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Friday, November 23, 2012

What innovators and investors want to find in each other

Looking for an investor that understands you

I think the most important aspect for an innovator who’s looking for investors is to find a ‘smart money’ investor. That means, finding an investors who has experience in exactly your field.

Maybe it’s your technology; maybe it’s your segment of the market; maybe it’s your scientific background. The key thing is to find an investor who has empathy for what the innovator is doing, and has a personal interest. Angel level investors invest based on their instincts, on intuition. They base their decisions on the person and on what types of chemistry reaction they have with that person—unlike early-stage venture capitalists that invest based on objective assessment of risks, how to mitigate the risk and how to maximize potential returns. The process for a venture capital investor is to assess the business plan, the financial model, the integrity of intellectual property, the integrity of market research, the strength of a competitive analysis and all of these factors that require objectivity.

Then the valuation of a company can be assessed. The valuation will have some sort of range. Once the venture capitalist has a range of valuation then he can negotiate with the innovator. The buyer wants to buy cheaply and the seller wants to sell expensively. But in a situation of a pre-seed stage project where you have a technology idea or brand new fundamental science which may be revolutionary or even disruptive, it’s highly important for the innovator to feel comfortable with the angel investor, and know and feel that the angel investor is going to be there to help him. The valuation at this stage of project development is going to be very low, much lower than the innovator probably feels the technology is worth. There has to be real understanding between the innovator and the investor. The value that the angel investor will provide will absolutely change the financial dynamics and structure and the future valuation of the company. Therefore it has to be a smart investor, someone who has wise understanding of that sector. And the only thing that will push the innovator to agree is that same intuitive feeling that this is the right partner to work with. Looking for investors is extremely important. Innovators should look at the type of people, at what types of projects they have been involved in, what success stories the investor can point to, and so forth.

Looking for an innovator that is not a lone wolf

Investors have lots of choices. Most angel investors look at numbers, many numbers every week; they get invited to a lot of different projects. As an angel investor I’m looking at five or ten or twenty different projects per month through my networking activities and speeches, presentations, blogs, chatrooms, email correspondence, LinkedIn, Odnoklassniki and many other forums. Sometimes I receive two-three projects every day. And 99% of the material that I receive I’m rejecting because I think, “No, it’s not really for me.” Maybe I don’t have enough experience in that sector; maybe I don’t have the understanding of that geography or that market; maybe I feel that the team presented is not exactly the team that I can work with.

What I’m looking for in an investment team is that there’s not a single innovator but there is a real team. Why am I looking for the team? Because a team has already understood how to compromise. If I’m dealing with one single scientist that means this person is trying to do everything himself; he hasn’t had to compromise, and maybe if he has had arguments with partners, the partners have left him. From my standpoint, it’s extremely important to have three, four or five members of the team. That’s already a very important indicator for me that this is a group I can work with. I need the scientific leader but I need to make sure that the scientific leader or the project initiator has already brought other people into the project, which believe in him or her and believe in that project in the same way as the innovator believes in that project. To me, this is an indicator that the innovator has been able to sell the idea to someone else. If he’s alone, I almost always reject the project.

What the innovator has to understand about the angel investor is that the angel investor is someone searching for the next Google. What am I looking for? I’m looking to change the world. I believe that technology can be used to solve global problems and improve the human condition. So, I want to invest in things related to global warming, methods to purify water, etc. These are not necessarily idealistic goals on my part, but I believe that these types of disruptive technologies will create extreme value. A lot of business angel investors are motivated by improving the world.

Usually business angels are people who have already had two or more big successful projects. They’ve developed companies, they’ve sold them, they organized the public issuance of shares of their companies. Usually those things took place when they were in their late forties. And then they are looking for other projects to do. They typically work 24/7. Most angel investors I know never plan on retirement, never think of the day they will lie on the beach and do nothing because that would be boring. That’s what’s interesting in life, and life is short.

So, innovators have to understand the motivation of the angels: why are they doing what they are doing? The wealthy people with a lot of money in the bank can go to restaurants and take their families to some exotic trips. Business angels also do something like that periodically, but mostly they want to be changing the world. And they are looking for that type of disruptive technology which exactly would achieve that. Angels mostly look for people like themselves, for people with fire in their eyes.

They typically form a portfolio of 10-20 or sometimes, as a friend of mine in California, Frank Peters, told me, up to 30 projects. Some of the projects might not succeed, but a few of them might succeed beyond your wildest dream. And that’s the dream of every angel investor.

The investor and the innovator should understand the psychology of one another. For the innovator, the project might be something he’s spent 10-15 years of his life on; it’s something he believes in deep to his soul, something he wants to achieve as a major goal in life. If the angel provides some sort of advice which says to completely change the technology that may not be easily received information. The angel has to be sensitive that for the innovator, the project is his baby. It’s important that angel investors have a lot of experience and understanding of how to present themselves and their ideas to innovators; and innovators should be prepared that the angel investors are going to be strong-willed and they are going to push them. The ideal combination is when the two forces push each other forward, when none is completely dominant over the other, but both try to achieve the maximum valuation of the project.

For the innovator, it’s important to understand what he’s good at. I had a conversation recently with a man who’s been working for 15 years on his innovation project. It has to do with supercomputers. The man worked on this with a very small team, leading almost every aspect. I asked him, “Who created the marketing plan?” He proudly pronounced, “I did it himself.” I asked, “Who created the financial plan?” He proudly announced that he’d done it himself. Who created the idea itself? – he did it himself. And he has one programmer.

It’s a little bit scary for an angel investor to see that one seems to be completely self-reliant and does not really need a lot of people. When I suggested to him that maybe he should change his strategy, he absolutely refused. To me, this is a very dangerous kind of project to take on because what you want to find is a person who understands his limitations and weaknesses and feels the need to bring someone else like an angel investor into the project that could complement him and work on a commercialization strategy.

I explained to that innovator the example of my uncle’s business angel club which he created 40 years ago in Chicago. My uncle together with seven of his friends worked with professors from University of Chicago, North-Western University and some other universities in the mid-West. Once a month they would gather together. I explained to that innovator that those professors understood they were not CEOs of companies—they were start-up artists, they were creative innovators that would work on a project for six months or a year, develop it, and then hand it over to the people who could commercialize that project. And my uncle’s friends would take on the projects at a certain stage, hire accountants, marketers, the CEO, and they’d develop a team which could present all of the information to the venture capitalists, different VC funds in Chicago and the mid-West. What made this so successful in Chicago is that the professors understood themselves that they couldn’t do that alone and that they didn’t want to be the CEOs of their companies. They wanted to continue to work on technology, which is what the innovator should focus on. And the business people should focus on what they do well.

I was received with a look of shock. “Well, I’m not going to let anyone run this company; I’ve developed it from the start!” …In fact, he didn’t want to get advice on commercialization; he didn’t want to listen to anyone else. And what may happen unfortunately is that this project may not survive because in this day and age the professor sitting, say, in Siberia is probably having competitors in three other cities around the world working on exactly the same topic. And those other innovators may have a different view; they may believe that the speed to the market is the critical aspect of success. Those who wait may lose the market. If you try and do everything yourself the project may not succeed not because of its technology or whether it’s superior or inferior to any other technology, but simply because someone else beats you to the market as he understood they need professional management, they need professional venture capital, and they need to move into a new level of production and patenting and licensing and prototyping.

If I can understand that the innovator is not willing to get advice, for me this project is not interesting to work on. I want to work on a project where people need my influence and experience.

Friday, November 2, 2012

Why Crowdfunding Is The Next Big Thing: Let's Talk Numbers

This op-ed by Victoria Silchenko, founder and CEO of the U.S.-based Metropole Capital Group, was first published at Huffington Post

Stephen Hawking once said: "I don't think the human race will survive the next thousand years, unless we spread into space." Bold statement. But as I've been working on organizing the upcoming Next Generation and Global CrowdFunding Forum which is set to be on November 16th here in Los Angeles, I've been asking myself the similarly dramatic question: can we, as entrepreneurs in desperate need of capital, survive the next ten years unless we spread into crowds?

A Global Entrepreneurship Monitor (GEM) study revealed that out of the $51 billion invested in start-ups by individuals in 2010, only $9.4 billion was committed by angel investors (formal investors) while the bulk of capital, $41.6 billion (81%), came from friends and family. What about VCs? Let's look at the data from the National Venture Capital Association (NVCA): in 2010, venture capitalists invested approximately $22 billion into about 2,750 companies, 36% of which received funding for the first time.

Now let's compare the numbers: in 2010 we had $41.6 billion coming from friends and family, aka "informal" investors, fearlessly backing up start-ups and only $22 billion from the VCs committing to both: start-ups and established business. Are you thinking what I'm thinking?

More recent data from GEM confirms that in 2011, 4.8% of the U.S. population personally provided funds for new businesses while only 1% of the population was represented by formal or accredited investors (must have an annual income of at least $200K or over $1 million in liquid net worth) along with venture capitalists. Alas, the last were not much of a help to the majority of entrepreneurs - 95% of business plans received by the accredited investors and VCs were rejected.

From my frequent talks with VCs, I've collected even more astonishing numbers - on average a VC reviews 2,000 business plans annually while choosing to invest in just 3-5 ventures per year. So, your probability of getting funded by a VC is 0.2%. On the flip side, one of the VCs told me that he has to raise capital himself most of the time and is often sad to let the company go - moreover, he wouldn't be surprised to find out that his "rejected portfolio" would perform better than the acquired one. What? Does it mean that we might miss the next Mark Zuckerberg? And who holds the cash anyway - money that might have been invested in the emerging ventures otherwise?

The enlightening answer has arrived from the Federal Reserve. It turns out that large U.S. corporations currently hold about $1.73tn (50% more than they held in 2007) and banks keep in their reserves an estimated $1.5tn in excess. Realistically speaking, can we expect such cash hoarding to be unleashed any time soon with a goal of rescuing small businesses under the premise "too small to fail because nobody will notice anyway"? You get the point.

Needless to say, entrepreneurs in the U.S. are waiting with their hands up for the SEC to arrive with new solicitation and general legislation rules that would allow them selling shares over the Internet utilizing the equity- based crowdfunding model. Yet, some of them have already employed an altruistic or reward-based crowdfunding model which is operational today. If you are a small business owner or have a creative project, chances are you are familiar with Kickstarter ,IndieGoGo or GoFundMe - crowdfunding platforms with the investment proposals spanning from film makers to innovators offering non-financial incentives for micro-sponsors. Furthermore, last week Lockitron released a crowdfunding software under an open source license and launched Selfstarter - a ground-breaking platform which would allow inventors to set up their own crowdfunding campaigns.

Interestingly, the long awaited crowdfunding model where micro-investors take an equity part in the company, has been already operational in the UK for over two years, in Australia for seven, and recently was legalized in Italy by the Monti government. My Italian friend commented after that legislation: "I must say that this is a time I am proud to be an Italian!"

Overall, according to, the company that does an admirable job tracking the industry numbers and trends, the crowdfunding platforms raised $1.5 billion in 2011 - still a tiny number in global terms but the growth is impressive: 72% from $854 million in 2010 and almost a triple jump from the $530 million raised in 2009. The study forecasts further growth which is expected to be almost doubled this year reaching $2.8 billion globally.

What's next? Well, I am sure that SEC with the help of the two most active groups in the industry Crowdfund Intermediary Regulatory Advocates and the Crowdfunding Professionals Association will frame the legislation just right remembering that the initial goal of crowdfunding has been to simplify access to untapped capital for the entrepreneurs and innovators, not complicate it. Quoting Stephen Hawking once again, "The idea of 10 dimensions might sound exciting, but they would cause real problems if you forget where you parked your car."