How to Dance with Angels

Small businesses often prefer to slow dance with angels than boogie with venture capitalists. But knowing when to change partners is also important.

For some entrepreneurs, who want to guide their companies to expand gradually in lock-step with revenue growth, angels are a better fit. Consider McNeil and her husband: the duo started Boston Software in 1986 and built it steadily via sales growth. The company, which develops work-flow automation systems for the health-care industry, has increased its sales by 25 percent annually since 2000, and now boasts 1,500 customers in four countries. Early on, Boston Software worked with a partner that licensed the company’s software technology and provided sales and marketing support. The partnership helped Boston Software grow without having to boost funding or hire a staff.

McNeil says taking cash from VCs is risky. Boston Software has always been focused on moving “to second base…and that’s what [has] kept us very, very profitable.” But stopping at second isn’t good enough for VCs, opines McNeil. They want home runs, and if the return they expect doesn’t materialize within a few years, the business either goes belly up or its assets, including proprietary products, are sold for pennies on the dollar.

As the name suggests, angel investors also tend to be more tolerant of typical start-up mistakes. Witness Ed Adams, CEO of Security Innovation, a software-security firm. Had Security Innovation been financed with institutional money, says Adams, he would have been fired after making a strategic sales-related error.

At the end of 2005, Security Innovation had revenues that represented a 200 percent increase over the previous year. That bump came from spin-off business created to focus on the federal government earlier that year, as well as a training unit for software developers, architects, and testers launched the year before. Unfortunately, management also was sitting on a proprietary software tool that wasn’t selling. According to Adams, company engineers had built an effective tool that only software geeks like themselves could appreciate.

No one got the word out about the product, and without customer education, sales came to a grinding halt, recounts Adams. If institutional money had been backing his company at the time, he posits, he would have been out of a job. He believes that angel investors put a lot more trust in management than VC firm managers would have allowed. “VCs are much less forgiving of strategic errors,” but it’s those kind of errors that help entrepreneurs grow and succeed, says Adams, whose company has been operating for five years.

Devil’s in the Details

Still, companies backed by angels don’t always have a heavenly experience. Shunning institutional funding often leaves new companies with a dearth of start-up cash, as angel investors don’t often have the wherewithal to supply extra padding, such as working capital, on top of their initial investment. That often leaves a nascent business with insufficient reserves to survive market slumps. “You have to be a bit more conservative in your risks,” says Yves Schabes, co-founder and president of Teragram Corp., a search software company based in Cambridge, Massachusetts. In hindsight, Schabes says he could have reinvested more of his revenues into his business in the first three years, but at the time, the lack of a financial cushion from his investors held him back.


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