Investor Real Talk will dive into the deep end with the folks that hold the pocketbook in the startup world. We’ll get into angel funding, VC, growth equity, and even corporate venture to shine a light on why and how investors do what they do.
“I invested in what I would consider raw startups — a founder and nothing else,” Charlie Paparelli tells Hypepotamus.
The entrepreneur and angel investor has a long track record: founding a dozen startups, investing in 23, and mentoring and advising many, many more. He also blogs fairly regularly to share his wisdom beyond the many founders he works with.
Paparelli says he is “sunsetting” his highly active angel career in favor of more passive advising activities, but took the time to talk to Hype about how angel investing really works, what angels should look for in a startup, and when startups should look to start getting angel money — and when they shouldn’t.
How did you get into angel investing?
It was one of the more interesting times in my life — a transitional time. I was 40 years old and left corporate life sort of involuntarily, thinking I would go back to startups. I got into corporate life when they bought my startup company and then I did a 10-year run, though I was pretty unhappy there.
The first thing I did was I went and worked at a startup. But I quickly realized, I didn’t really want to lead a company. [A former colleague] called me and said, ‘I want to start a services company and I want you to fund it and I’ll run it.’ And eight months later, she quit on me. I was down $150K, in a business I didn’t want to be in, and running a company, which I didn’t want to do.
I then got a call from an ex-VP of Sales who worked for me for ten years and was looking to change jobs. I said, ‘I just happen to have a company.’ And that was my first investment.
At the time, I didn’t even think about it as an investment. But as it all started to pick up, I got really excited about being an investor.
How did you learn how to go about creating an investment thesis and being smart around your investments?
I got together with an attorney I had worked with who really understood both startups and wealthy executives. He helped me construct a thesis around what I would be investing in, we created an investment model and term sheet and all of that. I worked with this attorney and a CPA and they helped me put together a deal structure, cleanse my thesis, and I was off and running.
Let’s talk about that thesis — what kind of companies were these?
I invested in what I would consider raw startups — a founder and nothing else. We would invest anywhere from $250K to $1 million into cash-flow service companies. Part of my thesis was that I would invest by putting in loans, as these were companies that would quickly have revenue. They would pay me back my principal plus interest and I would have a retained interest in the equity plus a retained interest in the future revenue of the company.
My exits were what a Series A is today, in the $4 million to up to $30 million range. But because I caught these companies often before they were even incorporated, I’d get a significant portion of that deal.
For example, TeamOne was a services software company that we sold to PeopleSoft in the late 1990’s. That company started and ended within 24 months, and if that deal hadn’t happened, I would be working for somebody else today. I went in pretty big — it had to work, it wasn’t working, and all of a sudden it exited.
Another big win for me was Tax Partners, a sales tax business that sold after seven years to Thompson Financial.
How do you decide which companies to work with when they are at such an early-stage?
I looked at three things. First, I would interview these founders, taking them from childhood on, and looking at the arc of their life to see if this idea intersected with that arc. In other words, was it almost a God-calling that they had to start this business?
The second thing I looked at was if they had deep experience and deep network in the market and in the technology that they were about to incorporate into this startup.
Thirdly, did we share the same values? For me, that means Christian values. That was so we had something in common should everything go wrong.
The first thing I mentioned was all about the entrepreneur — they could never quit until this thing is a success. The second thing was risk reduction — he knows so much about the industry and the market and the buyers that the risk is reduced. And the last thing is a character issue. Was this a person that I can trust?
Once you’ve invested, how did you work closely with entrepreneurs?
I actually started what I called a services incubator. I rented office space and installed a back office accounting system with a CFO. I had an HR person and lawyers that had put together contracts for employees and customers.
So I would talk to someone who wanted to start an IT services business, and within 24 hours we’d have a logo, a contract for investment, be incorporated, and they’d be sitting at a desk with an entire back office setup behind them. That was how I added value.
Another thing I did was a lot of these younger entrepreneurs were used to having an executive go with them when they went on customer calls. I would come in and play that role for them and go with them to the first few calls. Very quickly, of course, they would realize that they didn’t really need me; they could do it themselves because they were in fact the CEO. It was fun to see them grow into that role.
When should a founder start looking to raise a formal angel round. Similarly, when when do they really not need it?
I think the time to ideally go looking for angel funding is when you’ve already determined product market fit. What I mean by that is, they’ve seen a problem in the marketplace, built a solution, and hopefully done a couple of deals, so they know who they’re selling to — they’re pretty sure that it will work.
That helps me mitigate my risk as an angel — just getting that very early traction, though it could change for sure. If you need money then to prove the product out and get to that first million in revenue, that’s when to go for that first formal angel round.
On the other side. I always tell entrepreneurs that the best place to get money is from your customers. If you can get money from customers and keep it going that way, you’ve got enough cash flow, keep your expenses down, start building product market fit and revenue up at the same time, then you’ll just need money to scale. Your valuation is going to be much higher and your dilution will be much lower. You’ll be able to get a higher-quality investor and move forward.
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