Below is a compilation of essays Daryl Tan and I wrote about angel financing from 2009 to 2011. They were written to entertain as much as to educate. They are forthcoming in a book entitled “Angel Financing – A Primer for Entrepreneurs” in 2011. (Disclaimer: Some of the advice is dated. Please read at own risk.)

CHAPTER 1: THE PITCH: The entrepreneur gets a taste of pitching to angels

“Everything will be free on eFree”.

“Free?” I asked.

“Yes, free! We’ll give away the newest and most updated products to our users. We’re going to revolutionize market research by giving away free samples to our users”.

“So how does it work?”

“Well, we help companies distribute their samples to their target audience and follow-up with questionnaires. The company will then get a full market intelligence report based on the analysis which we provide. It’ll be more than half the price of current market research companies.”

Kian Teck stood bravely in front of the 45 seat seminar room. His right hand held the presentation mouse firmly as he pointed the audience to the first of his three slides.

We were in Singapore Management University, where I was rounding up an entire semester of Entrepreneurial Finance. The 15 weeks spent in class exceeded expectations and as part of their course work, student teams developed business plans to pitch to VCs. The school was located right in the center of the small country, and a stone’s throw away from the shopping district. On a Friday evening like this, the noise from cars trying to beat the traffic lights poured into the room, reminding you that the weekend had already begun.

Only recently, Singapore’s GDP grew double-digits to pull the small country out of poverty into a developed nation. This shift had already made the last generation business leaders rich, rewarding entrepreneurs who started manufacturing and service businesses. Riding the next wave was different, and investors in Singapore now had to look for disruptive innovation that can quickly scale to regional or global markets. Like many governments in today’s world, Singapore sees entrepreneurship as the way to enhance domestic job and value creation.

Dressed in his crisp white shirt and black pants, Kian Teck stood in front of a well-prepared PowerPoint presentation. His team, were lined up at his side, look anxiously around the room like eagles looking for prey, carefully searching for any reaction from the crowd and their professor. Their task was to convince the class in three minutes that they’re business was worth investing in, a difficult yet powerful test of their product.

“Our business model makes sense because we are an internet business, with a low burn rate and an unlimited upside potential.”

Most internet business’s pitch start with the same strategy – provides a service for free, grow its user base by astronomical proportions and earn advertising revenue. Sooner or later they will show the famous “J” curve, telling the same story of 2-3 years of losses and many more years of profitability. After experiencing what it is like to grow a business from scratch, you start to lose your optimism.

Many people jump on the idea of an internet company because of the great potenial it has for allowing their product to reach the world. Like inexperienced pirates looking for lost treasure, they soon realize that the journey is more dangerous and perilous than told. Starting off with a simple map showing a straight forward route to the treasure, they soon find out that their journey will take them through many some of the most trying and desperate storms. Ask any serial entrepreneur to show you his vbattle scars, and you’ll find out that after exhausting all the intelligence needed to steer the business, start-ups are at the mercy of forces larger than themselves.

This makes the pitch a very crucial initial contact point between angels and entrepreneurs. We can summarize these criteria into 4 broad questions:

1. Characteristics of a successful company

Just like other asset classes, the savvy angel investor is one who understands the underlying business seeking financing. The type of business angels invest in should fit their expertise and asset-risk allocation. Depending on your background, you may want to invest in a cash-generative business over a venture-backed risky investment.

Incorporation

From an entrepreneur’s perspective, incorporation formally puts the founder’s skin in the game. A newborn start-up with life is born and the founder’s vision of the business is brought to reality. Although incorporation may not be high on the agenda of entrepreneurs at the beginning, investors look to it as a sign of commitment, a sort of self-validating signal that these entrepreneurs mean business. Without incorporation, hosts of financing options are closed to the entrepreneurs – incubators, early stage VCs, government grants etc.

Does it have intellectual property?

Intellectual property (IP) can come in many shapes and sizes (from the trademark logo to the revolutionary product). The two salient features about IP, which entrepreneurs must consider, are the IP’s protectability and commercial value. Protection of IP can come in many ways, the most costly of which is the application of a patent. In the early stage of a venture, this is not an absolute necessity unless the start-up has sufficient cash flow to finance the application of the patent. The cheapest way to maintain a company’s secrets is to maintain a ‘black box’ strategy when pitching to outsiders. This just means you tell them minimal information they need to know about how your product works and focus on how your product can transform inputs into real outputs.

Compliance

“We are targeting consumer products which have high turnover and offer a unique value proposition to our clients. They will be able to reach their potential customers with almost no cost at all.” Kian Teck continued.

I looked back at my watch; he’s doing well so far, covering much of the business model in the first one and a half minutes. The session was tailored as an elevator pitch and the only rule was that everything you wanted to say had to be done in three minutes. If an entrepreneur couldn’t interest you in those 3 minutes, chances are that you won’t invest.

Elevator pitches does wonders for angels. Firstly it saves you time from having to sit through a half-hour presentation on a business idea you know will not take off. Secondly it shows you how much thought and preparation the entrepreneur gave to his pitch. A good pitch must hit on the key points and issues and not waste time on less important things. Within 3 minutes, Kian Teck was expected to cover eFree’s target market, business model, competitors and milestones.

Finding the right match

Getting the business plan polished is not the only worry, as Francis, a Singapore angels says, “there has to be some chemistry involved. When I work with companies or asked to work with companies, I spent a few months trying to develop chemistry with the entrepreneur. Many a times the entrepreneur, for some reason, don’t feel you can add value to them. You can’t help everybody, you only help those who believe that you bring something to the table that they don’t have. Just because you put in money, it doesn’t mean you have the right to do things in the company. You really have to be yourself – you have to let them know that your interests are aligned with theirs, and you’re not there to exploit them.”

“Our competitors are larger market research companies who are not targeting local small and medium companies. This puts us in a good position to provide this service to this range of companies.”

I quickly flipped up my laptop screen and did a quick search for any similar businesses which may already be around. As Sun Tzu said, ‘know your enemy and know yourself’. Any entrepreneur who does not have a firm grasps of competitor business models and value proposition probably will not know differentiate himself.

“The first two years will be tough for us”, he continued, “we have to grow our user base to a critical mass in order to attract our anchor clients.”

“How exactly will you attract these initial clients and users?”

“We have a marketing plan, and will build the two simultaneously…”

This is where business school students shine – marketing, finance and corporate development. However if you look at the profile of successful entrepreneurial teams, there

‘The End’

Kian Teck smiled and gestured to his team as they ended the presentation. Now it was time for the next most important part of the pitch, the question and answer. Just like the wolf’s strong blows in the story of the Three Little Pigs, questions will destroy businesses built on weak thinking. I chuckled.

At the end of the day, the pitch only opens further conversation. Angels and VCs back the people behind the plan, for good reasons. Research from Harvard shows that entrepreneurs with a track record of success are much more likely to succeed than first-time entrepreneurs and those who have previously failed. In particular, they exhibit persistence in selecting the right industry and time to start new ventures. Entrepreneurs with demonstrated market timing skill are also more likely to outperform industry peers in their subsequent ventures.

“What type of products will you be targeting?” I asked, wanting to start with the easy ones before working my way down to the tougher, more prying questions. The question and answer is the most revealing time of the pitch. It shows you the team’s strength, their understanding of the business or markets and how serious they are. Just like a VC pitch, angel investors need to probe deep enough to find out where the teams’ weaknesses lie, and see if there can be a complementary fit in skill and experience.

“We’ll be targeting products which have higher turnover, where it will make sense for companies to use our cheap and effective market research channel.”

“Why would companies give their samples to you instead of doing it themselves or going through a bigger agency?”

Silence entered the room. Everyone in the room watched as the Kian Teck looked at his team mates for support. Someone must have had an answer to this question.

“We offer them the same access to the market but with a cheaper costs and shorter turnaround time. We’ll have their reports done up quicker than our competitors.” Kian Teck said, finally breaking the seconds of silence.

I quickly scribbled onto my notes, ‘needs more thought on competitor value propositions and business model’.

Entrepreneurs need to put a substantial amount of thinking into their initial business model and value proposition, but they also need to be flexible. Sticking to the initial business model turns out to be a good way to fail. Successful companies will always change their plans as they receive feedback from the market. <insert reference from Onset Ventures>. As Joichi Ito, a renowned and successful angel investor puts it, “If you’re not embarrassed by your first launch, you’ve released too late because the users are going to tell you what to do. You really need to just get out there, get people using your product and get feedback.”

“Any mentors or advisors you’ve spoken to?”

“Not at the moment.”

Another red flag for any pitch is empty advisor seats. Unless entrepreneurs are experienced in the industry, they usually need the help of advisors or angel investors to open doors for the company. Advisory seats and angel investing should help mitigate this gap. If this team was serious in this venture, they would have to talk to the correct people.

Paul Graham writes “Paradoxically, funding very early stage start-ups is not mainly about funding. All good investors supply a combination of money and help. But these scale differently. At our end, money is almost a negligible factor”. What good start-ups are looking for is smart money, money which can enhance their value proposition and increase customer acquisition.

‘Ding’, the second bell went off. A signal that their time was up, on a Friday evening everyone kept a close watch of time. The bell also meant that it was time for the verdict.

I picked up the ‘needs more work’ card. The students were told there would be three possible verdicts – ‘forget it’, ‘needs more work’ and ‘I’ll write you a cheque’; the replies they would receive from would be investors in a real setting.

If I were an angel investing thinking of making investments, my journey had just begun. The entire process can be quickly summed up in four stages – sourcing, screening, investing and coaching.

A key thing to do after the pitch is to bounce a business plan off to trusted people and investors. This gives you a better perspective of the business especially if you do not have particular domain expertise. Using networks in this manner also help you diversify risks through co-investments and may open doors to a good deal if it comes by another angel’s doors. I pulled out my smart phone and forwarded the business plan to a trusted friend and serial entrepreneur, R. Mariani.

I watched the last students walk out of the seminar room as I packed my things to leave. ‘Not bad pitches for first-timers’ I thought to myself as I went home.

The next morning I opened my email to find an email from R. Mariani:

“I find the business plan complete and clear, and I had a pleasure to read it several times. I clearly understand the value proposition but I have few comments related to my past experience in selling things online in platform such as CNET.com for software. CNET offers powerful packages for the industry to let users “try” and/or “buy” softwares and today, they have 38m users visiting their website daily. Now a problem emerges: how can my product be noticed in the thousands of products they represent? It requires expensive marketing, very neat brochures, proper keywords and even a premium to be paid for being noticed online!

If you target all the Small Medium Enterprises and they want to use business federations and networking sessions to get them: i think it is a great way to initialize their database. I guess the question an SME will have is three-fold, “One, how can you guarantee me that the consumer will “see” my product? (how much I need to pay extra to be on your top search results?) (as C|NET). Two, what happens if the product is not returned? Third, what happens if the product is evaluated by a competitor?

I understand that they have plans to get consumer signing up, but I think there is an extra marketing cost for getting these consumers to sign-up. They mentioned booth etc… but they may need to do more.
First. Marketing via ads – does the SME will put an ad somewhere and say “try it for free with eFree?” ? Second. viral marketing – what makes the user come and sign up? there must a product (or benefit) which is used to attract users (free l’Oreal etc…)
Third, can the team do social marketing – plugs to social networks;

I smiled. The team has plenty of work to do.

This is Part I of Chapter 1. To be continued in Part 2.

Tan Yinglan is a Kauffman Fellow and is serving on boards of innovative growth ventures and venture capital funds in Asia. He was the first director of 3i Venturelab China, a joint-venture between private equity firm 3i (LSE:III) and INSEAD, one of the world’s leading business schools.

Educated at Harvard, Stanford and Carnegie Mellon, Yinglan is an Adjunct Assistant Professor at Nanyang Business School and teaches the Masters program in Technopreneurship & Innovation (Chinese). He now works with the Singapore Government to enhance the innovation and enterprise landscape in Singapore.

Daryl Tan sits in PwC’s advisory department, a dynamic and capable team that does financial due diligence and strategy advisory. His deal experience has brought him to various parts of China and into the board room of pre-IPO companies.