Investors: Avoid These Investment Event Problems

Tim Berry , Founder , Palo Alto Software

11 Nov 2011

Many local angel investment groups work with a local event that creates the illusion of a business pitch contest, awarding investment to the winner. There are multiple benefits to this type of arrangement. The event generates local buzz. Local media cover it. Startups and investors discover each other, and the community wins because the event becomes visible evidence of new business and new jobs locally. And new angel investors are trained and oriented.

In most of the events that I’ve participated in, that the appearance of a business plan contest is to some extent illusion. It’s not just a one-time pitch or plan contest. In fact, before the final event, the investors have already done due diligence. They’ve heard multiple pitches, poured over business plans, talked to customers, and looked at the legal work. Decisions are made before the actual event.

Good as this is when it works, I’ve also had a chance to see some of the pitfalls, and the problems that come up when it doesn’t work. I think most of these can be avoided.

For example:

• Some of these events mix angel investment with straight-out prize money with in-kind compensation like free consulting, legal work, or rent. That tactic has the advantage of increasing the perceived value of winning, and generating headlines like the $XX million prize money. But it also has the disadvantage of mixing apples and oranges and playing up prizes that don’t work out to real dollar value. For example, the winner is based somewhere else and doesn’t want to move. Or the in-kind winning includes legal work or management consulting, but the startup that wins has its own providers.
• Angel investment events where the group investment is supposed to go to the winner, but the winner ends up hating the term sheet. Usually these term sheets involve convertible notes, which are supposed to convert to equity at the next round of financing, like when the serious venture capitalists do a Series A. I’ve seen several of these fall apart. The worst was one where the startup founder took it as a prize for winning, and never saw the angel investors as partners, or, for that matter, anything except usurpers. Why did they want to act as if they owned a piece of her business?
• Angel investment events where the due diligence isn’t done before the event. The event takes place, the audience watches, the pitches happen, and a winner is announced. But before the term sheet is signed, problems come up. Investors and startup winner end up never agreeing on terms.

Are these kinds of problems avoidable? Are they worth the risk?

From what I’ve seen, it’s critical to make sure startup founders are thoroughly aware of the term sheet and what it means. It’s apparently way too easy for founders to focus only on the prize money, and winning, and therefore acknowledge terms sheets without reading or thinking about them. I suspect it’s almost like the way everybody agrees to software terms every time they install, and nobody reads them. The underlying assumption is that winning is good, and we can work it out.

The best actual solution I’ve seen was the case of one very proactive fund manager, the head of the angel investment group, who spent his evenings the week before the event going over the term sheets, in detail, with the finalist startups. That made a huge difference. Make sure the startups know the terms they are competing for, so they back out before the event if they don’t like those terms.

And maybe we should go slowly with counting up the in-kind services as part of the big pot. These events compete with each other based on so-called prize money, but investment is not really a prize. And winnings that require moving aren’t often a prize.

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