Pennies from Heaven: Chicago Startups Experiences with Angel Investors
Second part of our series from guest writer Len Feldman.
Last November, Technori.com interviewed several Chicago-based angel investors to learn what they look for in potential investments, and to pass along some suggestions for entrepreneurs looking for seed funding from angel investors. The response to that article was so positive that we decided to talk to entrepreneurs who’ve received seed funding from angel investors (in some cases, from investors we interviewed for the November article) to get their side of the story.
Wikipedia defines an angel investor as “… an affluent individual who provides capital for a business startup, usually in exchange for convertible debt or ownership equity.” Individuals can make seed investments by themselves, or join angel groups or networks that share research, evaluate investments and pool their capital. The “granddaddy” of and model for most angel groups is Silicon Valley Angels; in Chicago, the biggest angel group is Hyde Park Angels, affiliated with the Polsky Center for Entrepreneurship at the University of Chicago’s Booth School of Business. Angel investors almost always invest in initial (seed) funding rounds, and they usually invest a limited amount of capital—anywhere from a few thousand dollars at the low end to $500,000 at the top.
Meet the Entrepreneurs
Technori interviewed six Chicago-based entrepreneurs for this story:
Joshua Hernandez (http://www.linkedin.com/in/joshuahernandez) is the Founder and CEO of Tap Me, Inc. (http://tapmeinc.tumblr.com/), a company that’s developing what it terms the “next generation” of in-game advertising. Tap Me has developed its own games for the Apple iPhone, iPad and iPod touch (bitFLIP and bitFLIP:HD) and for Facebook (Friends in Space) in order to test new features before they’re rolled out to the company’s game developer and advertising partners. Tap Me started as a game development studio in June, 2009, and launched with its current business plan in May, 2010, with an undisclosed amount of angel funding.
Michael Johnston is the Co-Founder of and Senior Analyst for ETF Database (http://etfdb.com), a website that provides analytical resources designed for investors interested in exchange-traded funds, as well as industry news, analysis, and commentary. (ETF stands for Exchange Traded Fund, an investment fund traded on stock exchanges. ETFs often track a well-known index such as the S&P 500, and hold shares in the same companies that comprise the index being tracked.) ETF Database was founded in April, 2009, with $100,000 in angel funding.
Mike Sands (http://www.linkedin.com/pub/mike-sands/1/544/807) is the President and CEO at BrightTag (http://www.thebrighttag.com/), a technology provider to website owners that enables them to better control, protect and manage the data created by their business. The BrightTag Data Distribution Platform centralizes all of the data collected and generated by a website, and controls what and how much data gets distributed to advertisers, website partners and service providers. BrightTag was founded in the Summer of 2009, and received an undisclosed amount of angel funding.
Sean Harper (http://www.linkedin.com/in/harpersean) is the Founder and CEO of FeeFighters (http://feefighters.com). Here’s Sean’s description of what FeeFighters does: “We’re like Priceline for businesses that accept credit cards. On top of the fees that Visa and Mastercard charge, which are already high, the credit card processors and their brokers and agents add an additional markup, which is usually not well disclosed and, for small and midsized businesses is huge on average. We save our customers thousands of dollars in a few minutes. Eventually, we’ll move into other financial services, such as insurance, loans, payroll processing, etc., just like Priceline expanded beyond flights into hotels, cars, etc.” FeeFighters was founded in Spring 2009 and has received $565,000 of angel funding to date.
Our last two participants are serial entrepreneurs: They’ve founded more than one startup.
Genevieve Thiers (http://www.linkedin.com/in/genevievethiers) is the Founder and CEO of Sittercity, Inc. (http://www.sittercity.com/), as well as Co-Founder and Executive Director of OperaModa (http://operamoda.com/), and Co-Founder and President of ContactKarma.com (http://www.contactkarma.com/). Here’s Genevieve’s description of Sittercity: “We’re America’s first and largest network to connect parents with caregivers nationwide, in five divisions: child care, pet care, senior care, home care and tutoring. We have over a million sitters nationwide! Our corporate program also services companies like Avon, Mastercard, the U.S. Department of Defense and more.” (ContactKarma, her most recent startup co-founded with husband Dan Rattner, expands the Sittercity model to doctors, dentists, plumbers, electricians, landscapers, and a wide variety of other personal services.) Sittercity was founded in 2001 and has received an undisclosed amount of angel funding.
Jason Rexilius (http://www.linkedin.com/in/jasonrexilius) was the Founder of HostedLABS (http://www.hostedlabs.com/), a Platform-as-a-Service/Cloud Computing startup that he founded in 2004 and left in 2009, and is currently Co-Founder and CTO of NowSpots (http://nowspots.com/). The Knight Foundation describes NowSpots as follows: “As a way to help online startups become sustainable, this project will develop an improved software interface to help sites create and sell what are known as ‘real-time ads.’ These ads are designed to be engaging as they constantly change–showing the latest message or post from the advertiser’s Twitter account, Facebook page or blog.” HostedLABS received $500,000 in angel funding, and NowSpots received $250,000 in seed funding as one of the winners of The Knight Foundation’s 2010 News Challenge (http://www.newschallenge.org/knc-2010-winners).
Challenge #1: Finding Investors
The first challenge for any entrepreneur trying to find seed capital for their startup is to identify potential investors and get them to listen to your pitch. Both the entrepreneurs interviewed for this story and the angel investors we interviewed last November agree that referrals are by far the best way to reach potential investors.
According to Sean Harper, “I prefer to network into potential investors—it’s usually the only way anyone will listen to me. There are only a few (angel) groups in Chicago so we didn’t need to look far. Both Josh (Joshua Krall, Co-Founder and CTO) and I went to the University of Chicago and were plugged into the Hyde Park Angels network through some of our professors (Ellen Rudnick and Ira Weiss). We were very actively pitching funds, both coastal and local and networked into our other angel investors through that process. Excelerate Labs (http://www.exceleratelabs.com/) was a great help as well for finding investors.”
Joshua Hernandez located investors using the Chicagoland Entrepreneurial Center (http://www.chicagolandec.org/), Excelerate Labs and people already in his and his co-founders’ networks. According to Joshua, “The network and just getting your message out there is critical. Any professional angels that we didn’t already know who invested always came from a warm introduction.”
Michael Johnston went to two angel investors who he already knew: Andy Hagans and Jimmy Atkinson. According to Michael, he approached Hagans and Atkinson directly, and was introduced to two other angels through a common acquaintance. (After reviewing ETF Database’s business plan, the two angels referred through Michael’s network decided not to invest.) Michael said that “The process for locating our angel investors was probably less formal than that of many entrepreneurs. I had known Andy and Jimmy socially for several years, and they had expressed a casual interest in the ETF Database business model.”
That’s great if you’ve got an established network, but what can you do if you’re just starting out? In Genevieve Thiers’ case, she and Dan Rattner invested their own seed funds and raised a small amount of additional funds from their families in order to get started. They then directly contacted a number of other angels.
Be prepared to spend a lot of time making contacts and giving pitches. For his first startup, Jason Rexilius attended endless networking events and cocktail parties. In his words, he pitched “…too many (potential investors) to count, both Angels and institutional VC's,” and that was even with getting introductions to many investors.
If you’re very lucky, you can get investors to come to you. Mike Sands’ previous experience as the CMO/VP of Marketing and COO of Orbitz, followed by being a Partner with The Pritzker Group (http://www.pritzkergroup.com/), the private investment firm representing the interests of Chicago’s Pritzker family, gave BrightTag the credibility to attract investment without a long search. In fact, BrightTag’s funding round was oversubscribed, and the company had to turn away potential investors.
One additional avenue to consider is seed funding through winning a foundation competition. In the case of NowSpots, the startup applied for a grant from The Knight Foundation’s 2010 News Challenge, and received $250,000 in seed funding. Twelve contestants, both commercial and non-profit, received a total of $2.74 million in grants. Similar competitions are run by organizations such as the Ewing Marion Kauffman Foundation (http://www.kauffman.org/), whose Kauffman Labs for Enterprise Creation are funding 20 entrepreneurs to “enable them to launch high-growth, transformative companies in the education market.” (http://is.gd/j1RrV).
There are plusses and minuses to foundation competitions. On the plus side, the foundation money is a grant, not an equity investment, so it doesn’t give the foundation ownership or voting rights. On the downside, there are only a limited number of foundations making these grants, and most startups won’t qualify. There can also be significant restrictions and conditions placed on the organizations receiving funding. In addition, foundations almost never make additional grants to startups that they’ve funded.
Challenge #2: Understand Your Business
It’s essential to be fully prepared before you make your first presentation to angels. Investors have long memories, and first impressions count. According to Jason Rexilius, “One thing I did find was that you really only get one shot per investor, as (they’re) swamped with pitches and live off their first reactions. Once they form an opinion (rash or otherwise) they don’t change it easily.”
Here’s what Michael Johnston found to be most successful when presenting to potential investors: “Details, details, details. I spent a lot of time putting together a business plan, projections, and risk assessment. When I was formally pitching ETF Database, it showed that I had spent a ton of time considering all the risks and opportunities facing the company, and that I wasn’t chasing down some wild idea that wasn’t a viable business.”
“I also found that honesty was an effective part of my pitch. You obviously have to be enthusiastic and believe yourself in the potential of the new venture, but if you have unrealistic expectations or fail to acknowledge any risks, potential angels are going to be turned off. I was open and completely transparent with the risks inherent in a start-up. Angel investors are generally very sharp individuals, and I found that they appreciated my honest assessment of both the risks and opportunities.”
For Jason Rexilius, the process of developing an effective pitch “…was more an evolution through constant effort and abuse. I may not be the sharpest tool in the shed in this area, so for me it was a lot of soak time–probably because you have to know SO much in order to pitch effectively. Some of the biggest (mistakes I made) were not having practiced enough (this in direct contrast to the next), having pitched before I was ready (how's that for a paradox?), having doubts or lacking confidence in the pitch, being too confident in the pitch–you get the idea. It's a paradox that’s only solved through working at it.”
Think through your business very carefully, and answer the questions (including the difficult ones) that investors are likely to ask you before you get into your first meeting. Just as lawyers in a courtroom don’t ask any question that they don’t already know the answer to, try to anticipate every question that an investor is likely to ask and have a good answer for it. Genevieve Thiers said that for her and her husband, “The key thing was just to listen to what they (potential investors) were saying and come into a meeting prepared the next time to answer that question in advance. It’s always better to tackle a potential problem by mentioning it yourself and presenting the solution before it’s even asked.” Mike Sands says that “Having a compelling story with a strategic solution for a market need and a great team to address that need are always the best techniques.”
There may be a problem that you don’t even think exists until potential investors tell you. Genevieve Thiers and Dan Rattner thought that they had the perfect management team, but not in the eyes of some investors: “We found that the biggest thing that investors thought about when (we were) pitching was the fact that we were married. Ironically, while couples often create the best companies, they are also oddly stereotyped by investors…instead of seeing the benefits of the combined brainpower of a couple aimed at a company 24/7, a lot of investors only dwelled on negative “what-ifs.” Dan and I ended up taking a “we are who we are” attitude and I am happy to say it worked. Our current investors in Sittercity are great, and they understand that we are a serial couple-preneur.”
Challenge #3: Understand Your Investors
Just as you need to understand your business thoroughly, you need to pay just as much attention to your potential investors. Thoroughly research potential investors to understand what they do and don’t invest in. Investors limit their investments by market, technology and geographic area, so focus on investors whose preferences match your startup. It’s much easier than it used to be to research potential investors, with sources such as AngelList (http://angel.co/), LinkedIn (http://www.linkedin.com/) and Google.
Once you identify other companies that an angel or angel group has invested in, don’t be shy about contacting those companies to learn their experiences. You can use LinkedIn and ZoomInfo (http://www.zoominfo.com/search) to identify and contact top managers at the companies. Be prepared to keep everything these contacts tell you strictly confidential.
Joshua Hernandez said “Make sure you pitch to angels that are relevant to helping you build your business. Until we focused in on angels that understood our business we had a hard time connecting. Luckily we didn't do this for long.” Michael Johnston added, “Just as potential angels are doing their due diligence on you and your business, you should be doing your homework on them. Find out what they can bring to the venture besides capital.”
The reputations of your investors can help or hurt you in finding additional capital, whether in your seed round or in future rounds. One of the angels that Sean Harper brought into Feefighters.com was 500 Startups (http://500startups.com/), a seed fund and startup accelerator run by Dave McClure, one of Silicon Valley’s best-known angel investors. McClure gave Feefighters.com additional credibility with and visibility to potential investors outside the Chicago area.
Highly-recognized investors can also help turn your fundraising efforts from outbound to inbound, just as Mike Sands’ experience and strong connections enabled him and his team to turn away investors in BrightTag. Gaining the confidence of a “star” investor decreases the perceived risk of investing in your business by other angels.
Challenge #4: Active or Passive Investors?
Should you look for angel investors who will give your startup advice and actively participate, or simply look for angels with money? The entrepreneurs we interviewed each had different answers to that question. According to Jason Rexilius, as a practical matter, “…beggars can't always be choosers, but you have to know what you're getting from the investor. Sometimes it’s better to walk away from money rather than take a mismatched investor, but other times it’s just a sub-optimal case and you need to know how to fit that into your overall strategy. My personal opinion is that a start-up should be hyper-focused on two things: Building and selling. Angels can help run interference on other items, but I say better still that they put you in front of customers. Advice, strategy, M&A intros, positioning…all those are good things, but that critical first stage is building and selling. Ideally, your whole team (investors are part of the team) help with those.”
Michael Johnston is a firm believer in active angels: “I absolutely believe that angel investors should bring more to the table than just a check. That doesn’t meet that they should be actively involved in the day-to-day operations of the company, but if they are able to offer insights on high level strategy, or even a more relevant skill set (e.g. marketing or valuable contacts) it will dramatically increase the odds of success.”
Mike Sands says “This depends on the sophistication/experience of the executive team. We trust our advisors and board members, of course. And we work collaboratively with them since we have prior relationships upon which to draw. Other companies I have worked in have seen different kinds of relationships. Board members and investors can add a ton of value, and many will bring in the right kind of contacts to help build the business, and not just provide capital.”
Sean Harper’s take is that a few active investors are great, but “too many cooks spoil the broth”: “Not all of your investors need to be involved that way. In fact, it would probably be disruptive if all your investors were involved in that way–assuming you have more than a few investors. But, it’s good to find a few people to get more hands-on, especially if they have relevant domain expertise.”
On the other hand, Genevieve Thiers takes the “passive angel” view: “I believe that angels should be primarily used for capital. If they want to contribute more, great, but I think that an angel looks to the entrepreneur to put together a business and thesis that works. When you get to the VC level, you should expect more added value, but I think at the angel level, it’s primarily funding that should be identified as the asset.”
Joshua Hernandez also finds himself more on the “passive angel” side: “If you can find someone that just writes a check and doesn't ever call you again, go for it. However, I think that anyone you are involving in your business should be able to contribute to it.”
What Suggestions Do They Have?
We asked the entrepreneurs to pass along some suggestions that would be valuable for other people who are looking for funding, and here’s what we heard:
Mike Sands says that “The compelling need is always the first start. All successful businesses solve a problem or create a new market.” Sean Harper suggested the following: “First, consider the time it takes to raise money. Can you get to your next stage without it? Second, start with investors that have domain expertise or are likely to be predisposed to your idea. Getting the domain expert investors will help convince other investors with less domain expertise. Finally, be inbound. Some of our best investors found us, rather than us finding them.” Jason Rexilius suggests: “Network like a demon. Pitch to as many experienced entrepreneurs as possible to help refine and improve your ideas and pitch.”
Genevieve Thiers cautions entrepreneurs that “It’s a hard time. If you have any funding you yourself can give, or anything you can get from family, try it. If not, there are certain wonderful groups you can approach, like Golden Seeds in Boston and Hyde Park Angels in Chicago. It’ll just take some time.”
Joshua Hernandez and Michael Johnston both recommend that you focus on the amount of money that you need to raise. According to Michael, “Once an angel expresses interest in your business, there is an obvious level of excitement and eagerness to get the deal DONE. I wish I had given more thought to exactly how much capital could have been raised in the first round, and under what terms. Hindsight is obviously 20/20, but now that ETF Database has become successful, I wish that I had fought for less aggressive financing terms and maintained a bigger ownership stake in the company.” Joshua adds, “Set a range and consider closing it as soon as you hit the minimum. Remember that you are not in the business of fundraising.”
Now It’s Your Turn
Chicago startups are successfully finding angel investors to fund seed rounds, but only one of them, Mike Sands, had a fairly easy time of it, and that was due to the depth of his experience and connections. Networking and referrals are, by far, the most effective way to get in front of potential investors. You don’t have to network solely person-to-person; organizations such as Excelerate Labs and the Chicagoland Entrepreneurial Center enable you to network quickly with like-minded entrepreneurs and investors. However, even with referrals, you may need to make dozens of presentations in order to raise the funds you need.
Understand your business in as much detail as possible, and anticipate questions from investors before you get them. If you do get asked a question that you can’t answer, make sure that you’ve got the answer before you make your next presentation. And, if there’s a major issue that you didn’t anticipate or can’t get around, such as the unexpected objections expressed because Genevieve Thiers and husband Dan Rattner were working together at Sittercity, don’t ignore it. Address it in future presentations before you’re asked about it, in order to take it off the table.
Research your potential investors as much as they’re likely to research you. Figure out each investor’s preferred markets, industries and geographic areas, and limit your pitches to those investors for which your startup will be a good fit. Also, don’t hesitate to contact founders of angel-funded startups to ask their opinions of and experiences with the investors they’ve worked with.
As for whether you should go with angels with money or angels with money and advice, there’s no consensus, but it never hurts to work with angels with strong domain expertise in your market or technology, so long as they understand that you, not they, run your business.