The Economy and Entrepreneurs

Inside Entrepreneurship: Turmoil likely to make angels cautious
By SUSAN SCHRETERSPECIAL TO THE P-I
Q: Getting investors for my startup is essential to moving forward. In your opinion, will the recent roller-coastering of the stock market and the economy in general make finding independent investors more difficult? Or are potential investors looking for alternatives to the stock market?
-- M.P., Seattle
A: Entrepreneurs usually are a highly optimistic and confident breed. But judging from the letters I've received this week, their mood has become more cautious.
Prospective entrepreneurs are questioning the timing of their startups. They ask, "Should I bother to start up in this economy?" or, "If I work at my startup on weekends, can my employer make any claims on my technology?"
I like this wry commentary best: "Susan, since banks and investors have turned me down, can you give me the government bailout address to rescue my failing business?"
While it's clearly too early to make many useful forecasts, I do believe that recent financial market turmoil will affect the psyche of independent angel investors for some time to come.
Unlike venture capital fund managers, angel investors are not paid a salary to invest in entrepreneurial companies. It is a discretionary hobby to them. Further, they invest their own money rather than act on behalf of other institutional investors. This means that the amount of money they budget for new venture deal investments is directly related to the value of their retirement accounts, real estate and security portfolios. If their liquid net worth has plunged dramatically, then expect angels to write fewer checks to young companies.
This is not good news for most startup entrepreneurs, who usually are not far enough along in business development to qualify for venture capital or more traditional asset-based financing offered by commercial lenders.
During the past few days, I've spoken to angel investors from around the country. The most common sentiment expressed by them was a need to get a better handle on the stock market, the overall economy, the fiscal demands on the U.S. government and the value of their portfolios. More active angels suspected that they would have to allocate more money to existing investments that might struggle during a slow economy rather than invest in new opportunities.
Here are some likely responses from venture investors.
Expect angels and venture capitalists to use the current market conditions as an excuse to bring down company valuations. Investors will want to build in "more room" to make money by starting with the lowest valuation possible.
Expect investors to demand more onerous liquidation multiples and preferences like they did in the aftermath of the dot-com meltdown.
Expect investors to favor startup companies that can reasonably reach cash flow break-even sooner rather than later. First-round technology development investors will worry that entrepreneurs may never secure second-round investors needed to finance product introductions. Entrepreneurs will have to look further down the road in developing their financing strategies.
Expect investors to favor entrepreneurs who have a really practical answer about how investors will ultimately get their money back. IPOs will get tougher. Corporations will become more selective in their buyout activities.
To your last question, will angel investors eventually view privately held, high potential companies like yours as a better deal than the seemingly more volatile public markets? Certainly it's a good talking point.
You can strengthen your appeal by looking for every possible way to reduce the perceived risk associated with investing in your company. This means pursuing operating partners to speed progress. It also means lowering your cost structure and checking the credit-worthiness of customers. Like investors, you, too, have to protect every penny you have.
Susan Schreter writes about startup planning and small-business financing for the Seattle P-I. She has an investment banking and buyout background and serves as a coach to entrepreneurs and consultant to corporations. Find more Inside Entrepreneurship columns at seattlepi.com/venture. Send questions about small-business management or raising money for your business to susan@insideentrepreneurship.com or by mail to Inside Entrepreneurship, c/o Seattle P-I Business Section, 101 Elliott Ave. W., Seattle, WA 98119.