Ask an Angel: How do angel investors develop effective communications with the entrepreneur before and after an investment decision is made?

There is perhaps no single aspect in any angel deal that is more important to an effective working relationship between the angel investors and the entrepreneur than the ongoing sharing of information through open and respectful communications.

To explore this topic, we spoke with Bill Payne, member of Vegas Valley Angels, Las Vegas, NV (www.vegasvalleyangels.com: Katherine O’Neill, executive director of Jumpstart New Jersey Angel Network in New Jersey (www.jumpstartnj.com), and Rebecca Lovell, program director of Alliance of Angels, Seattle, WA (www.allianceofangels.com).

ACEF: The tone and pattern of communications between angels and entrepreneurs is set early on. The Alliance of Angels (AoA) places a special emphasis on extensive communications with the entrepreneur long before any decision is made to invest in a company.

RL: That’s right. Our group may be a little unusual in that we invite virtually every company that sends us a business plan and application fee in for a 90-minute, face-to-face interview. We listen to their pitch, drill down on the plan in a Q&A session, and then save 30 minutes at the end of the meeting for detailed, slide-by-slide recommendations based on our experience with what resonates with our angel investors.

In my tenure, I have interviewed more than 320 entrepreneurs. For every interview cycle, we average more than 18 face-to-face coaching and screening interviews with entrepreneurs before selecting the three that ultimately will present to our membership.

We work hard through our coaching process and workshops to position ourselves as the entrepreneur-friendly angel organization. Our goal is that even if the investment results aren’t what the entrepreneur desires, he or she still has a good experience with AoA.

ACEF: Once an entrepreneur has presented to your group, what’s the next communications step?

BP: The Vegas Valley Angels use a small committee of members to pre-screen deals. Those entrepreneurs that pass are invited to present to an “all hands” screening meeting.

We feel that feedback to the entrepreneur is very important to the process. Once the entrepreneur has presented, we ask him/her to step out of the room for ten minutes while we have our discussion. Then we call the entrepreneur back into the room for immediate feedback. We usually tell the entrepreneur at that time if we are establishing a due diligence team or declining interest in the company.

KO: At Jumpstart we try to set the tone of clear and consistent communications from the beginning. We tell the entrepreneur that we will call them within a day no matter what our decision is, and we do. We don’t want them to be left hanging.

RL: AoA tells our entrepreneurs the results as soon as we know. Whether or not they only make it through the first step with our program staff, the second step with our screening committee, or are selected to present to our membership, we pass on comments, questions, and suggestions every step of the way. When appropriate we suggest milestones that could make the deal more interesting to investors.

If we see something promising but not yet ready for our monthly meeting, we will identify some milestones and ask the entrepreneur to keep us informed as things progress. We might exchange emails and voice mails with them for several months or longer.

ACEF: And once the group decides that they are interested in a deal?

RL: Up to and through the AoA membership meeting, the AoA program staff handles all communications. At the meeting, AoA members who are interested in the deal sign up. Within two weeks following the luncheon, we recommend that the entrepreneur meet with interested angels, ideally at the company offices so investors can “kick the tires.”

After that, the investors and the entrepreneurs communicate directly. Our best deals have a lead investor who volunteers to direct due diligence efforts and finalize any negotiations on deal terms.

KO: In Jumpstart, if there is sufficient interest in a business plan we appoint a deal leader and form a deal team right at the meeting where the entrepreneur presents. We want to have one point person who deals with the company, so in our group, the deal leader coordinates the team and takes responsibility for communications with the entrepreneur.

The deal leader could be the person who brings in the deal or it could be someone in Jumpstart who is interested and willing to take on the responsibility for coordinating the process. Ideally, from the start, we want the entrepreneur to be connected with the person that they will be dealing with over the life of the deal.

ACEF: It is reasonable and necessary for angel investors to know what is happening inside the company. Once the deal is struck, what’s the most effective and efficient way to accomplish this?

BP: A good start is to spell out the entrepreneur’s reporting responsibility in the term sheet, recognizing thatdespite what the legal documents say and the best of intentions by the most capable of entrepreneurs, investors often don’t receive the updates and information that they discussed early on with the entrepreneur and sometimes even wrote into the terms.

ACEF: How can participation and direction from board members or observers improve the process?

BP: It is seldom that you will see angel groups invest where there isn’t some level of representation—either a board seat or observation rights—negotiated as part of the deal. The board member or observer can be very helpful to the ongoing process of communications between the investors and entrepreneur. In many cases, it becomes a board duty to make sure that the reporting gets done.

Whether one of the angels or some other investor represents the round, angel groups can make it clear to that director or observer that he or she is ultimately responsible making sure that all investors receive the information that they want in a timely manner.

Sometimes the reports are issued jointly by the board chair and the CEO, which is a good policy. Assuming the chair isn’t the CEO, a joint report helps demonstrate that what is happening with the company is out in the open and fully shared.

KO: Our members invest as individuals but they usually use term sheets that we’ve worked up before hand that are along the lines of the standard term sheet on the Web site of the National Venture Capital Association (www.nvca.org). These terms include a seat on the board or observer rights which go to the investors in the deal.

The investors then will do a separate agreement about that part of the deal. It’s up to those who invested in the round to determine who will represent them on the board and what that person’s responsibility will be in terms of communicating to the other investors.

ACEF: As is so many other aspects of the angel/entrepreneur relationship, it seems that setting expectations up front can substantially benefit the relationship later on.

BP: Very true. It’s appropriate for the angel groups to discuss in general terms what information they expect from the entrepreneur, and it’s not even a bad idea to publish it. After all, we angels have invested in the company. We have a right to this information and in most states the entrepreneur has an obligation to provide it.

ACEF: Information rights and the delivery of frequent reports can be a major complaint from investors and entrepreneurs. How can an angel group effectively balance the interests of both?

BP: You don’t want to be a burden to the entrepreneur, but the company does need to provide brief, quality updates to the investor group. After the deal has been funded, a really useful approach is to outline a process for providing reports that satisfies most members of the angel group without putting an undue hardship on the company.

A two or three page quarterly financial report with another page focused on milestones is not an unreasonable expectation. Angels might also want to include an audited or reviewed annual financial statement from an outside accountant and a two or three page annual report.

ACEF: Why is reporting such a challenge for entrepreneurs?

BP: It’s not so much that they don’t want to do it; they just get wrapped up in the details of running the business. Also, reporting is less important to entrepreneurs. They know how the company is doing; they don’t need reports.

That’s why rather than delegating this to the entrepreneur, the investor(s) representing a round must be the ones who make sure than the reporting back gets done.

ACEF: How can angel groups streamline the process?

BP: Some angel groups provide a form and template for reporting that they expect the entrepreneurs to complete. Some groups even provide these templates to their entrepreneurs online. That is a good way to create a repeatable set of standardized reports which can be checked frequently, archived regularly, and retrieved easily

ACEF: Clearly, angels don’t want the entrepreneur to spend more time reporting to investors than building the company. Don’t the angel groups need someone to run interference from time to time?

BP: Sometimes they do. Certain investors may feel free to call the entrepreneur with a request for information—regardless if they are the designated contact or not. We want the entrepreneur building his company not responding to ad hoc requests.

The best way to avoid this is for the investors to sit down as a group and determine the kind of information they are going to want from the entrepreneur and the frequency. Then they need to abide by that. If a problem continues with a subset of the investors, the deal leader needs to intervene.