...Continued from above...
Avoiding dilution is crucial, since it is often towards the end of a startup’s journey, just before an IPO or it being acquired, that its value soars. Henrik Persson Ekdahl built his fortune on the betting business of Bestpoker and lead generation company Catena Media. Today he runs the venture capital firm Optimizer Invest. “If your initial investment was 1 million SEK, then always reserve twice that amount in order to defend your stake against dilution,” he explains.
Once an angle investor has the required capital, he must establish a so-called “deal flow” of promising companies that are looking for funding. Sometimes you may come across such companies through your work or other contacts. Stefan Backlund advices that occasionally you can observe other early stage investors: these may come in the form of family offices, small venture capital firms, or state-run development funds. “Such actors usually have a framework in place for screening promising companies – doing so called due diligence – which evaluates the prospective investment object’s economics, technology, patents, market potential, etc.”
But what distinguishes a private company with truly great potential? This is naturally a difficult question to answer, but all five angel investors that Dagens Industri spoke with identified the very foundation of the company as the most crucial component: “Evaluate the foundations of the company and the leadership as firmly as you evaluate the business idea,” says Henrik Person Ekdahl.
Nicklas Storåkers is not only the CEO of Pricerunner, but also an active angel investor in Swedish technology companies. “Most crucial for me is to understand how a potential investment object differs from its competitors from the point of view of their target customer. In other words, how are they aiming to create value for their customers? If the leadership of the company is highly motivated, highly competent, and have a great idea of what they want to achieve, then things often work out well,” explains Nicklas Storåkers.
Anders Borg, former Swedish Minister of Finance and a fellow angel investor, agrees with Nicklas. “There is never one single factor that settles the matter, but it is crucial for an investment object to have a strong core team with members that complement each other,” says Anders Borg. He continues: “It is a massive advantage if the platform that is being developed is of high quality, and that it really meets the needs of a market segment that demonstrates high demand. Equally important is the presence of a clear path towards profitability, as well as healthy margins.”
Stefan Backlund explains that in today’s market climate the entrepreneurs have a lot of power, and promising investment objects can shop around for offers from interested business angels: “There is a lot of money in circulation, and the best entrepreneurs make a careful choice as to which investments and investors they want to bring along on their journey. The money is the same, no matter where it comes from, but if you as investor also can offer some unique knowledge and expertise, then your attractiveness will grow exponentially in the eyes of entrepreneurs.”
Since there is a strong supply of risk-seeking funding, entrepreneurs are often looking to quickly drive-up the valuations of their companies. As a new angel investor, determining which level to invest at might be a challenge. Our experts explain that there is no exact answer to this challenge, but you will gain crucial experience over time, and negotiations often end with a compromise.
One of the most crucial differences between investing in public and private companies relates to the availability of information. A listed stock always brings with it real-time updates, quarterly reports, and in some cases continuous monitoring by market analysts. Everyone gains access to this information at the same time and on a more or less leveled playing field. “Such is not the case for private firms. Here you yourself must perform the analysis, which can be a challenge since you rarely have perfect access to information. Some private firms do a great job at keeping their investors up to date with everything that goes on in the firm, while some absolutely do not,” says the angel investor Ann Grevelius, previous head at Handelsbanken and SEB, and current advisor for venture capital firm GP Bullhound. Henrik Persson Ekdahl encourages investors to actively engage in their investment objects, possibly on the board or as an advisor. “It is easy to miss out on important information in private companies. There is a great risk that you end up in an information-disadvantage, if you don’t actively engage,” he explains.
Before the signing of any contract it is furthermore crucially important to ensure that everything legal in nature is in order. It is rare to come across shareholder agreements where parties feel tricked or deceived, but it is still important to ensure that deal terms are similar and fair for all investors involved. It may also be a good idea to ensure that company founders participate in a so-called “stock vesting” agreement, meaning that the founders are not allowed to sell their stakes in the firm for an agreed upon number of years. Making sure that founder and the company leadership own a meaningful part of the business is also important for ensuring they remain highly motivated.
“Invest time in a legal due diligence, to ensure there are no irregularities in the shareholder agreement,” says Henrik Persson Ekdahl. But it can be a very expensive task, explains Stefan Backlund, who also recommends that you therefore consider co-investing alongside more experienced investors.
Once you have decided to invest in a private company, do remember that it is a long-term investment. “In normal cases your investment won’t have any liquidity to speak of. You cannot reduce or sell of your stake, so the funds are locked, and often for long stretches of time,” says Ann Grevelius. “Better expect that it may take years until you can get close to a payoff or a sale”, Henrik Persson Ekdahl elaborates.
On the topic of patience, our experts explain that the patience of an angel investor ought to range from “very significant” to “infinite”. Sometimes you are looking at an investment horizon of ten years. Sometimes a successful exit waits at the end of those ten years, often as a result of an acquisition by a large venture capital firm or a strategic buyer in the same industry. “You as an angel investor must establish realistic goals and understand that this will take time. I don’t believe in quick IPOs. Much better to find strong partners and build a strong company, before you look towards going public,” says Anders Borg.
But the long-term commitment has high risk – which goes hand-in-hand with high potential reward. A reasonable return expectation is to make ten times your investment back, and it is good to keep this in mind when calculating the initial investment object valuation at the time of your initial investment. “In a very early stage firm you must expect a ten-year investment horizon and high risk. For this you ought to be appropriately rewarded, and a fair target is a 10x return on your money. In the case of a slightly later stage firm, which is closer to an IPO, a 2x return might be considered fair and attractive. Every situation and every company is unique,” explains Ann Grevelius.
But always keep that risk in mind, for not all startups succeed. According to a new survey from analytics provider CB Insights, almost half of all startups that fail do so because of low market demand for their product or service. Only 30% of failed startups fail due to a lack of funding. Thus, perhaps the most important piece of advice from our Swedish angel investors is to “never bet everything on one card". "One way of doing this is by only investing a smaller portion of your total capital in private firms, or by diversifying by investing in at least 10-20 different private companies,” advices Stefan Backlund. “You can’t put all your eggs in the same basket, and traditional choices such as stocks and real estate should make up the majority of your portfolio,” says Anders Borg.
But if you can afford to tie-up both energy and capital for a longer period of time, then private companies can be a very attractive choice. “These are exciting times, but waiting for the ‘stars to align’ can be frustrating. However, once they do it’s the best feeling in the world,” explains Stefan Backlund enthusiastically.
In swedish: https://digital.di.se/artikel/sveriges-affarsanglar-sa-ska-du-tanka-nar-du-investerar-i-onoterat