Investing

In any startup, the founder and/or CEO tries to have their own team of advisors and investors to help the company scale. In addition to the financial benefits of angel investors, they bring years or even decades of experience and serve as mentors to entrepreneurs, helping them grow and scale their businesses.

To accomplish this, investors typically look for entrepreneurs with great teams and products, but mostly those who are coachable and open to feedback. Ideally, a CEO would seek advice from seasoned investors and avoid common business pitfalls. But that's not always the case, and CEOs tend to ignore investor advice and fall into common business traps.

Long-time angel investor Dave Berkus has made more than 200 investments to date. He attended our 2021 Investor Capital Expo and shared his experience working with entrepreneurs. Here are 6 pieces of advice, cumulated from his decades of experience, that entrepreneurs are most likely to ignore.

 
Advice #1: Don’t Accept Money from Family Members

Accepting money from family members can be tricky! Today, more than a third of startup founders raise money from family members. While you may think it is beneficial to have family members be a part of your business, here are the pros and cons of asking your relatives to invest:

Pros

• They are willing to invest in you because of familiarity & the family connection
• They do not question your business decisions
• They are more likely to reinvest

Cons

• They believe that the family bond is their guarantee of getting their money back
• Family relations can be negatively impacted during a business loss/or inability to return their invested amount

Dave recommends only accepting money from experienced family members if they are willing to invest in the business and can walk away without regrets if the money is not returned. In the instance that you want to ask for money from a wealthy family member, it is advisable to present them with the idea and give them the opportunity to say no without it affecting your relationship. If this family member has put money into your business on three or more occasions, then it is perfectly acceptable to ask them without out getting emotionally involved. He went on to say that if they've invested with the entrepreneur in the past, entrepreneurs may not need to worry about emotional distress before asking them to invest again.

The real problem comes when the business fails and the entrepreneur cannot give them their money back. Family members tend to think of family ties as insurance to get their money, and failure to do so may create a bad feeling for family members investing in the business. Remember, just because an entrepreneur has a family relationship with an investor doesn't mean they don't expect a return on investment.

Always instruct entrepreneurs to consider whether family members who are asked to invest will be able to walk away without remorse if the business fails.

Advice #2: Don’t take money from unsophisticated investors 

The most important advice here is to not take any money, especially a startup loan from an unsophisticated investor.

Dave shares an example here where he was a co-lender and took over the role of chairman of a fledgling startup where the entrepreneur’s cousin loaned money on the same terms. After the deal fell through, the entrepreneur's cousin sued everyone involved, including the entrepreneur, Dave himself, Dave's wife, and his family trust, just to get his money back. Dave said it cost him several times the cousin’s loan value in legal fees to settle and extradite his interest from the baseless lawsuit.

Carefully vet investors to ensure they have the experience and temperament to handle all types of situations.

Advice #3: Get investors to purchase equity 

It is advisable to take loans from sophisticated investors only after you have done everything possible to convince them to purchase equity. But, ensure that they have a clear understanding of the potential extension and the repayment process. Entrepreneurs should let investors buy equity for the following reasons:

• If the corporation is a C-Corp - the legal form of a corporation, the owners or shareholders are taxed separately from the corporation.
• You can benefit from Section 1202. This provision encourages non-corporate taxpayers to invest in small businesses. Exempting capital gains from federal income tax on the sale of small company stock is the primary purpose of this IRC section.

Getting investors to purchase equity, which is good for everyone, keeps entrepreneurs from having too much debt on their balance sheet and allows them, if required, to take a loan in the future.

Advice #4: Don’t talk yourself into high valuations

This is an important one! Talking themselves into high valuations is a trap that entrepreneurs often set. Don't convince yourself into a high valuation in your first funding round. Even if the idea is a never-seen never-done-before. Even if the idea could be worth billions of dollars.

Not only is it a difficult lesson to teach, but Dave also says, it's one that entrepreneurs overlook quite regularly. Friends and family are often the first investors in a company, and they don't have the experience and knowledge to adequately compare value ​​or ask the difficult questions about the business. So, when evaluating a company, they trust the words of the entrepreneur. Only when angel investors get involved, they may or may not agree that the valuation is reasonable and comparable to other opportunities. More often than not investors walk away from deals when the valuations are unreasonable.

It's not worth arguing with entrepreneurs and early-stage investors such as friends and family when valuations are too high when many other deals require sophisticated investor money.

Advice #5: Don’t take “Dumb Money”

Always advise entrepreneurs not to take dumb money, especially when the investor or lender has nothing but cash to offer. Angel investors aren't just good for writing checks, but so much more. Here are 5 attributes that make investors indispensable to your team!

1 – Capital inflow: Funds brought into the company by angel investors on reasonable terms.

2 – Ability to lead entrepreneurs: Investors are able to guide investors into the context of a business plan relevant to the market to ensure they are not in the wrong place at the wrong time or their product/service is not premature or arrives too late at the market. An investor also helps entrepreneurs better understand the TAM (Total Available Market), SAM (Serviceable Available Market) & SOM (Serviceable Obtainable Market), this is crucial to understanding how their product will fare in the market. Investors can advise them on the context of their actions so they can be better prepared when they enter the market.

3 – Investor's experience growing a business: Any experienced investor has a history of managing or owning a business. Almost all investors have made mistakes and lost money while trying to make money, so there is valuable experience/knowledge that can be shared with entrepreneurs to help them avoid similar mistakes and save the money invested into their company by investors.

4 – Investors know the best use of time: This means investors know when is the right time to launch a product. Faced with such hurdles as entrepreneurs who want to approve every decision, can create significant bottlenecks in product launches. There is also a core time to control, especially early in the development cycle, so that the development team understands the value of time and ensures that it is used in the best possible way. Otherwise, most investors will have put their money in a company whose core team can't come up with a finished product.

5 – Leveraging an Investor’s Network:  Last but not the least, an investor’s access to extended relationships with fellow angel investors and entrepreneurs alike.  Dave states that every investor has investor friends and acquaintances and all of them have made mistakes and learned from them along the way.

As an investor, you can influence the decisions of entrepreneurs and their teams, whether you join as an individual or as a member of a group such as Keiretsu Forum, or as a chairman of the board or advisor to entrepreneurs. All in all, all investors have smart money to offer, but they're worth as much or more than the money they bring to the table.

Advice #6: Don’t walk away from rejection by experienced investors

Entrepreneurs might hold residual bad feelings towards investors who don’t invest in their company.

But rejection isn't always a bad thing! Most early-stage investors have seen thousands of good and bad proposals and know how to distinguish a good deal from a bad one. Investors may reject it because they compare it to previously lost investments, or because of their industry experience and understanding of the market. He suggests using the ‘Berkus Method of valuation’ to better evaluate the scalability of a startup.

As an investor, Dave says, you should advise entrepreneurs to ask three progressive sets of deeper questions to find out why investors aren't investing in their companies. Every encounter should be a learning experience, so inform entrepreneurs that a well-worded "no" can be a step toward a correction of the course, and maybe a later "yes".
 

About the Speaker:

Dave Berkus is a noted speaker, author and early-stage private equity investor. He is acknowledged as one of the most active angel investors in the country, having made and actively participated in multiple technology investments. He is a much-in-demand keynote speaker throughout the world, addressing technology trends for corporate planning, building great companies, and sharing great, epic stories about entrepreneurism from his vast personal experience. As Managing Partner of Kodiak Ventures, L.P., Wayfare Ventures, LLC, three ACE Funds, and Berkus Technology Ventures, LLC, all private equity investment funds – and Chairman- Emeritus of the Tech Coast Angels, one of the largest angel investing networks in the United States, today Dave is board chairman or board member of ten technology companies. You can watch his keynote here.

In the Keiretsu Forum Northwest & Rockies March 2022 Roadshow, we invited thought leaders from the angel investment world to share their expertise at the event. Angel investor, business owner, and Joylux CFO Karen Howlett joined our forum sessions in Bellevue and Salt Lake City/Boise. In her keynote, she dives into the core components that make up Term Sheets and CAP Tables to help you, the investor, make informed decisions and better manage your deals.

CAP TABLES VALUATION 

Karen emphasized that the most important considerations as an investor in CAP tables are the company valuation, stock price, and fully diluted stock. According to her, different people have different meanings for the concept of fully diluted stock. It is important to know whether it includes all stock options or only stock options that have been granted or exercised. She explained that it's good to thoroughly evaluate and understand what's on the CAP table.

Why do you need to know your fellow investors?

It's imperative to know who the company's investors are, how many of them are outside investors, and how much early-stage investment is from the founder's family and friends. Also, what are you investing in? Common stock, preferred stock, notes, equity, or stock option plans and evaluate these factors before investing.

Why does a Founder/CEO stock matter? 

When it comes to a founder's stock, it's important to know how much he or she owns, which is enough to keep them committed to making the company successful. What is their motivation for staying? Have they invested? Are they getting a salary? Her advice is to understand their motives.

Another strong consideration she puts forth is - What happens to the founder’s equity if the founder leaves? If it is not subject to vesting or repurchase, it will have a substantial impact on the employee stock option. In addition, having to replace the founder can have a big impact on employees' stock options. Lastly, who owns the company IP? Is it the founder, the company or a university? These are a few questions an investor should get answered before investing.

Employee Stock Option Plan

When Karen first started investing, she didn't know much about employee stock options. When she started, she put 10% to 20% into the employee stock option plan. Over the next few years, as she spent more time investing, she realized that it was essential to know what stage the company was in, how much of the capital pool was allocated, how many new employees could be hired, and how many were in the pipeline, such as consultants and advisors. It's necessary to understand where you stand in terms of employee stock options, as adding them can significantly dilute your investment. Here’s an example of how investors lose share value from the employee stock option.

Example: The authorized shares of a company are worth $1 million, and as an investor, you own $250,000 worth of shares or 25% of the whole pool. If the company decides to increase the pool size by 20%, your percentage of ownership will drop below 21% of the company. With no new money coming in, you have no choice besides stock options.

A company has $1M Authorized Shares
Investor buys $250K = 25% shares
The company increases the employee stock option pool to 20%
Investor share value declines to less than 21%

The key learning here is that investors get diluted as there are additions in the pool.

WHAT CONSTITUTES A TERM SHEET? 

Karen stressed that all types of investments should have Term Sheets: equity, convertible, and SAFE notes. The Term Sheet is not a legal document and is non-binding, but it sets out the most basic terms of investment, so investors should pay attention to the content of the document.

SO WHAT’S A CONVERTIBLE NOTE? 

Most convertible notes automatically convert when qualified financing is available. The financing must be higher than what they are raising now. Example: If you raise $2 million, ideally you need to convert the note to a higher amount. As an investor, you also need to know what price to convert at, the discount on the next equity round, or the discount off the next valuation cap. If the company is sold or there is a change of control, how does it affect conversion? What matters is that you have the opportunity to convert it yourself rather than getting paid off. Karen recalled that in some cases, companies were simply trying to pay off investors, rather than turning them into common stockholders, which could generate returns of up to three times as much. She believes the choice of conversion should not be a decision of the company, and you as an investor should not be forced to accept the majority in this situation, so always be aware of this fact when renewing convertible notes.

Is the maturity date of the convertible note, prepayable only with the consent of the note holder, or can companies choose to do so? Most people in the Northwest hate stocks and avoid SAFEs and convertible notes because traditional convertible notes have no valuation cap or maturity provisions. Other factors to consider include interest rates, length of the note, securities conversion, and the type of entity you wish to invest in. All of these are things to consider when reading your Term Sheet and making an investment.

TO-DOS 

For the Investor:

• Like the company you are investing in
• Invest in the team
• Trust the entrepreneur
• Plan to invest in future rounds

For the Entrepreneur:

• Be coachable and be open to feedback
• Have a clear value proposition
• Have the right background & skills appropriate for this stage
• Products/solutions that are exciting/disruptive
• Sizeable market – is it worth the effort?

KEY TAKEAWAYS 

According to Karen, the Term Sheet has a lot to offer, and don't miss a great opportunity when you're focused on the nitty-gritty of the documentation. She states that there was no perfect Term Sheet or prepared proposal document. One insight she offers is that entrepreneurs' responses to questions or feedback can be very revealing about how they run their business and how they feel about it. In their experience, they don't read documentation most of the time, but what matters is whether they have the expertise and are open to feedback. She continues to emphasize the importance of the Keiretsu Forum Term Sheet committee’s feedback on each deal. The Term Sheet committee consists of fellow experienced and accredited members that review each deal and provide their feedback in the Due Diligence report. If there is no feedback; you should request that feedback as it will give you the structure and guidance you need. Finally, if you don't understand something, ask questions and use the resources around you to maximize your knowledge.

ABOUT THE SPEAKER

Karen Howlett is an entrepreneur, angel investor, and CFO of Joylux Inc. She has worked for Corporate America at Ford Motor Company for over 20 years. She has been a small business owner for 12 years in the steel and construction industry. She joined Keiretsu Forum as an angel investor in 2018 and became the CFO of Joylux in 2020. As a small business owner and large international corporation, she has a solid reputation for delivering results. She is a Six Sigma Greenbelt with excellent leadership and mentoring strengths. She has proven capabilities to succeed in multiple industries and has the expertise in developing business, strategic and tactical planning, and building relationships. Click here to watch her keynote address.  

Keiretsu Forum saw a 21% investment increase in 2021 as its members continued to power seed, late-stage, and early-stage companies.

SEATTLE, WA, May 10, 2022 – The Keiretsu Forum Northwest and Rockies regions within the world’s largest angel investing community, has announced its 2021 funding data. Angel investors in the Northwest & Rockies have invested more than $60 million in 93 companies across multiple sectors, surpassing all investment forecasts and making 2021 the most invested year to date.

“Keiretsu Forum continues its vibrant growth across our regions. Investors and entrepreneurs are benefiting from our unique footprint, disciplined process for originating quality deal flow, and success syndicating early and late-stage investment opportunities,” said Brianna McDonald, Keiretsu Forum Regional President.

According to Pitchbook's 2021 global annual figures, Keiretsu Forum in the U.S. invested in 167 companies, and the global network invested in 246 companies, bringing the total to over 380 fundings in the past year. In a year of economic and social uncertainty, angel investors have funded entrepreneurs and start-ups in one of the most challenging business environments in recent history.

“We continue to welcome expanded partnerships to benefit the Keiretsu Forum Network community. Despite the global disruptions, we are likely to see continued growth across all sectors in 2022,” continued McDonald. Keiretsu Forum has also expanded its international presence and is now represented in 24 countries across 4 continents.

2021 has been an incredible year for the Keiretsu Forum global network, with investments up 21% since 2020, and Life Sciences/MedTech, Fintech, and Technology attracting the most funding.

In 2021, Keiretsu Forum has backed the following companies and many more:

• AI Optics
• DigitSec
• E2C Technology
• Epilogue Systems
• Healionics
• Inmedix
• Joule Case
• Key Co Travel
• KitoTech Medical
• Light Line Medical
• LumiThera
• Lumoptik
• Orion Biotechnology
• Oticara
• Seneca Therapeutics
• Soteria Battery
• Steelhead Composites
• Summit Venture Studio
• Vartega
• VKTRY

About Keiretsu Forum Northwest & Rockies

Keiretsu Forum Northwest & Rockies is the Pacific Northwest portion of Keiretsu Forum. It includes chapters in Vancouver (Canada), Denver/Boulder, Bellevue, Seattle, Salt Lake City/Boise, and Portland. Keiretsu Forum Northwest & Rockies has more than 400 members and has invested over $500 million in over 775 companies since its founding in 2005.

For more information visit www.k4northwest.com

About Keiretsu Forum

Keiretsu Forum is a global investment community of accredited private equity angel investors, venture capitalists, and corporate/institutional investors. Keiretsu Forum was founded in 2000 by Randy Williams. Keiretsu Forum today is a worldwide network of capital, resources, and deal flow with 50+ chapters on four continents. Keiretsu Forum members invest in high-quality, diverse investment opportunities. To date, it has invested in over 2,000+ companies. The community is strengthened through its involvement in social and charitable activities.

For more information visit www.keiretsuforum.com

If you're thinking about going the angel route, here are five critical things to know about the process that can lead to a successful round.

For startups, a great alternative to venture capital is angel funding. A silver lining that has rapidly emerged over the past year is the uptick of virtual angel investment groups. 

At Keiretsu Forum we have pivoted online, a notable trend amid large angel investment groups, which means existing investors, no matter their location, can access and evaluate any of the deals that go through the network. Concurrently, new investors seeking to diversify their portfolios are gravitating to the virtual angel model. Member onboarding, due diligence, live presentations, and member meetings are now all conducted online.

If you’re thinking about going the angel route, here are five critical things to know about the process that can help lead to a successful round:

1. Prepare for virtual fundraising

In a post-Covid-19 pandemic, world capital must be raised virtually. The biggest challenge for entrepreneurs is that investments are made without ever meeting potential investors face-to-face. There is minimal eye contact and little body language—which is the language of funding—in a Zoom meeting. The goal is selling the upside potential and creating interest.

Try and get into the mind of the angel, who will be evaluating you and asking themselves:

• Who are you?
• Why would I want to be involved and work with you?
• Do I support the journey, the mission, and the impact?
• Is the technology compelling?
• How vast is the market opportunity?

All those questions must be addressed during the pitch presentation.

Fundraising as an ongoing process, with presentation and speaking skills evolving over the course of the campaign. Constantly evaluate your own presentation: Is the audience-market quickly defined? What is the pitch about? Why is it being pitched? Who will benefit from it?

Indeed, the most effective technique for improving your pitch skills is to watch entrepreneurs with similar stage companies deliver pitches. Presenting to 50, 60, or hundreds of investors is no small task. Before and during the process, put your ego aside, and attend a few online investor forums to see how the best do it.

A good pitch coach is someone who can simplify the process and make it less daunting. In addition to the pitch itself, not to be underestimated is honing the presentation skills that enable the entrepreneur to deliver an engaging and compelling presentation.

2. Angels like familiarity

Angels gravitate toward opportunities in the industries they have direct experience in, and the insights they can share with founders on how to successfully grow companies within those markets is invaluable.

Relationships between entrepreneurs and angels can get started quickly and can be very hands-on, with angels oftentimes embedded within the company’s extended management and advisory network. In scenarios like this, the expertise, plans, and funding take place within an exciting and collaborative environment.

“People invest in people they know, like and trust. Once an entrepreneur goes through the process of securing angel funding, they are part of a tight community.”

People invest in people they know, like, and trust. Once an entrepreneur goes through the process of securing angel funding, they are part of a tight community. By example, approximately half the entrepreneurs that present to Keiretsu Forum are members of the group. Many are angels and entrepreneurs that have built and sold several companies.

The companies that make it through the full process are typically ones who raise capital, have a track record of success, understand the fundraising process and the value of seed funding. This environment helps to cultivate relationships between the investors and the entrepreneurs.

3. Due diligence is the force multiplier

Due diligence is the key to a successful funding round. The process can be lengthy, taking upwards of 80 to 100 hours over six to eight weeks, but once completed the company is now able to syndicate and receive further capital.

Typically, in an angel group setting, companies initially pitch first to a deal screening committee who determines if the opportunity is worthy of a full investor presentation. If there is interest, the due diligence process begins. Keiretsu Forum deploys on average 50 to 60 members that evaluate the opportunities and vote on inviting opportunities forward to the next step. Tight screening should be a confidence builder for both angel and entrepreneur.

For example, Keiretsu Forum members back more than 80% of the companies that go through the process. An affiliated fund, Keiretsu Capital, will often invest alongside the members backing the company. This process gets repeated when the deal is syndicated across the network that includes numerous additional angel groups. At the end of the cycle, there should be 50-70 interested angels to close capital from.

4. Protect intellectual property

Most angel investment groups will not sign NDAs to conduct due diligence. It is critical to have a proper patent strategy to protect key intellectual property (IP). That said, due diligence plays a large hand in formulating that strategy, ensuring there is a good framework in place for the company to document a sustainable differentiation, with the freedom to operate and prevent competition from infringing on their patents.

Most angel groups have IP attorneys who are members and conduct those reviews. Be careful about what you put in writing—angels should be able to understand what is going on with your business without you disclosing important assets.

5. Family offices deliver patient backing

The alignment between family offices and angel groups is the future of entrepreneurial finance. Indeed, family offices are experiencing a huge transfer of wealth (approximately $20 trillion) to the next generation of family members who are eager to make impact and diversity investments. Consider that more than one-half of the companies funded through Keiretsu Capital are now also funded by family offices.

Moreover, unlike VCs, family offices are geared toward investing over a longer horizon and do not have an incentive to overly dilute the companies they invest in. Most important, family office investment adds a substantial balance sheet for fueling growth, and a sense of financial confidence for anticipated tough stretches.

The symbiotic relationship between the angel investors that have the entrepreneurial expertise and the family offices that have the wealth that should most excite female entrepreneurs seeking to raise capital.

Brianna McDonald is president of Keiretsu Forum Northwest, the largest chapter of Keiretsu Forum, the world’s biggest angel investor network ranked by Pitchbook #1 “Most active investors early stage US region” and “Most active investors late-stage US region.” Brianna is adept at screening companies for angel investment, coaching companies on presentation and investor relations, sales strategy execution, relationship management, and leading due diligence teams. Brianna believes in companies that have “multiple bottom lines”, in that they are not solely focused on profits but also focused on impact, social good, diversity, and making the world a better place for the next generation. 

Keiretsu Forum Northwest is delighted to be recognized by several major news source publications for their 2015 accomplishments. As a collective, Keiretsu Forum Norwest region oversaw the funding of 57 companies with over $43.5 Million in angel investing. We are honored by the recognition of this accomplishment and grateful to the following news sources for their coverage of our success. Check out the articles featuring the Kieretsu Forum Northwest investment collective.  

Seattle Times

GeekWire

Xconomy

Business Journal