By Anne Field
Think Internet stocks are overvalued? Then don't buy them.
Here's a better way to profit from the Net's explosive
Stephen Coleman figured that finding a promising, IPO-bound
Internet start-up would be a lot like his own specialty,
laser eye surgery: To the novice observer, it looked like
a quick, simple operation. Only when you stood there with
equipment in hand did you realize how much experience and
training was really necessary. It would take a lot more
than just instinct and timing to find a good prospect and
determine whether or not to go with it.
What Coleman did was piggyback on the experience of
others. Three years ago, he joined the Gathering of
Angels, a group of wealthy private investors who meet once
a month in Santa Fe, New Mexico, to listen to
entrepreneurs make their pitches and talk deals. Two years
later, he invested about $10,000 in USA Talks.com, an
Internet telephony company that seemed likely to go
public. And it did. After a wild ride in the market, his
stake rose to about $200,000 before plummeting again.
Nevertheless, Coleman is eagerly waiting for his next
opportunity. » Although cyber-stocks seem to many
investors to be prohibitively overvalued, there are
actually lots of ways to get in on an Internet company
early -- before the IPO. Only not just any old wealthy
investor can play. To become a successful Internet angel
-- someone who invests anywhere from $25,000 to $1 million
of his or her own money in a fledgling company -- you have
to know where to find the deals and how to evaluate them.
Getting in on the ground floor of an Internet start-up is
one of the riskier gambles you can make with your money.
The standard rule of thumb applies: "Investors should
only put in money they can truly walk away from the minute
they write the check," says Bob Fitzwilson, a Menlo
Park, California, investment counselor who has invested in
about 25 companies in the past five years. There's no way
to be sure a company will ever make money, much less be
bought or go public. And while the company remains
privately held, your investment will be highly illiquid.
You need to think like a venture capitalist and invest in
a portfolio of as many as ten companies. Like any
self-respecting portfolio, yours should be diversified,
representing different segments of the Internet market --
a few content providers, say, a few routers, a software
security firm, and so on.
Then there's the time factor. You can expect a firm to
take three to five years before it stages a successful IPO.
And you may be expected to put in lots of time during that
period working with the company as an adviser. That has a
good side: Many companies require that you be an
accredited investor, meaning, according to the Securities
and Exchange Commission, that you have assets of $2
million and income of $300,000. But if you work so closely
with a company that you can be deemed almost a part of it,
then this rule doesn't apply.
Not every start-up will take your money, either. The hot
ones, in fact, might be really picky, since the wrong
angel can kill later venture- capital interest. "I've
seen cases where venture investors stayed away because
they didn't want to be encumbered by an unsophisticated
angel," says David Gerhardt, president of the Capital
Network, a group in Austin, Texas, that links angels and
entrepreneurs. You'll be more likely to find a taker if
you can bring more than just cash to the table -- say,
expertise in an industry or a helpful Rolodex.
How to find deals? Start by contacting lawyers and
accountants who handle start-ups (particularly Internet
companies), tell them you want to make investments, and
ask if they could show you their deal flow. You could also
contact ultra-plugged-in financial insiders, like
investment bankers, who are likely to know which clients
are about to do an IPO. "This way, you get in on the
upside of the market," says Kathy Lane, a San
Francisco Bay–area investor who bought shares of
Vignette, a company in Austin, Texas, that makes Internet
tools. It went public seven months ago, and Lane doubled
her money on the first day. Other sources: business
incubators associated with universities or firms like
Technology Ventures in Albuquerque, which helps
engineering whizzes turn their innovations into companies.
Also, find out where the deal makers go to break bread and
talk turkey. "In most communities, there's a spot the
VCs go to eat," says Lane. In Silicon Valley, it's
Buck's in Woodside. VC heavyweight John Doerr has been
known to stop in for breakfast, and rumor has it that the
founders of Netscape drew up the plans for the company on
a napkin there. One easy way to get started is through
matchmaking services. Often associated with universities
or business incubators, they put angels and money-hungry
entrepreneurs in touch. Angels register with a network,
like the Capital Network in Austin or Technology Capital
Network at MIT, and provide information on interests and
investment criteria; entrepreneurs provide details on
their companies. When organizers see a good fit, they send
an executive summary to investors, who then decide whether
to contact the company. Online services that do similar
things have also sprung up. (See "Contact
For a more organized approach, try venture forums and
fairs. Often run by chambers of commerce and universities,
forums are monthly breakfasts and lunches for which
members pay around $100 a year to chat, hear talks on
appropriate subjects, and, most important, figure out
who's doing what and who's worth hooking up with. At the
Baltimore-Washington Venture Group's forum, company owners
and private investors provide a 15-second sound bite
explaining who they are and why they're there.
Participants can also do more intensive networking,
handing out business cards and arranging further meetings.
Venture fairs provide an even more informative view of
specific companies. Over a day or two, anywhere from 15 to
50 start-ups present their business plans in 15-minute
snippets to an audience of interested investors; attendees
pay anywhere from $300 to $1,200 to come.
For more efficient access to deals, angel clubs are a
better bet -- particularly for experienced investors.
These alliances provide a systematic way to listen to
brief presentations from companies and to pick the brains
of other angels. Members usually meet once a month and
hear pitches from two or three entrepreneurs; there's a
question-and-answer period and the chance to meet
privately afterward. That's if you can get in. Perhaps the
best-known club, the Band of Angels, a 140-member Silicon
Valley group started in 1995, has fairly stringent
requirements: You have to be accredited and sponsored by a
current member -- and you're required to make investments.
Smaller groups, like the 20-member Walnut Venture
Associates in Wellesley, Massachusetts, have similar
Not all groups are so picky. The Gathering of Angels in
New Mexico, for example, has a mailing list of 1,500
investors and does not require that they be accredited or
even that they make an investment. Based in Santa Fe, it's
opening affiliates in Atlanta and Scottsdale, Arizona,
next year. One angel club, Seraph Capital Forum in
Seattle, runs what it calls a boot camp for new investors,
a half-day workshop on such topics as how to find a deal
and how to value a company. Recently, some angel clubs
have fine-tuned their approach by forming funds -- groups
of 60 or so investors who pool their money and vote on
which companies to invest in.
Perhaps the biggest advantage of these clubs is their
access to expertise. Four Internet experts are carefully
positioned at each meeting of the Gathering of Angels, so
they can ask the tough questions that other, less
cyber-savvy investors might not think of. That's really
helpful during the due-diligence stage, when members can
divide up the work. More frequently, however, one person
will become the lead, doing most of the research and
taking responsibility for the validity of the deal.
Stephen Coleman, for one, makes investments purely on the
recommendations of well-respected colleagues, like the
Gathering's founder and a few others. "I decided I'm
not going to business school," he says. "I'm
going to trust one or two people and follow their
If what you want is someone with a lot of experience to
act as a screen for you, two new Internet outfits may also
help. OffRoad Capital acts as a matchmaker for later-stage
investments, finding and selecting companies and
conducting due diligence. Then it lists firms and their
plans online for subscribers; the minimum investment is
$25,000. Some deals have as many as 200 participants.
Typical of the backers is Richard Dreskin, a principal at
a broker-dealer in Roseland, New Jersey, who recently put
$47,000 in OffRoad's first completed transaction, a $4.5
million financing for a company called PNBC, which does
online trade shows. "I relied on OffRoad's expertise
completely," he says. Similarly, Garage.com targets
entrepreneurs seeking $1 million to $4 million in
early-stage funding and puts them through an equally
rigorous evaluation process. Those that pass muster are
presented to investors in an area called Heaven, which
member-investors can regularly review. If you're
interested in a company, you notify Garage.com, which
sends along your profile. The entrepreneur looks over your
vital statistics and decides whether to talk further.
If becoming an angel sounds too risky, there are public
companies that make Net investments, most prominently CMGI,
based in Andover, Massachusetts. CMGI has a majority stake
in ten Internet businesses, including AltaVista, and a
minority stake in dozens of others. Recently, it
introduced a program that lets investors with at least 100
shares of CMGI buy into an IPO of one of its majority
holdings at the offering price. Its first offering, in
July, was Engage, an online marketing company. Similarly,
Safeguard Scientifics, a company in Wayne, Pennsylvania,
with 30 Net companies in its nest, sets aside 20 to 25
percent of the equity of the firms it has a stake in so
that Safeguard investors can participate in IPOs.
If you're able to provide services to fledgling companies,
you might even be able to arrange a trade. And that
doesn't just mean providing accounting help. Late last
year, Soi Tee Lee, then the owner of a restaurant in
Burlingame, California, offered a couple of starving
entrepreneurs free food in return for stock options in
ZipLip.com, their fledgling Internet company, which sells
E-mail security systems. Lee got 10,000 shares worth $800.
Since then, the company has raised $1 million, and its
valuation is $6 million. His shares are now worth $12,000,
and he's poised to make a lot more if ZipLip goes public.
Who knows: Perhaps their janitor might also be interested
in making a deal.
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