Respectfully, I disagree.  Here’s why.

• There are about 300 angel groups in the United States at present.
• The largest angel group in the United States is currently Tech Coast Angels.
• Tech Coast Angels normally invest in about 10-12 new deals per year.
• Assuming 300 angel groups each invested in 12 new deals per year, they would fund about 3,600 deals per year in total.
• 57,225 companies received funding from angel investors in 2009, including follow-on investments.
• Based on these numbers, angel groups funded less than 10% of all angel deals in 2009.
• Angel groups are easy to find.  I’ve encountered people offering to sell lists of angel groups.  What a crock!  You can find the biggest and best list of them here for free.
• Because angel groups are so easy to find, they are often inundated with business plans from entrepreneurs clamoring for attention.  What happens when the demand for capital far outpaces investor supply?  Investors get a lot pickier.  Is this the perfect environment for an entrepreneur?

Solo angels and informal investors represent a far better funding opportunity for most startup and early stage companies.   Here’s the story the numbers tell.

• There were nearly 260,000 active angel investors in the U.S. in 2009.  An estimated 20,000 angel investors are part of organized angel groups, leaving a total of 240,000 solo angels. These solo angels were responsible for more than 90% of all angel deals funded in 2009, with an estimated total investment of more than $15 billion.
• Informal investors (including friends, family, and associates) invested in more than 4,000,000 deals in 2009.  They provided more than $70 billion in small business funding in 2009.

You can draw your own conclusions from these numbers; the math is pretty straightforward.

All that being said, raising money from solo angels and informal investors takes time, lots of work, and persistence to succeed.  Some professional guidance won’t hurt either!

1. Customers buy from you and perceive value

The question professional investors often ask is, “Will the dogs eat the dog food?” If you have an existing business where customers pay reasonable prices for your products and services and perceive value in the exchange, you have the foundation for a successful business. The absolute best source of capital for your business is satisfied customers. But if your company has strong proven customer demand and you need expansion capital to meet that demand, you’re in a highly attractive position to investors. For start-ups, the question is more difficult to answer until customer traction is achieved, and we’ll address this issue in a future post.

2. Your business generates strong earnings

Many start-ups launch with strategies to attract customers with free or low-priced goods and services. Of course, the company eventually has to generate profits to be successful, so prices usually escalate and more revenue streams are established. Most start-ups lose money for a while, and even well established companies lose money occasionally. If your business is not currently profitable, you need to demonstrate a clear and credible path to profitability. Investors are looking for proof of your company’s ability to maximize earnings while keeping the customer value equation in balance.

3. Your business is scalable

How much realistic growth potential does your business have? Is there a way to double or triple your revenues within a year or two? What will it take to make it happen? If you can demonstrate the scalability of your company, you’ll find more investors willing to talk to you. However, if you have a $1 million business today and can grow it to $5 million within the next 3 years, your deal won’t appeal to venture capitalists or angel investors, but it may be attractive to informal investors or commercial lenders. The type of investor will depend on how much your company can reasonably scale. Proof of scalability enhances your strength in the eyes of investors, even if it is on a limited or trial basis.

Start-up companies generally don’t have much evidence of these issues, but are often able to achieve it after a period of bootstrapping with a focus on generating the necessary proofs. Both investors and lenders respond well to business owners who have taken this approach.

How would you respond?

• Smart money, of course!
• Dumb money, that’s why I’m talking to you.
• Which kind can I get from you?

The question is ridiculous, yet the issue comes up a lot. Money is inanimate, and is neither smart nor dumb in and of itself. The way entrepreneurs or investors manage and invest money can be smart or dumb, and this gets more to the heart of the matter. But before delving into this issue and its implications for entrepreneurs, let’s take a quick look at some definitions.

The term “smart money” is often used to describe investment capital from sources that also provide valuable expertise and contacts that will enable businesses to become more successful. This sounds like a smart idea, and I believe the principle is a good one. But the term is also used in other less useful ways, and not always explicitly. For example, a venture capitalist or angel investor may deem their investment as smart money, and infer that others who invested in your business at an earlier stage on an informal basis provided dumb money.

There are many elitists in the capital markets. But ultimately this doesn’t matter, and I’ll tell you why. I’ll also tell you what’s far more important as an entrepreneur looking for capital.

First, many of the “smartest” financial people in the world helped create the recent global economic meltdown. And even today, whenever they talk about the future, the only truth is “we don’t really know . . .”

Second, $18 billion (the same amount angel investors and venture capitalists each invested in 2009) was entrusted to Bernie Madoff by thousands of smart people.

Third, let’s compare the failure rates of companies that received angel investment, those that received venture capital, and the whole gamut of U.S. start-ups that survive at least 5 years. Perhaps surprisingly, the approximate failure rate in all cases is 50 percent!  While different studies report varying failure rates, these numbers reflect a reasonable average.

What does the data indicate about the value of so-called smart money?

Taken on the whole, it doesn’t seem to make much of a difference.

So what does matter for you, the entrepreneur?

YOU being smart.

Here are some tips to help guide you along.

• Bootstrap your company using appropriate capitalization solutions that don’t require you to go down the equity capital path.  Aside from banks, there are many other viable ways to grow a business by leveraging all available capitalization options.
• Smart entrepreneurs surround themselves with advisors, strategic partners, board members, employees, subcontractors, customers, vendors, etc. who bring expertise and contacts to the business. When you look at the big picture, you can get vastly more support from these resources than you are likely to get from your investors, though good participating investors can be very helpful members of your team.
• Investors who are also well-known and successful figures in your industry could be very helpful, if they take an active role in supporting you. There are many anecdotal tales of high profile experts that promised to help for a premium, but never did. Find out how active such investors will really be for you (check their references) before you take their money.
• Don’t take money from investors that are likely to become a problem for you later on. You can conduct due diligence on them by asking to talk to the owners of other companies they invested in.
• If investors are too “smart” you could end up in a dangerous situation where they can take over your business if you don’t meet certain performances on schedule. While this a a major concern for entrepreneurs, the reality is that it doesn’t happen very often. Most angel investors don’t want your business, don’t have time for it, and would rather support it with help from time to time rather than taking it over. Onerous terms and conditions proposed by an investor should flag you to perform due diligence on the investor, and talk to your trusted business advisors before committing to do a proposed deal. This is the path of the smart entrepreneur.
• Develop a strong financial model of your business built on leading indicators that will help you manage the business from the beginning of the marketing and sales cycle. Show it to experienced advisors you trust. Refine it until you completely believe in your ability to achieve these numbers. Don’t start trying to raise money until after this has been accomplished.
• Expect that you’ll have to do a major overhaul of your business model within a few years in order to ultimately succeed.
• Know that a smart entrepreneur can make just as much with so-called “smart money” as can be made with “dumb money.” So focus on being a smart entrepreneur. That’s something you have a lot more control of.
• Don’t be a smart aleck, that’s not the same thing as being smart. You’re unlikely to succeed with Tip #1 if you’re a jerk. I’d like to be able to say that jerks are also more likely to fail, but I haven’t seen any reliable numbers on that issue yet . . .