OCTOber 4, 2019

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How Investing Works In the Heartland:  Angels are the Pros

By Eric Dobson

There are few VCs left in early stage investment space.  It has been surrendered to incubators, accelerators, and angels. 

The challenge is that angels have been fragmented for decades, which has only been exacerbated by the move of VCs out of the market since 2008. Version 1.0 of angel investing was the “lone wolf,” who simply followed the coattails of the pre-Sarbanes Oxley (“SarBox”) era VCs as an individual or a member of a stand-alone geographically-focused angel group or fund. 

Version 2.0 came when angels and angel groups and funds began to syndicate.  The reason is simple.  One angel group, outside of the traditional early stage innovation centers (Silicon Valley, Boston, New York, Miami, LA, etc.), will have trouble backing one great company from concept to exit.  And, the goal is to do so a dozen times.  So, strength in numbers became the going plan.  But, these first syndicates had a fatal flaw, they were built on loose amalgamations of groups with polite agreements to collaborate.  Without a more rigid structure, they had redundant diligence processes, lack of aligned values and processes, and closings that approached glacial pace.  They were simply not aligned with a clarity of unified purpose and action.  As the VCs moved out of the market, beginning with SarBox, and rapidly accelerating after the 2008 Great Credit Contraction, a void was left that has been filled with a new breed of angel. 

That is why we call the strong syndicates of today, Version 3.0.  Angels have become the “pros” in the market.  They have to manage the dealflow, diligence, legal wrangling, etc. (once done by teams of analysts) as interested, educated members in angel groups.  This is the future of angel investing…….with one caveat.  The JOBS Act Reg A+ statutes are effectively restoring the small-cap IPO. 

Time will tell if this draws VCs back into the early stage market or it simply gives angels a path to liquidity without the VCs participation.  I tend to believe the latter will be the case, because that is how I intend to use the new regulations with our portfolio where it makes sense.

With the rise of these syndicates, we see a massive shift of attention from the traditional investment centers to the Heartland.  Steve Case published a book, The Rise of the Rest, which supports this hypothesis.  But, I am not sure even he realizes the extent to which this is happening in the Heartland.  It is not just the Louisville and Nashvilles of the Heartland that are rising, it is the Ashlands and Florences that are organizing capital and creating high-growth companies under this new syndication model.  We see this because, as angels have become more organized, they brought to the market a sense of love of community that VCs simply don’t share.  Third, and even fourth tier metros, are seeking to compete in a new economic reality as traditional industries have collapsed, coupled with a bubble in the traditional innovation centers…..Voila!  The rest are rising.  The Heartland is organizing and marching to a new drum.  And, they can because, and we have said this often, tech and talent are ubiquitous.  Capital is the bottleneck, and there is substantial residual wealth across the Heartland that is organizing now.

It is clear that capital investing is being disaggregated away from the traditional centers.  Angels in the Heartland are snatching up startups based on IP from universities and research laboratories right and left.  Partially, because this is where these entities have tended to form, and mostly because of the shift of employment patterns from large metropolitan areas highlighted by Richard Florida’s book, The Rise of the Creative Class.  We see this with every industry the Internet touches – the traditional gatekeepers are being bypassed, disaggregation of assets, and democratization of activity.  We have reached a post-Silicon Valley world. 

So, let’s talk about how funding gets done in a post-Silicon Valley world.   If there is no local capital the company dies or is usually forced to move to be close to capital sources.  Increasingly out-of-town (OOT) capital wants local capital to have invested first.  And for good reason.  First, local investors are well vested in these companies and in seeing them grow.  Second, every investor wants local mentors to serve as advisors and as “canaries in the coal mine.”  They want to know that someone has already done a lot of the heavy lifting and is minding the store!

But, you may ask, where does crowdfunding fit here?  The problem with this model is simply, who curates the deals?  Crowds may be good a creating capital, but they tend to be lousy at adding value to a company.  Angels first, and foremost add value.  And, there is still a great deal of skepticism of the SEC regulations regarding equity-based crowdfunding.  This will change over time, but for now, crowdfunding does not lead to angel or venture capital.  It seems to preclude it.

As VCss have moved out of the space expanding the Series A Crunch, angels have to take these companies further and...   continue reading    


4 Reasons You Should NOT Operate Your Business as a Sole Proprietorship

By Alex Day

Today I want to get down to some very basic concepts.  I want to cover why you should never run your business as a sole proprietorship.  First let’s cover the difference between a business that is operated as a sole proprietorship and one that is operated as an LLC (our preferred method of establishing a legal entity for a business).  A sole proprietorship is when you have a business and you run it in your name.  There is no legal difference between you and your business.  Any debt you incur is personal debt and you are directly and personally responsible for it.  Any liabilities you incur, whether financial or legal, you are responsible for them.  There is no legal distinction between you and your business. 

When you establish and LLC for your entity (or incorporate as an S Corp or C-Corp), you are establishing a new legal entity for the business.  This legal entity has rights and responsibilities that are separate and individual from you as an individual.  So below are four reasons why we recommend establishing an LLC and running your business as an LLC:

1. Reduction of personal liability

As my attorney and good friend likes to say, this is America, you can be sued for anything.  I have experienced that with one of my companies and I was dumbfounded at what a disregard the legal system has "truth" or "justice".  The LLC through which I was working was sued by an individual who had NO GROUNDS for a case.  The business was insolvent, he was a contractor who had been paid over $25,000 for 3 months of part time work (which he did not meet HIS obligations under the contract) and he sued the LLC.  If I had not had the LLC, he could have gone after me personally.  Have your LLC and be prepared for these type of issues. 

2. Exit

If you have an LLC you have a documented asset which can be legally sold.  You will have records with which you can demonstrate the assets and operations of the business.  I recently worked with a gentleman who had a very nice little business that had a very nice cash flow with virtually no overhead.  I was engaged to help sell the business and I really thought it would be a no brainer.  One of the major downsides that we had was that the business was a sole proprietorship and he had no documentation separate from his personal finances to show what the business was doing.  This became a major issue and we were unable to sell the business in the time period we...   continue reading    


A Mini-Primer: Understanding Convertible Debt

When your startup needs to raise cash, the conversation about convertible debt generally begins.  in effect, the investor would be loaning money to a startup and instead of a return in the form of principal plus interest, the investor has the option to convert their return into equity in the company.

How do I think about convertible debt?

When a company borrows money from an investor or a group of investors and the intention of both the investors and the company is to convert the debt to equity at some later date. Typically the way the debt will be converted into equity is specified at the time the loan is made.

When evaluating a convertible note, there are a few key parameters that must be kept in mind:

Discount Rate

Investors will often have a valuation discount relative to investors in the subsequent financing round, which compensates the initial investor for the additional risk born by investing earlier.

Valuation Cap

The valuation cap is a plus for bearing risk earlier on. It effectively caps the price at which the notes will convert into equity. Note often have upside, if the company grows early and well.

Interest Rate

Interest often is accrued in a convertible note.  Interest accrues to the principal invested, increasing the number of shares issued upon conversion.

Convertible notes are often issued so that both investors and startups can avoid a valuation that can really come later during Series A financing, after the idea of the company has become more solidified and moved forward with planning and potentially first sales.

There is security for both the investor and the startup in this plan.  Ideally, an investor wants to convert the bond to stock when the gain from the stock sale exceeds the face value of the bond plus the total amount of leftover interest payments.

When Should You Start Building Your Business?

By Carlos Hernandez Ocampo, Esq.

When Should You Start Building Your Business? I first heard a similar question from a Jim Rohn YouTube video. In a seminar, he asked the audience a rhetorical question, “When should you start building a house? The answer is, as soon as it’s finished.”

He was referring to the process of building something in your mind. Going through the planning stages, outlining it, drafting it, and finally, after it is conceptually realized, laying the first brick.

Entrepreneurs usually start with an idea. It is quite easy to get wrapped up in the excitement of the new idea and let that first spark of motivation fuel you all the way to the bank. The better alternative would be to sit down and go through as much planning for your business as you reasonably can before running to your relatives and friends and asking them to fund your latest world-changing solution.

The concept of starting with the end in mind isn't new, and Mr. Rohn isn't the only person to have talked about it. Richard Covey also wrote about it in his book The 7 Habits of Highly Effective People. It's the second habit he teaches.

From a legal perspective, I would counsel an entrepreneur to first think of their exit strategy, then work their way back to incorporation. This process allows them a moment of clarity where they can consider what they want from their company, or the impact they want their idea to have. Some possible questions to ask oneself when starting with the end in mind are:

  • Do I want to have a lifestyle business?
  • Will a more prominent company acquire me?
  • Will I be raising capital from investors?
  • Will I get financing from a bank?
  • Do I want to merge with another business that strengthens my market share?
  • If my business gets acquired, do I want to stay on or walk away?
  • Do I have to pay my grandma back for that loan?
  • Will my partner divorce me if I pursue this business idea?

Good legal drafting can address many of these questions at the very beginning of an enterprise.

There are several ways an attorney can help an entrepreneur plan for these future events. When drafting an Operating Agreement, for example, an attorney can include a Vesting Schedule if the...   continue reading    


Oct.9th, Network for Entrepreneurial Women. 6:00– 8:00 PM, Mightily, 111 West Main Street, Ste. 202, Louisville. Presented by: Alli Truttmann, Founder and CEO of Wicked Sheets. $10.
Oct. 15th, CNPE 2019 (Center for Non-Profit Excellence). 8:15 to 3:30 PM. Marriott Downtown Louisville. Dan Pallotta, author of the book Uncharitable and known for his ideas about disruption in the field of social services, will headline this CHANGEMAKERS Conference. CNPE’s conference brings together nonprofit, corporate, and public sector leaders to learn, build relationships, and celebrate excellence.
Oct 17, Louisville Sheltowee Business Network Node Meeting. 3:00-5:00 PM, iHub Coworking Space, 204 South Floyd St, Louisville, KY 40202. Free.
Oct. 23, The Trade Navigation Series--Export 101 by the KY World Trade Center. 8:30 AM to Noon. $100 to $150. Location: Amatrol, 2400 Centennial Blvd., Jeffersonville, IN 47130. Wondering who you need to know and what you need to do to start exporting? In partnership with the World Trade Center Indianapolis. This seminar is an approved STEP Grant reimbursement. If you have not applied for the STEP (State Trade and Export Promotion), please visit the Kentucky Export Initiative website for more information.
Oct. 30th, Louisville LEAP & Techstars Founders Series, Building Great Corporate Partnerships. Featured: Dave Drach, VP Corporate Strategy at Techstars. 6 to 7:30 PM. Story Louisville, 900 E. Main St., Louisville. Free.
Nov. 11-15th. Techstars Louisville Startup Week.
Nov. 15. Founder Hunt. Churchill Downs in Louisville. 11 AM to 5 PM. Founder Hunt is a startup pitch event, but in reverse. The University of Louisville and the University of Kentucky researchers will pitch their technologies to a room of entrepreneurs looking for their next big opportunity. Their goal is to connect research-backed technologies with startup founders who want to build a company around them.
Register for SBN events at www.sheltowee.com/events
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