Navigating Risks, Rewards, and Innovations in Angel Investing with Patrick Gouhin (Part Two)

Forbes Books presents the Startup Science Podcast with Gregory Shepard, brought to you by startupscience.io. Greg is an entrepreneur who's built and sold 12 businesses, a recipient of 4 private equity awards, featured TEDx speaker, and Ben Bella Publishing and Penguin Random House author. Here's Gregory Shepard.

I'm back with Patrick Gouin, the CEO of the Angel Capital Association. We've been discussing his journey from aerospace engineering to leading an organization that represents over 16,000 angel investors. Patrick, let's talk about risk from both perspectives, the investor and the entrepreneur. Starting with the investors, how do you think about balancing risk and opportunity when evaluating potential investments? Then let's shift to the founder side. What are the risks for founders when taking money from outside investors?

Yeah, so there is all kinds of risk, right? I don't think anybody would disagree with that. And the further along the company goes, the more they should be de-risking, but also they're taking on new risks as they scale up and build the manufacturing facility or whatever it may be. So what I think many people don't understand is to be successful in the angel space, It really is about diversification. You've got to have a certain number of portfolio companies. Remember we said earlier that even the best are going to fail 50% of the time. So if we take an absolute minimum portfolio size of 10 companies, right? And we say, okay, 5 of them we're going to write off, but at the start we don't know what 5, 2 or 3 of them, maybe we're going to return our money. But 1 or 2 is where we're going to, you know, really make this work for us. If you think about it in that little example, that means that each and every one of those opportunities has to have at least a 10x return. And if it doesn't, you're probably not going to get the overall returns that you need. And so often I see entrepreneurs come in with a higher valuation than maybe what is realistic for the particular time and part in the country. And they say, well, I can get you a 3x return in 3 years. It's almost guaranteed. I mean, many angels would look at that and say, well, that's nice, but again, if I'm going to value your company at $10 million, I got to be thinking, what's the probability of that getting to a $100 million exit in 5 years? And that's if there's no dilution from future rounds. So that's my advice to entrepreneurs is always to think about it, that it's not angels being greedy. It's that they need those home runs to make up for all the other investments and the losses. And this is what we tell Congress too. This is why those incentives such as 1202 are so important. You know, if you're on the entrepreneur side of that and you've worked to build up this company and after 10 years, you know, you have a liquidity event, you know, you've probably taken below market pay. You've probably taken below market benefits as has your management team. You did real well. You were lucky enough to get this exit after 10 years, and now you've got a windfall. Well, that's your retirement, right? That's what you've recovered after all of that investment. And I think there are some that in DC that don't necessarily see it that way, and they say, well, this is about the rich getting richer, and we're going to tax you heavily on that, not understanding that it is a perhaps once in a lifetime windfall, but certainly at best, you know, a once in a decade or so. So you can't treat that as ordinary income on an annual basis. And this is part of the, you know, the message that we're trying to advocate for, to communicate so that we can keep private dollars flowing into innovative companies to build economic growth, you know, throughout the US.

So let me switch a little bit and talk about advice. So if you are sitting in an elevator and you have a founder in there and you're in a good mood and you're like, hey, how you doing? And that person tells you that they're a founder, you tell 'em who you are and they ask you for one piece of advice. What would that piece of advice be for that entrepreneur?

The first thing I'd have to say is coachable. Make sure that you are coachable. Don't think that you've got all the answers. It's a It's a team sport. Look to those investors that you're going to bring on, and they've got a lot of experience, most likely. They want to contribute beyond just the capital that they provide. We estimate that our 16,000 members, in addition to, again, $500 million to $1 billion that they contribute annually, invest about 1 million hours of volunteer work simply working with and coaching. Not only their portfolio companies, but just the local entrepreneurial innovation hubs so that these entrepreneurs have a network. They've got somebody to talk with who's been there, who's done it, who has high-level connections in whatever the industry may be. So take advantage of all that. But it starts with being coachable and listening.

Let's put that now on the other side. Let's say that you're in an elevator and you have an investor. And they're a high net worth individual and they're sitting there saying, I've never done this before. Why should I go in and invest in the startup ecosystem? How does it work? And what advice would you have for me?

Well, it's a team sport, so I think those that have the most fun and are most successful do it by building a network. And we have angel groups, 250 different cities across the country, just about Every place that you might imagine, and they're great people. I came into RTP Capital in the RTP, North Carolina area and was just blown away at how well received I was, the talent in the room, the breadth of experience, lawyers, doctors, whatever it may be, that whenever a company came in, at the time we had about 65 members. We'd say, who knows about this? And sure enough, there was several handfuls always went up that said, oh, we know all about that. Here's what the opportunity is, here's what the risks are. And so as being part of a group, you'll get all that for free, right? I mean, it's just part of the ongoing monthly conversation when an entrepreneur pitches. So again, I would say none of us are the know-it-alls that have all the answers. We need to tap into the networks that exist, the other investors that are out there, and learn from each other while having fun and while growing the local community. Let me give you a couple stats here. One of our member groups, Desert Angels out in Arizona, did an economic impact study. And what they found is that over a 10-year period, for every $100,000 that that group invested It led to 5.8 direct jobs. It led to 458,000 in labor and 2.1 million in economic output. So there's a 21x multiplier on that private investment versus what it brought back to the community. And over that same decade, that one group put in $47.3 million.

Wow.

So multiply that by 21x, you've got $1 billion worth of economic growth in one community that was created by the local angels that use their private money to reinvest in their community. I think that's pretty inspiring.

So speaking about continuous learning and education and coachability and all of these things that have to do with that, What would you recommend for current emerging entrepreneurs in terms of learning? Like, where would they go and what do you think they should be learning these days?

You know, there are a lot of great incubation centers out there, innovation communities, the accelerators programs all across the country. Those are wonderful. There's a lot of great university programs in entrepreneurship that have much to offer. And I'm not dismissing any of those, but I would add to those opportunities what comes from the investor community. And at ACA, we believe we have the biggest collection of accredited investors that, again, over the past 20 years have built this curriculum called Angel University that talks about everything from the fundamentals to valuations, to term sheets, to cap tables, to A board of directors and exit strategies, portfolio management, and so forth. What we have found is that when the entrepreneurs go through a curriculum such as that, they're meeting the investor in their own backyard. And so even if they're not ready for a raise, you know, let's say it's a year or so later, because they went through a local incubator accelerator or whatever, they built some contacts and all that. They've gone through this education. Now they're finally ready to do that seed round. They know what to expect and they know how to get inside the mind of the investor. I think that gives the entrepreneur a huge leg up. You know, just something as simple as that understanding they're looking for a 10x return on, you know, every investment. And it's not because they're being greedy, it's because there's gonna be losses and they need to cover 'em. So it's about, you know, Calibration and mutual expectation setting.

And when you think about this, you know, if you're sitting there and you're having these conversations and you're at a coffee shop and you think about the most innovative startup sectors, so you're sitting there and you're talking to somebody at a coffee shop and you're just kind of jamming along and somebody asks, what do you think are the most innovative? Where are the sectors that founders should be focused on right now, if there are any emerging or what I call inch-wide, mile-deep opportunities, what would be what you see from your perspective?

Yeah, so we publish annually what we call the Angel Funders Report, and this is freely available to the world. That is a study on all of the investments made by our member groups that report their investments to us. And so we look at it by region, we look at it by sector. You see the similarities, you see the differences. We do it each year so you can see it over time. At the moment, you know, certainly artificial intelligence is the hot market. We're seeing premiums there, but there certainly is a lot of funding that goes into SaaS companies, you know, fintech, An area that we don't see a lot at present invested in would be something like aerospace that's very capital intensive. Energy is another one that, you know, quite often if you're talking about a concept that needs hundreds of millions of dollars, that's probably not something that's going to be of interest to angels because most angel groups are putting maybe on the order of $4 or $5 million a year into multiple companies, they might put a couple hundred thousand at a time in. So they want to make sure that they are making a meaningful difference in that journey of the entrepreneur. And that, you know, let's just say you've got 4 groups that put in, you know, $250,000 apiece. That's a million-dollar round in the seed stage. Is that going to make a difference? You know, it's not if you've got a $100 million need and $99 million is coming from you know, VCs or others. The angels aren't going to have any input or say, right? So it's kind of about finding that right fit. But I would recommend looking at the Angel Funders Report for specific statistics on different sectors and different parts of the country.

So closing in on the conversation here, I just have 2 more questions. The first is, you know, there's this whole impact You know, inclusion both impacts social impact and environmental impact, which encompasses inclusion and diversity. What is the ACA doing in that regard? It seems like it's a pretty hot topic right now.

This is something that we're very concerned about. We did see over the past couple of years some nice increases. However, in the most recent data, we've seen a reversion. You know, in kind of the level of investment that's going to both female founders, Black founders, Hispanic founders. And so this is a real concern. We do believe that simply because of the way we're organized, meaning 250 angel groups and all across the US, we're able to move the needle relative to these stats more significantly than the VC community. And so one of the things that we do is challenge all of our angel groups to increase the diversity of their membership. Because we know if they get more diverse members in there, that's gonna bring a new network to 'em. It's gonna change the deal flow that they see, and it will most likely increase the level of funding that goes into, you know, those underserved communities. So the job is not done, But, you know, we do continually talk about that and look for ways that we can do that. You know, just to give you some specific numbers there, in the most recent analysis of the Angel Funders Report, we found that the investment into females was 24%. That's actually down from what it was the year before. Obviously, we'd like to see that up around 50% or so. But it's better than it historically has been. If we look at Black founders, that we did see a spike up around 10% or so that unfortunately is now back down to 2%. So we've got some work there. And relative to Hispanics, about 3% of the deals. So these are real concerns. We're trying to work it by a group-by-group level. And also, you know, that syndication helps with this because there are certain regions that may be higher in one demographic than the other. So if we can take those underserved founders and give them exposure in other markets where perhaps it's harder to find, you know, the deal flow that they're looking for, that helps spread the wealth, if you will, as well. So it's an ongoing job. We're not happy with where we're at, but we are making some progress.

So in the last question here, if you could redesign the funding model, if you could go back in time and say, okay, this is wrong and this is how it should be done, what would that look like?

We've seen some changes over the past couple of years here. I think one of the knocks against the angel community was, hey, it takes too long for too little of money. And so when the VC community was flush with cash and looking for deal flow, We saw them kind of come down the pipeline and say, hey, you know, we'll make a decision and give you more money much quicker. However, to do that, you know, if they did not have an efficient due diligence process, they had to shortchange it. And what all the stats show is that the more due diligence you do, the higher the outcome, most likely. And so that's what we focus on, is trying to standardize that due diligence process so that we've got an efficient way to get the information needed to, to the extent possible, de-risk that investment. And this is another area where through trust between groups, through a standardized due diligence process, we're able to do some level of fast-tracking of that by sharing due diligence between groups. Another thing that we recently did and launched was a model convertible note document. And the idea here is that that was put together over about a 9-month period by a team of lawyers to really look at it from both the investor and entrepreneurial perspective. We put it out there, it's freely available, and again, it's meant to calibrate and be that expectation-setting document so that a founder doesn't have to go, get a high-priced lawyer, start at ground zero. Take this document, modify it for your particular needs, take out what you don't like, add in what you want to add, start the conversations there. And so I think these things really help with the efficiency of the process that will hopefully get more capital into more entrepreneurs' hands more quickly so that they can stay focused on building their business.

Patrick, I really appreciate your time and energy on this podcast. You're a wealth of knowledge. And I really believe that people are going to get a lot out of it. I appreciate it so much. Thank you.

Well, thank you. It was great to be here. And we believe the Angel Capital Association has a whole lot to offer both entrepreneurs and investors, and many of it is free of charge. So I would encourage all of your listeners to go to angelcapitalassociation.org and browse around and take a look at all that's there for them. I'm sure they'll find a lot of great value.

I'm sure they will. And that's it for another episode of the Startup Science Podcast. If you can leave a 5-star review on Apple or Spotify, I would really appreciate it. And for founders, as a thank you for leading the changes in our world, I'm offering free access to the startup science platform Visionaries by Gregory Shepard, a one-stop shop for founders. It's got everything from a startup academy to investor match, grant finders, pitch finders, and more. Go to gregoryshepard.com. Click on Visionaries and use the code Founders, all capitals, for access to the platform. I'll see you next time. Namaste, my friends.

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