Why Most Startups Shouldn't Seek Angel Investment: A Candid Look with Andrew Kazlow of PitchFact

Welcome back to Startup Stories from the Treehouse. This week, we're exploring angel investing with Andrew Kazlow, CEO of PitchFact. His work with angel networks and startups gives him a unique perspective. As he states, "I think most entrepreneurs shouldn't raise capital from angels," a contrarian take that can save founders time, money, and frustration. This isn't about oversimplified advice but understanding the nuances, acknowledging the messiness, and making decisions with a clearer view.

Angel Networks as Unique Marketplaces:

Angel networks are more than wealthy individuals; they're dynamic marketplaces connecting startup founders and angel investors. Their core function is to facilitate deals, measured by the interaction's effectiveness. Unlike venture capital firms or syndicates, angel networks don't control individual investment decisions of their members. This means that, as a founder, you're not just pitching to investors; you're navigating a platform with its own dynamics and metrics.

A founder has a great product with early customer traction but fails to secure funding because they don't understand that angel networks need a steady stream of deals, interaction with other investors, and the chance to pool resources. If the presentation doesn't align with these needs, even a promising company might get overlooked. As Andrew notes, the core interaction in an angel network is a deal getting done. They differ from venture capital firms or syndicates because the operational team around the community has very little control over the members' choices. Unlike a syndicate where a lead investor commits first, in a true angel network, there's no upfront dollar commitment.

Actionable Takeaway: To engage effectively, approach angel networks with an understanding of their objectives.

To view a full transcription of the podcast, click here.

The Angel Ops Framework: A Five-Step Journey

Angel network mechanics follow a specific process called the "Angel Ops" framework. It outlines five key steps: Source, Evaluate, Engage, Close, and Monitor. Each has its own challenges and opportunities for founders:

• Source: This is about generating enough deal flow. The best angel networks don't wait for applications; they cultivate relationships within the ecosystem for referrals. Many ask "How did you hear about us?" in their application, indicating their desire to be found by startups. A key aspect is managing inbound interest. Some networks may have complex applications, while others are more informal. The application's complexity can influence the volume.

• Evaluate: After sourcing deals, the network must decide which ones fit, often involving a screening team. According to Andrew, a common bottleneck occurs during due diligence. Many angel groups operate around a predictable cadence of pitch events, inviting the "best applicants" to present. Some networks have an explicit investment thesis, while others rely on a functional, implicit one based on member preferences.

• Engage: Founders present to the broader membership in a "Shark Tank" style pitch event. Andrew notes that "pitches suck," since they only show investors the "shiny" parts. A critical aspect is the preparation and distribution of investor materials, which can range from basic to robust analysis. The "best network operators recognize the pitch event's critical importance to their success, not just the founder's," so they equip their members.

• Close: This phase is about finalizing investments. Andrew notes that many angel networks struggle with process management after the pitch event, leading to a "wild west" situation, where members must "figure it out on their own." Some networks offer "white glove" service, where staff engage with members to address questions, while others leave them to engage directly with the founders. Deal documentation is created during this step.

• Monitor: This often-overlooked final step involves tracking company metrics, sharing updates, and benchmarking performance to inform future investment decisions. Networks should address common questions like "How did those other deals turn out?" or "I haven't heard from Startup X in a while, how are they doing?"

Actionable Takeaway: View your journey through this framework. Anticipate each step’s requirements and prepare accordingly. Understanding the Angel Ops framework is like knowing a complex dance before stepping onto the floor, making you more effective in engaging with a network.

Due Diligence: The Undercurrent of Every Step

Due diligence isn't a separate phase; it's an ongoing process in Angel Ops. It's about the research and analysis. According to Andrew, the primary bottleneck occurs in Steps 2-4 due to poor due diligence, which starts as soon as an application is submitted.

• Poor due diligence might look like an angel investor being "interested, but not confident enough to commit," which may drag out the process. Andrew notes that "due diligence and extended due diligence can often be a soft no," which can manifest as an investor wanting to examine the financials or have follow-up meetings for a long time, but never committing.

• Another red flag is the creation of an inconsistent process through unclear communication of the next steps or decision time frame.

• A lack of clear criteria can signal that the network is not well run, with unclear investment criteria.

Actionable Takeaway: Handle due diligence by being transparent and doing the hard work upfront to avoid information asymmetry, and be prepared for tough questions from investors. Back up all claims. An effective angel community has "a clear, consistent ability to say no to an entrepreneur that's not a fit," because they "say no to 95% of applicants."

Relationships and "Smart Money": The Currency of Angel Investing

Angel investing is a relationship business where investors aim to be "smart money." They offer mentorship and advice, not just capital.

• Investors want to leverage their expertise. They want to help you succeed and may offer valuable introductions in their field, as Andrew points out.

• They want a clear plan for the requested capital. As Andrew noted, they want to see how your current round will lead to the next.

Actionable Takeaway: Seek investors with experience, connections, and genuine interest in your space. Build relationships long before you need capital. As Andrew emphasizes, "The best time to start building relationships is before you need capital."

Valuation and Deal Structure: The Art of Negotiation

Startup valuation is complex, more art than science. According to Andrew, "one of the quickest ways to make an investor walk away is to get your valuation wrong," which signals you don't understand the ecosystem.

• Research valuations of similar companies. Then, approach investors with a realistic and well-researched valuation.

• Understand deal structures. There are three main ways to raise capital: safe notes, convertible debt notes, and priced equity rounds. Be aware of the implications.

• Don't be weird. As Andrew says, anything outside the three main ways to raise capital is "weird".

Actionable Takeaway: Research valuations of similar-stage companies in your region. Overvaluing your company can quickly lose interest. Be open to significant ownership dilution to launch your startup.

The Decision: Is Angel Investment Right for You?

After seeing thousands of pitches and watching founders spend months in fundraising limbo, Andrew's conclusion is clear: "The best founders spend less time fundraising and more time building." Before diving into angel investing, ask yourself three critical questions:

1. Could you reach profitability without outside capital? Many founders pursue investment when they should pursue customers.

2. Do you need the expertise of angel investors? If not, consider revenue-based financing or traditional loans.

3. Are you prepared for the true time cost? Remember: 98% of startups that pitch don't get funded. That's months of preparation that could have been used to develop your business.

If you pursue angel investment:

• Engage with the angel community before seeking funding.

• Watch for the red flags discussed during due diligence.

• Be ruthlessly honest about your progress.

Angel investing isn't impenetrable, but it may not be the right path for your startup. As Andrew emphasizes, "The best founders I know spend less time fundraising and more time building."

Listen to this week's Startup Stories from the Treehouse episode for more insights from Andrew, including examples of startups that successfully raised funds and those that prudently decided against it.

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