Schuerman: Today’s topic is University-Angel Investor relations, and I’m fortunate to be talking with exactly the right person for that topic, Mr. Jamie Rhodes. Jamie is the founder of the Central Texas Angel Network, which provides funding and support to Texas entrepreneurs across a broad spectrum of industries. He created the Alliance of Texas Angel Networks, which represents over 300 investors. He is vice-chair of the board of directors of the Angel Capital Association, a national organization spun out of the Kauffman Foundation representing seed stage investors. I say that Jamie is exactly the right person because in addition to all of this, he served as The Texas A&M University System’s Director of New Ventures and has experience in looking at things from the university perspective.
Before we begin, Jamie, I wanted to share with our readers the fact that angel investment in Texas is seeing some exciting new developments – could you comment on this?
Rhodes: In Texas we have focused on growing our angel investing ecosystem for the last seven years and it is paying off. The Halo report on angel investing for 2013 shows that two of Texas’ angel groups are in the top four most active angel groups in the country, as ranked by number of investments.
Schuerman: I’ve embedded the report above, and queued up slide 14 that shows the Houston Angel Network and Central Texas Angel Network rankings that you’re talking about. There really does seem to be a new ecosystem since I came to Texas back in 2001 – angels seemed few and far between and most of the VCs I knew were not local. In any case, well done and thanks for everything you are doing to support entrepreneurs.
That brings us to the topic of entrepreneurial effort of universities and their goals in forming start-up companies, as well as how they can best work with angel investors to get discoveries out of the lab and into the marketplace through new company formation. It’s always a good idea to understand the motivations of someone you want to work with, so let me ask first of all – what motivates a typical angel investor?
Rhodes: The typical motivation for an angel is to invest in a team that can grow a company in three to five years to an exit. Notice that I said team, and not technology. The challenge for a university is that most of their opportunities, because they are very early stage, are more like six to eight years from an exit, and the team is generally not in place yet. So universities don’t have typical opportunities and should not be looking for angels who are motivated in a typical way.
Schuerman: So working with a university is not for every angel investor.
Rhodes: Exactly. Universities need to connect with angels who have an interest in a scientific field and who are interested in getting to know researchers and evaluating them. Angel investors generally assess entrepreneurs, but university start-ups or university opportunities are, in most cases, not far enough along to have attracted an entrepreneur. So an angel working with a university needs to be applying the same due diligence process they would use with an entrepreneur to the researcher and anyone else from the university that will be on the early-stage team.
Schuerman: In what other ways would such an angel investor be different?
Rhodes: They’ll be on the board of directors, and the rule of thumb for board members is “nose in, hands out.” But that doesn’t work for university start-ups – in this case, angels need to get their hands dirty.
Schuerman: It sounds like the ideal angel is someone who is also a bit entrepreneurial themselves.
Rhodes: Yes. If an angel approaches opportunities like an entrepreneur – doing some market research, brainstorming about the possibilities – that is a very good sign. If the angel is focused on the transactional aspect of the opportunity – licensing the patent – that suggests that they are not thinking about making an investment.
Schuerman: So what would they be thinking about in that case?
Rhodes: They may be benchmarking – trying to get a sense of how your technology compares to technologies they have in one of their companies, or how they might complement them. Benchmarking is a legitimate activity, but as a university you need to recognize it and take the opportunity to expand the relationship.
Schuerman: It’s like having a shop, and having someone come in just to browse and kill some time – it’s an opportunity to engage them and make a sale.
Rhodes: That’s right.
Schuerman: Good advice. Okay, so let’s talk about experience. How important is it for an angel investor to have invested in university start-ups before? Or to have invested in similar companies before? Or to have invested in any company before?
Rhodes: Let’s take those one at a time. First of all, I would say it’s highly desirable for the angel to have worked with a university before. If they haven’t, it’s crucial that the university tech transfer office (TTO) get involved, because there are some pitfalls for an unexperienced angel.
Schuerman: Such as?
Rhodes: Researchers may not clearly understand or explain complexities about intellectual property rights. It may be that their IP rights are constrained by a sponsored research agreement, or even by an existing license agreement. IP rights may be spread across two or more institutions due to collaborative technology development. They may talk about technology as patented when it is patent-pending.
Schuerman: I have seen examples of all of those. Another problem is that a researcher may want to start a company, but then continue to use the licensed technology in their own research enterprise and engage commercial customers, effectively creating a competitive situation between their lab and the start-up.
Rhodes: These situations are unique to universities, and that’s why an angel who has never worked with a university needs some help from the TTO to recognize and either avoid or manage these problems.
Schuerman: Okay, so how important is experience in investing in similar companies?
Rhodes: For university opportunities, there is far more technology risk, and so domain experience is crucial.
Schuerman: I agree. I have seen people retire from the energy sector and decide to helm a university biotech start-up. They have no domain expertise, and so they have no idea what they are getting themselves into – and no way to get themselves out of it. I can easily see that the problem for an investor without domain expertise would be the same.
Rhodes: You also asked about first-time angels working with a university. The blunt answer is that angel investing is tricky and first-timers are likely to fail – and are much more likely to fail when working with a university. A first-time angel working with a university would have all of the challenges of being an angel investor, compounded with the challenges of working with an early stage opportunity.
This is where the value of an angel network lies. If an angel investor has peers who he or she can observe, learn from, and be mentored by, the risk of failure can be greatly mitigated. So if I were at a university and had an interested first-timer, I’d want them to be part of a good angel network.
Schuerman: Most people looking for start-up investment immediately think of VCs. What criteria should I use to decide whether to approach venture capital investors vs. angels?
Rhodes: Approach both, but recognize the differences. Angels are your best bet for funding a broad range of business opportunities as compared to VCs, and odds are that more of your opportunities will fit the angel’s investment criteria. VCs have more narrow criteria and are looking for deals that will require significant investment, but have the potential for much larger payoffs. A $30M return would be a homerun for an angel, but a failure for a VC. And with VCs, like angels, most don’t like university-stage deals. So universities need to do their homework and focus their efforts on connecting with ones that do.
Schuerman: I’ve talked with people who get excited by the prospect of pitching to a single angel investor, but who see angel networks as potentially too complicated to deal with. What are the pros and cons of investment from a network?
Rhodes: For universities, it’s all upside; there is power in numbers. A network means more check writers, more evaluators, and more diversity of deal funding. Since universities need to look for that special subset of angels who are right for their early-stage deals, networks are ideal for simplifying the job of finding those individuals.
Schuerman: I’ve heard a VC complain that a start-up was “messed up” by an angel investor. Should I be concerned that taking money from the wrong angel investor can damage a start-up?
Rhodes: VCs who claim that “angels screwed things up” are putting the blame in the wrong place. Companies get screwed up with they are mismanaged – the IP doesn’t get locked down well, equity stakeholders have come and gone without the right paperwork being done, liabilities have been created, and so on.
Schuerman: Makes sense. If I give someone gas money and they drive their car into a ditch, it’s hardly my fault.
Rhodes: Right. Someone can certainly blame you, but ultimately it’s whoever was behind the wheel that was responsible.
Schuerman: Okay, very good. Let’s talk now about stage of development. How far along does my start-up need to be in order to attract angel investment (e.g. concept, beta, product launch, first customer contract)?
Rhodes: You need a prototype or beta version. It’s possible to get investment earlier, but you’re going to be competing with other opportunities that are farther along.
Schuerman: Let’s say, though, that I’m not at that stage. Is it reasonable to want to work with an angel to develop business concepts?
Rhodes: It doesn’t hurt to ask, and many angels would be delighted to get involved at this point. Just note that you won’t be attracting financial investment, you’ll be attracting their attention and expertise. This is a great way to build a relationship.
Schuerman: I’ve heard that some angels charge a fee in order to hear a pitch. Should I be concerned if an angel wants to charge me to pitch to them?
Rhodes: For an established company to make a pitch to an angel group, this is reasonable. Pitch fees serve a gatekeeping function, so that angels don’t end up hearing from the guy who is opening a second sandwich shop, and they also pay for the due diligence that is a necessary step before investment can be made.
Pitch fees for a university don’t make sense and I would regard them as a red flag. Universities are not generally pitching start-ups so much as they are pitching potential start-ups. However, universities can consider ways to make it more interesting to an angel group to listen to and provide feedback on opportunities. For example, a university could offer to cover a certain amount of patent expenses for any company that is formed as a result of angel investment. This type of gesture builds trust and communicates that the university is willing to be a true partner.
Schuerman: Jamie, this has been very informative. Thank you for your perspectives and insights. Any last thoughts on best practices for universities when partnering with angel investors?
Rhodes: Don’t wait until you need money to get to know angels. The goal is to create a trusted relationship.