How to prepare for meeting an angel investor

The term "angel" investor originated not in the well-known epicenters of business startups, but on Broadway. To the actors, playwrights, producers, and choreographers in New York City, wealthy patrons who funded new musical and theatrical productions were angels who helped the artists' dreams about getting to the big stage come true.

Thereafter, wealthy individuals investing in emerging companies became known in finance circles as angel investors.

The problem with this term is the tendency for many first-time entrepreneurs to assume that angels are warm-hearted rescuers of their cash-poor enterprises. The truth is that angels, especially members of angel investment clubs, are demanding. They set high standards and expect entrepreneurs to be sophisticated about the fund-raising process.

Here's what entrepreneurs need to do and know before approaching angel investors for funding. (For tips on how to find an angel investor, see this related article.)

1. Select the right business structure.   Most angel investors prefer to invest in businesses that are organized as standard "C" corporations. The primary benefits to investors of C corporations are that they operate with board of directors’ oversight, can issue different classes of stock, and have no limitation on the number of stockholders. In contrast, businesses that are organized as "S" corporations can’t have more than 75 shareholders or any international investors. Similarly, businesses organized as limited liability companies and partnerships are usually asked to restructure to C corps before receiving funds from investors.
2. Understand the different classes of stock.   Most founders of new C corporations receive shares of common stock. Investors, however, usually insist on receiving a separate class of stock, called "preferred stock." All the terms of a company’s preferred stock are negotiable and different investment rounds are likely to give stockholders different advantages over common stockholders. For example, when a company is acquired, all preferred stockholders receive a payback of their original investment plus a cash premium before common stockholders receive compensation.
3. Solicit accredited investors.   Accredited investors, also known as "qualified investors," are defined by Regulation D of the 1933 Securities Exchange Act as individuals who have a net worth of $1 million or more, or income of at least $200,000 in the two years prior to investment. Entrepreneurs who raise money through accredited investors generally don’t have to put together a costly legal document called a "private placement memorandum."

   A private placement memorandum ("PPM," or "offering memorandum") provides prospective investors with detailed information about the terms of the securities to be sold in the investment round. This comprehensive legal document also covers a broad range of investment risks, a description of the company, expected use of investment funds, and other information federal and state securities agencies require. Most first-time entrepreneurs assume that a traditional business plan is a satisfactory substitute for a PPM. Not so. Retain an experienced securities lawyer to help you prepare a credible PPM document. While it may seem more difficult to attract wealthy investors to your company, soliciting non-accredited investors will ultimately be more time-consuming and expensive.

4. Hire an experienced corporate lawyer.   Given the complexity of state and federal securities laws, it is unwise to try to raise money without legal guidance. Interview at least three attorney candidates and ask how many angel fundraisings he or she negotiated during the last year. Your money should buy experience. Simply stated, if you don't have a great lawyer at your side, you won't get a great deal from investors.
5. Demonstrate restraint.   Effective fund-raising requires showmanship, professionalism, tireless energy, and an optimistic attitude. However, because of securities laws, entrepreneurs have to be careful about how they publicize their deal to potential investors. In general, promoting the sale of securities through public Web postings, spam, and print advertising is not allowed. Entrepreneurs also have to be careful not to offer any guarantees of a successful outcome to potential investors.
6. Address investor issues.   Nothing makes me wince more than listening to entrepreneurs waste precious presentation time talking about issues that just don’t rank very high with angel investors. Yes, it's fun to talk about cool features of new Web sites and gadgets—but not at the expense of addressing the marketing, partnership, and pricing strategies that will make a business successful against competitors.

   Angels also want to know how entrepreneurs will spend their money, and when a business will reach cash flow break-even and profitability. Entrepreneurs who are vague about these issues will lose out to other entrepreneurs who know their numbers, their industry, and their game plan.

7. Keep your cool.   Potential investors are entitled to ask detailed questions about a business, its managers, and its competitors. Entrepreneurs who express frustration with questions or try to rush investor decisions won’t like the fast answer they will get from investors. Basically, smart angels are intuitive and watchful. They assume that impatient entrepreneurs will eventually turn off potential customers and damage a company's long-term prospects.
8. Make it convenient for investors.   In my book, entrepreneurs who think their work schedule is more important than a potential investor's schedule are likely to have an empty bank account for a long time. Because most angel investors lead active business and personal lives, they review business plans during their spare time. As such, entrepreneurs should not expect immediate return phone calls. Keep e-mail messages brief, and schedule meetings wherever and whenever they are most convenient for the prospective investor.

Raising money from investors is an impressive accomplishment. Not only can the effort provide working capital for a growing business, it elevates the founding entrepreneur's knowledge of securities laws, accounting, contract negotiation, and so much more. In fact, with the right attitude and information, the fundraising process can be interesting—even fun.

About the author   Susan Schreter is a Seattle-area investment banker and venture-funding expert serving startup entrepreneurs and fast-growth company executives. She also teaches business financing and entrepreneurship at business schools, angel forums, and microfinance organizations in the United States and internationally. Write to Susan at susan@takecommand.org.