Understanding capital model key to angel investing success, Silicon Valley investor says

The biggest mistake made by angel investors, who play a key role in supporting Kiwi start-ups, is not understanding the company's capital model before investing, says Ron Weissman, a member of Silicon Valley's oldest angel organisation, Band of Angels.

Weissman is in Queenstown for the annual New Zealand Angel Summit and the Asian Business Angels Forum, where he talked about successful capital strategies and when to exit an investment.

New Zealand has 600 people registered in angel clubs and another estimated 200 to 300 who are active privately while more than 2000 are thought to have invested through equity crowd-funding platforms since last August. Angel investors and networks have invested a total $374 million in young Kiwi companies since 2006.

Band of Angels, which has been operating in San Francisco since 1994, has 150 members who have invested US$231 million in 277 deals, of which they have exited a quarter.

Weissman said angel investors shouldn't confuse their capital model with that of the start-ups they're putting money into but they need to understand the company's capital model before investing. Capital-efficient deals are an angel's best friend rather than an exciting story.

He cites the example of a biotech start-up likely to need $US100 million over a 10-year period to become sustainable. That requirement for so much follow-on funding from venture capitalists who come in after early angel investors means they risk their stake being heavily diluted.

"The larger the amount of money the industry needs to raise, as a norm, the worse it is for you as an angel investor, and that's why you have to understand the company and industry's capital requirements," he said. "That's why we look at companies that are likely to need $US10-15 million to get to sustainability."

Another mistake rookie angel investors make is forgetting that for every $1 invested at the start, they'll need to reserve another $3 to $4 for follow on investment to avoid cram down – where an early investor's stake is reduced by new investors putting money in.

The third most frequent mistake angels make is being too greedy on the valuation of the company in the early stages, Mr Weissman said.

If the valuation is too high, there may be a down round with the next stage of investment which is where the valuation is lowered and early investors suffer a bigger dilution of their stake. Down rounds typically happen when a red hot economy starts to slow significantly as happened in the 2000 dotcom crash.

Mr Weismann said angel investors should "create their own luck" by understanding the eco-system the investee company operates in and having a list of large companies or follow-on investors that could add value to the start-up and create connections with them.

Band of Angels' investment committees also draw up a list before investing in a company of potential buyers and look at exiting before the company fully matures or an initial public offering to avoid too much dilution, he said.

(BusinessDesk)