The Primer for Angel Investment in Canada

C HAPTER 5: B RIDGING T HE G AP : H OW T HE P RUDENT A NGEL C AN S URVIVE T HE D OWN -R OUNDS

THE RETURN OF REASONABLE VALUATION Returns in almost every market, from equities to venture capital, have fallen during the past two years. In hindsight, the real question is not why the fall occurred, but why it did not happen sooner. Valuations between 1998 and 2000 were outrageously high and added to investors’ uncertainty about how to assess risk. Amid all the energy and excitement that surrounded the late 1990s, people began using bizarrely high multiples, overly optimistic forecasts, market share projections and other novel methods to estimate potential success. None of these novel methods lasted beyond the bubble. Thankfully, the past two years have seen a return to the fundamentals. Investors of all kinds are looking at conventional valuations (based on actual earnings, revenue, cash flow, and other tangible indicators) and conservative valuation strategies using lower multiples and more realistic forecasts. Indeed, the pendulum has swung back with a vengeance. Everybody has been affected. Early-stage companies, financed by angels at the height of the madness, are now being funded at reduced valuations. Of course, this puts a further financial squeeze on angel investors. The prudent angel is just as likely to have been swept up in the madness as everyone else – and just as likely to be looking at lower portfolio valuations. WHAT CAN ANGELS DO? The solution lies in formulating strong funding and defensive strategies. Angels must ensure that an investee company has a solid business plan outlining how and when it will deliver promised results. They should also be prepared to supplement this by providing hands-on management and marketing assistance, as required. In portfolio terms, the prudent angel will focus careful attention on the fundamentals, including value propositions, sales channels, competitive advantage, market size and product and service differentiation. Moreover, angel investors must remain keenly aware of developments affecting their investments. If restructuring is required, then the investor should try and lead it – by contacting management and other stakeholders to arrange for financing. By being the initiator, the angel investor will retain a measure of control and reduce the risk of being squeezed. PARTICIPATING IN LATER ROUNDS At some point, there will be a later round of financing. For angels, this can be an opportunity – after all, a down-round is a good time to invest as businesses have reduced their valuations, the inflated sales figures are flapping like torn flags, and management is increasingly eager to negotiate. However, the decisive factor for further investment must be sustainable profitability. Clearly, bubble-type valuations have had a lasting negative impact and investors and managers have become more concerned with building profitability. The prudent angel will have also adopted profitability as the fundamental element in investment valuation. PREPARE FOR THE FUTURE AND BE READY TO STAY IN THE GAME Angels who have prepared for the next round of financing will have already determined their course of action. If not, they still have a choice. They can enter the next round, where a better deal is being offered (in essence, averaging down, but retaining some control over the dilution); they can

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