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Angel Investors Really Earn Their Wings Through Due Diligence

May 17, 2000|JUAN HOVEY

What makes for a good angel investor?

In the dreams of many entrepreneurs, the good angel is a kindly soul who, checkbook in hand, just wants to help. In reality, the good angel looks you over with hard eyes and makes you sweat while deciding whether to back your idea, and later on, while helping you turn your idea into a going business.

The good angel, in short, knows the meaning of due diligence--the more or less rigorous process by which angel investors measure the character of the entrepreneur and judge the strengths and weaknesses of the business idea itself.

There is good news and bad news for entrepreneurs in how angel investors see these things.

The good news is that angel investors often act on instinct when deciding whether to back a start-up, with the result that many good ideas take form that might otherwise die aborning. The bad news is that to the extent angels gamble, they don't perform their due diligence, with the result that many an angel-backed start-up sputters and then dies unnecessarily.

Unfortunately, too many entrepreneurs don't get the backing of good angels, according to two Orange County angel investors who want to change that--John Garcia and Jim Casparie, respectively a founding partner / principal and CEO of a relatively new Newport Beach angel investor group called Angel Strategies.

"Too many angels labor under the delusion that you add value to a start-up by investing in it," Casparie says. "But money is not the solution. You add value through due diligence, and after the business actually gets started, by lots of disciplined hand-holding."

Garcia and Casparie come to angel investing with extensive backgrounds in the health-care industry.

Garcia has two start-ups to his credit--a maker of medical computer systems and a medical software development company--and he also founded a boutique Bay Area venture capital firm, Healthlink Strategies, focusing on medical technology and biotech companies.

Casparie, an expert in corporate governance, was a co-founder of a Del Mar, Calif., health-care services company called CardiaCare Inc., and chairman of an Orange County consulting firm, TRG Consultancy Inc., targeting high-tech growth companies.

Organized about a year ago, Angel Strategies seeks to make due diligence as rigorous in angel investing as it is in venture capital, Casparie says. The group has made only two investments so far, having seen more than 120 proposals--probably a sign of the toughness of its due diligence process.

"Due diligence can be random, and for most angel investors, it really depends on who's in the deal with you," Casparie says. "In any given angel group, only a few people really understand due diligence, and what happens is that everybody depends on them when they look at a deal.

"John and I come out of venture capital, and we're used to a more rigorous and systematic due diligence process. Angel Strategies is a due diligence and incubation angel-investor group."

What that means in practice is that Angel Strategies operates more like a venture capital firm than an angel investor group. Garcia, Casparie and Kurt English--also a founding principal--winnow all deals through a detailed three-stage due diligence process.

The first stage involves a preliminary screening of the business idea and the entrepreneur. Garcia says Angel Strategies wants to see hard dollars, not just sweat equity, in the idea, and a strong network of professional and business relationships with important strategic partners or customers or board members with solid experience in the industry.

The second and third stages subject both the entrepreneur and the business proposal to increasingly rigorous scrutiny--a thorough scrubbing, as Garcia calls it, of the entrepreneur's personal background and the business idea.

"Our goal is to minimize the time spent raising capital before the company goes public or becomes an acquisition candidate," Garcia says. "We want to nurture growth, and that means building strategic relationships, bringing in experienced board members, recruiting management, and getting top-level legal and accounting help.

"Too many angels invest more than once in the same start-up, and at some point the choice for them is whether to cut their losses or maybe throw good money after bad. Our goal is one round of angel financing followed by one round of venture capital followed by a public offering or a sale."

Angel Strategies invests as much as $2 million in companies valued at no more than $5 million and targeting markets of at least $1 billion. The second and third stage of the firm's due diligence process might involve bringing in outsiders to investigate, for example, the market potential of the business idea, the value of patents and other intellectual property, and the reasoning behind the enterprise's income model.

"It's hard for entrepreneurs to come to grips with their own strengths and weaknesses," Casparie says. "But we'll tell them when we don't think they should be CEO of their own company--and we'll tell them they're going to be better off if we go for a professional right now.

"In angel investing, it's all about packaging, not about money. But if all you have is an empty box with pretty ribbons, everybody's going to know it's empty when they pick it up and look it over. You've got to have substance--and that's what good angel investors do for you."

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Juan Hovey can be reached at (805) 492-7909 or at jhovey@gte.net.

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