Pennies From Heaven

Venture capitalism for the rest of us: Angel groups provide a means for the midsize investor to play the start-up field. By Anne Field

As the founder of First Coast Venture Capital Group, a 100-member Jacksonville, Florida, organization comprising mostly angels-private investors interested in financing start-ups - Henry Avery hears from lots of entrepreneurs looking for money. But a call from Arnold Heggestad, director of the University of Florida's Center for Entrepreneurship, sounded especially promising: A medical-device company called USBiomaterials, which makes a substance used to help human tissue repair itself, was doing research at the university, and Heggestad thought Avery ought to hear the company's pitch. Not long after, one of the company's co-founders, Jim Meyers, appeared before First Coast. Meyers's talk persuaded a member to get together his own investment partnership and put about $3 million into the venture. A smart move - the enterprise has been successful enough that it's now expected to go public.

Lots of risk but the potential for lots of reward - that's what you get when you become an angel, a private investor who puts $10,000 to several million dollars into a struggling start-up, hoping to eventually earn an annual return of 40 to 50 percent for an entire portfolio of start-ups down the line. But making a smart choice - even figuring out which companies are worth a preliminary look - requires an awful lot of time-consuming research.

Enter angel groups. A number of these investor alliances have recently sprung up, providing a systematic way for members to hear pitches from promising start-ups, swap information and opinions, and share due-diligence work.

The angel world is a highly decentralized, fragmented place. So if you're hoping there's an association of some sort to give you advice on how to form a group, forget it. You'll just have to go to the leaders of alliances around the country to learn why and how their babies were birthed. (For more on how to contact groups, see the table below.) Just don't expect a lot of information about payback, since these groups are usually only a few years old.

It's unlikely that you'll be able to copy step by step what someone else did. What works along the Boston area's Route 128 might not fly in Montana? But you'll get a lot of good ideas. Case in point: Tarby Bryant, who modeled his two-year-old Santa Fe based group on what may be the biggest success story in the annals of angel groups, a Silicon Valley alliance called the Band of Angels, whose members had $29 million invested in 64 deals by the end of 1997. (Bryant even named his group The Gathering of Angels.) He often consulted Band founder Hans Severiens while getting the group established. For example, when it didn't seem to be taking off, on Severiens's suggestion Bryant changed the Saturday breakfast meeting to an extravagant Wednesday-night dinner. Now the Gathering has more than 40 members, who have invested from $10,000 to $50,000 in eight companies.

Tip O'Neill's maxim on politics applies: everything is local. Your angels need to get together regularly, so they ought to all live in one area. More important, these are not passive investors. Angels want to get up close and personal with their companies, to monitor progress and act as advisers. That often means sitting on the board and attending a lot of meetings. "You need to be able to get in your car and drive to your company," says Tony Morris of Walnut Venture Associates in Wellesley, Massachusetts. "You need to be involved."

Some groups are highly focused. The Band of Angels targets high-tech companies, but, of course, Silicon Valley offers a plethora of technology start-ups, as well as wealthy entrepreneurs with expertise in those industries. In other regions, "you have to take an inventory of what's there, and go with what you've got," says Jeffrey Sohl, director of the Center for Venture Research in Durham, North Carolina. Since Tarby Bryant's Gathering of Angels in New Mexico, which isn't noted for any one industry, the group considers everything from retailers and restaurants to software and biotechnology companies.

You need enough investors to share due diligence and trade valuable information about industries, companies, entrepreneurs, and so on. That doesn't necessarily mean a 100-plus, roster like the Band of Angels has. With just 15 members, Walnut Venture benefits from the ability to swap insights and experience. In one instance, some embers were thinking of putting $500,00 into a software start-up. But a member revealed he'd worked with the founder, and based on what he knew about him, he felt there was a good chance the founder's oversize ego and brash personality could sabotage the company's success. The group decided to pass.

How do you track down the names of people to invite to join your group? No matter where you are, you'll contact friends, friends of friends, plus venture capitalists, brokers, lawyers, accountants local chambers of commerce - all of them should be able to suggest members. In areas like Silicon Valley or North Carolina's Research Triangle - places with a lot of wealthy, cashed-out entrepreneurs eager to invest in startups - the names will come in a snap. Other regions require more creativity. When Henry Avery launched First Coast Venture Capital Group in Jacksonville in 1993, he consciously set up a board of directors and invited well-known, prestigious bankers and the like to sit on it - people he knew could attract a lot investors. The group now has 100 members.

Most groups don't have many requirements for membership, other than that members must be high net-worth, accredited investors who intend to do more than just talk about putting money into start ups. Walnut Venture's charter explicitly states that members should be "fun to hang around with." If youÕre going to gamble, you might as well enjoy yourself while youÕre at it.

Most groups hold a monthly get-together, usually over dinner or breakfast. Either before or during the meal, two to three companies make 10- to 20- minute presentations. There's also a chance for chitchat and socializing before or after the talks. Then, for investors who really want to get serious, there's the follow-up, usually at a lunch or after the talks. Due diligence is normally done by individual members interested in a particular company, but it can also be shared. At Walnut Venture, for example, one person is the lead and coordinates the activities for everyone else.

You can't expect your group to consider financing every Michael Dell wannabe in the area. What's essential is a system for selecting companies. The toughest approach is probably that used by Band of Angels: Every firm that appears before the group has to be sponsored by two or three members. This means more than just giving the business an okay; members must also have already put some of their money into the company or be poised to do so. At the TriState Investment Group II in Chapel Hill, North Carolina, the group administrator looks through business plans passed along by members, chooses the promising ones, then picks three or four group members with appropriate experience to decide if a selected company should speak to the entire group. Tarby Bryant's approach is a lot less formal - he looks at all business plans and gives the thumbs-up or thumbs-down. But here's the bottom line; your group is doomed unless thereÕs one person who acts as coordinator and gatekeeper, overseeing which companies get the nod.

And which companies deserve to pass muster? The main common denominator is an obvious one - the potential for big growth. The reason is simple: These are risky investments. The future of these start-ups is hard to predict you can't expect a payoff for five to seven years, and you can figure many of your choices will fail. In a portfolio of 25 companies, it's likely that 10 will go belly-up in two or three years. So "your winners have to make up for the losers," says Mike Munsch, chairman of TriState Investment. And we suggest that when one of your winners reaches the IPO stage, as may happen at First Coast, champagne is in order.

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