting pre-money valuations is the average regional deal value; that is at what value have other similar deals in the area been done? Since angels tend to invest close to home, the entrepreneur will have to compete for funding locally. Angels will look at the value of other similar deals in the area in deciding what value to offer or accept from the entrepreneur.

Bill Payne is a well-regarded angel investor in Montana. He is a member of the Frontier Angel Fund. The Boise Angel Fund and the Frontier Angel Fund have a close working relationship, from time to time investing in each other’s deals. Bill teaches classes on angel investing for the Angel Capital Association and has made more than 50 angel investments himself.

He just completed a survey of 35 angel groups in 26 states and two provinces. The complete results are available on his blog at http://www.billpayne.com/. His survey asks the question “What was the average pre-money value for investments made by your group in pre-revenue companies?” The average answer was $2.1 million, an increase of $400,000 from the previous year.

However, averages hide a lot of data. Valuations ranged from a low of $800,000 to a high of $3.4 million. Interesting for local entrepreneurs is that the Boise Angel Fund was one of two with the lowest valuation of $800,000. The other was Fargo/Morehead Angels, another group with which the Boise Fund has a relationship. In fairness, the Boise Angel Fund only did one pre-money deal in the past year, so that value was very specific to the deal that was done.

There are several implications for Idaho entrepreneurs.

1. Many Idaho angels have generally avoided pre-revenue deals due to their inherent riskiness. In order to entice investors to accept that risk, you have to offer a terrific deal, which means a low valuation.

2. While it is even more difficult to secure money outside of Idaho than inside, an entrepreneur with a truly exceptional opportunity may want to try to get the attention of non-Idaho groups.

3. Some valuations are skewed by the fact that bioscience and medical device deals typically receive higher valuations at the pre-revenue stage. Most Idaho angels will not do such deals.

4. Your pre-revenue deal will likely receive a lower valuation in Idaho than it might receive in a money center. The cure for this is to not seek funding until your company has secured its first revenue, thereby lowering the risk to investors. With a lower risk profile comes a higher valuation.

In our consulting practice at the Idaho Small Business Development Center at Boise State we frequently work with entrepreneurs to help them set a value on their businesses before they go to the market to raise capital. Our services are free and confidential. Call the SBDC at 426-3875 for an appointment if you would like to discuss your company’s value with one of our counselors.
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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu.

Valuing Early Stage Businesses, Part III, Understanding Angel Math

This is the final article in a series on valuing early-stage businesses from the standpoint of the angel investor.  You can find the earlier articles at my blog, http://kevinlearned.blogspot.com.  Thanks to Mark Woychick, a participant in the MBA Honors Program for his assistance in preparing this series.

In the earlier articles we talked about the riskiness of an investment in your company and how lowering that risk will result in a higher valuation. We also talked about the importance of comparable such as the average regional deal value and similar businesses and about the value of the team.

In this article we want to present the math that most investors go through in order to validate a valuation.  It’s pretty simple.  Take these variables:

1.      How much money does the company need in this round?

2.     How much can the company be sold for and in how many years?

3.     What multiple of my investment do I believe I need to have the potential to earn to justify my taking the risk?

Given the answers to these questions, we can compute a preliminary valuation of the company.  For example:

1.     The company needs $500,000.

2.     The entrepreneur and our own due diligence suggest the company can be sold for $20 million in five years. 

3.     Given the risk profile, we believe we need to have the potential to receive ten times our investment. Therefore we need to have the potential to receive ten times the investment of $500,000 or $5 million when the company is sold.

4.     If the company will sell for $20 million and we need $5 million of the sales proceeds, then we need to own 25% of the company at exit ($5 million/$20 million).

If we need 25% of the company at exit in order to meet our return objective, and IF the company does not need to raise any more funds between now and exit (admitted a tenuous assumption in that most companies will need to raise additional capital which will dilute our ownership), then we can compute the value of the company today as follows:

1.      Money raised, $500,000

2.     Percent of company needed for this investment, 25%

3.     Value of the company after investment (the “post-money” value) must be $2 million.  That is, with a value of $2 million, our $500,000 investment will purchase 25% of the company.

4.     This means the value of the company before the investment (the “pre-money” value) must be $1.5 million (post-money value of $2 million less investment of $500,000).

Most investors will triangulate on a number of different approaches to valuing the company to substantiate the value.  In the above example, they will compare the computed value of $1.5 million to what they believe similar companies in the region are worth.  They may adjust the value up or down depending upon the quality of the management team or the strength of the intellectual property.  They may run a discounted cash flow analysis on the pro forma projections to see how it compares. 

Valuation of early-stage businesses is difficult and as much art as science.  In the end analysis, the value is what the investors and the entrepreneurs can agree upon.  But the well prepared entrepreneur will understand the different approaches and be prepared to negotiate with the investors based upon them.

In our consulting practice at the Idaho Small Business Development Center at Boise State we frequently work with entrepreneurs to help them set a value on their business before they go to the market to raise capital.  Our services are free and confidential.  Call the SBDC at 426-3875 for an appointment if you would like to discuss your company’s value with one of our counselors.

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu.

Valuing Early Stage Businesses, Part II, Comparisons

This is my second article on the valuation of early stage businesses. These articles have been written from the perspective of angel investors in the hope that I can give some insight into this mysterious process for entrepreneurs who have to negotiate valuation with prospective investors. I have been assisted in preparing these articles by Mark Woychick, a participant in the Boise State MBA Honors Program.

The focus of these articles is valuation from the standpoint of the investor.  I hope they will give entrepreneurs some guidance in how their businesses may be valued when they seek capital.  I assume your business plan (e.g., business concept, market size calculations, competitors, use of investor capital, etc.) makes sense.

I should point out that in my opinion the traditional discounted cash flow method of valuing businesses doesn’t work for an early stage business. This method may be appropriate for a stable business with an operating history where you can have some confidence in the projections.  But an early stage business has neither an operating history nor stability and therefore projections for such businesses are unreliable. In the many deals I have reviewed, I have never seen an investor do a discounted cash flow analysis.

Last time I discussed the fundamental relationship of risk and return, how the earlier in the business cycle a business is, the riskier the investment is likely to be, and therefore the lower the valuation of the business will be for purposes of seeking investment capital.  Of course this is an important factor but not the only one.  Here are some others that will likely impact the value of the company:

Average regional deal value. Sophisticated investors know the current valuation of deals in their region.  For example, the Boise Angel Fund participates in a monthly phone conference with about ten other angel groups throughout the Northwest.  We talk about the valuation of the deals we are seeing.  This gives us a basis for the initial valuation of a local deal.  For example, we know from this discussion that pre-revenue deals in the Northwest rarely have valuations of more than $2 million, and they are usually substantially less no matter how exciting the potential.   So if you approach local angels for your startup company with a valuation of $3 million, you are likely to not even get to negotiations as your proposed value is completely out of line with what other deals are being done for.

Comparable businesses. If there have been other companies started in your space, then angels may want to use the valuation of those deals as a basis for the valuation of your deal. For example, many Software as a Service (SaaS) deals have raised capital in the last year.  Generally well thought out SaaS deals are valued a bit higher than businesses which carry inventory and accounts receivable as they have the potential to be very capital efficient and to be highly profitable.  

Team. All businesses are dependent upon the quality of the management team.  A superb team with background and experience in bringing a company to market in your space is unusual and valuable.  In my experience, all investors will increase or decrease the value of a business based upon their perception of the management team.

In the next article we will examine the most important, and most difficult component, which is projecting the exit value for the investors and then try to bring all these factors together.  

Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu.

Valuing Early Stage Businesses, Part I: The Value of an Early-Stage Company is Related to its Riskiness

One of the toughest things to do is value an early stage business. Yet, in order to sell stock, the entrepreneur has to set a value on his or her company. Today’s article is the first of several on this topic. I’ve been assisted in these articles on valuation by Mark Woychick, a participant in the Boise State MBA Honors Program.

Risk and Return

Investors expect to be compensated for the risk they assume. The higher the risk, the higher the potential return must be to entice the investor to accept the risk. And early-stage investing is a risky proposition. Research suggests that around 40% of all angel investments in early-stage companies result in a loss of the investment, even after extensive due diligence. So investors must see the potential to make substantial returns in order to justify accepting the risk.

Business Stage

Risk is, in large part, correlated with the stage of the business. Here is a rough listing of risk, stage and returns expected in order to accept the risk.

Stage           Level of Risk           Return expected (compounded
                                                    per year)

Idea             Extremely high        100%+

Prototype    Very high                 75%

Initial
revenue       High                        50%

Multiple
customers   Modestly high            40%

Growing     Intermediate              25%

To put this in lay terms, if angels invest in a business that has started to generate some revenue, and if they expect a return of 50% (called the internal rate of return), then they are seeking to make about ten times their investment in five to six years.

Terminology

Most sophisticated angels use the concepts of “pre-money” and “post-money” valuation. The pre-money valuation of a company is the value that the entrepreneur and the investor agree the company is worth immediately before the investment. The post-money valuation is the pre-money valuation plus the amount of investment. If the entrepreneur and the investor agree that the company is worth $500,000 before the investment (the “pre-money” valuation) and the investor invests $250,000, then the company must be worth $750,000 immediately after the investment is made (the “post-money” valuation).

You can derive percentage ownership from the pre and post-money valuations as follows:

Pre-money valuation          $500,000        67%

Plus investment                  $250,000       33%

= Post-money valuation       $750,000      100%

After the financing the entrepreneur (and those who have previously invested) would own 67% of the company and the new angel investors would own 33% of the company.

Relationship of Risk and Current Value

The riskier your business proposition, the lower the current value of your business and the higher the proportion of ownership the angel will demand. If the angel is considering two deals, one which is only at the idea stage and the other is at the initial revenue stage, then, all other things (e.g. management, size of opportunity) being equal, the value of the company at the initial revenue stage will be higher than the company at the idea stage and the percentage ownership the entrepreneur will have to give up will be less. For example:

Stage:                     Idea                    Initial Revenue

Money needed         $100,000            $100,000

Value of company    $200,000             $400,000

% of company
to investors               33%                    20%

The lesson for the entrepreneurs is the further developed you can get your company before you seek outside capital, the more valuable your company will be and the less you will have to give up to investors.

Of course, valuation takes into account more factors than stage of business. We will explore other factors in subsequent articles.
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This article was originally published in the Idaho Statesman's Business Insider on August 10, 2011 under the title "How to set a value on your business so you can sell stock."

Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center  at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital Group which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu.