It's time to blow the whistle on Angel groups and VCs that charge entrepreneurs excessive fees and take advantage of a startup's desperation for capital to serve their other goals.
My Story:
Despite a big launch of my company and getting dozens of meetings with VCs and Angel groups in the fall of 2008, I could only secure enough capital for 6 months of runway. My team was putting in 150% effort while getting 30% of their deserved pay, while I took no salary. We had to find more capital soon or be forced to cut the team down.
My desperation led me to fall into the traps set by a tight network of NY-based Angel groups who prey on startups like mine to get what they want:
Trap #1: Tri-State Private Investors Network
One Angel group in New York invited us to pitch called the Tri-State Private Investors Network (
http://www.angelinvestorfunding.com/), run by a woman named Ellen Sandles. The group looks on the outside like a normal angel group. But I should have paid closer attention to a few tip-offs that this was not a group serious about investing *their own* money. They charge $90 just to apply, another $275 to be reviewed by the screening committee (by phone in my case), then if selected, another $300 to pitch to the full group. If Tri-State PIN members invest, they will take a 2.5% cash fee plus 4 years of options/warrants on 2% of the financing raised, or 1.5% cash plus 2% options/warrants if they instead help introduce you to another investor.
Here is their justification (available only on the website after you sign-in):
"Why must I submit an initial Submission fee with my business plan materials?
Venture capital funds typically collect a 2 -3% management fee from their funds (regardless of performance) for business operations. This fee is used for: hiring staff to read business plans, office rent, telephones, salaries, conducting due diligence, etc.
The Tri-State PIN is not a fund, but rather a membership organization of private individuals who control their own capital. Therefore no management fee is available, yet we have the same administrative responsibilities for our investors. The submission fee is required for our staff and administrative processing.
As an analogy, when applying for a bank loan or applying to attend college, an application fee normally must accompany the submitted materials."
Read: These fees are needed to pay Ellen Sandles. But apparently these fees don't guarantee Ellen Sandles will gather a room full of serious Angel investors willing to invest their own money, as advertised. In fact only ten people attended and most were serving as intermediaries for other funds, including one service provider, one representative of a family-wealth fund, one VC from Spencer Trask Ventures, another VC who admitted to me he was only attending to "check it out," and Mike Segal from Joshua Capital Partners. Should I have been asked to pay $665 to get to pitch to only three or four real Angel investors?
Trap #2: Private Equity Forums
Unfortunately I didn't learn my lesson. Mike Segal from Joshua Capital Partners contacted me saying he really liked our business, thought it had promise and that we'd be a good candidate to present at his upcoming Private Equity Forum (
http://www.privateequityforums.com/) -- a "classy" affair, 5-hours long at the Yale Club in NYC featuring companies to pitch for 10 minutes on stage to a few hundred potential investors. In his words:
"The upcoming event can provide a highly effective and prestigious venue for management to deliver its vision to a captive audience of receptive investors and well-qualified funding sources. Attendees will primarily include principals of private equity funds, investment partnerships, venture capitalists and Angel groups. More than 150 leading investment funds and other capital sources from throughout the United States are expected to be represented."
He listed scores of VCs that have attended their Forums in the past and gave a detailed pitch on why THIS is the most effective way to capture investor attention:
Very important: One of the principal reasons that our conferences have been so successful is that most other venues, having the similar stated objective of reaching investors, generally have a very low percentage of investors in attendance. This is because they are supported primarily by "paid corporate sponsors", who in-turn populate the events with their people. This is not the case at our Forums.The majority of the attendees at our events are reliable direct or indirect sources of capital, not service providers, who have no interest in making investments. In addition, the conference program has been specifically designed to maximize management's ability to meet with interested investors, one-on-one or in small groups in an upscale setting. As you are aware, most professional investors will not even consider deals where they do not know management or those which have not referred by a reliable source. Our forums significantly help to remove these barriers to management's ability to reach qualified investors.
The cost? Presenters would pay between $9500-$25,000 plus a portion of the money you raise from conference registrants:
"Presenter Fee Finders Fee Percentage
$25,000 No Finders Fees
$17,500 3% Flat Finders Fee
$14,500 10% to 5% Sliding Scale - Reducing 1% per Million Invested
$9,500 or less on wait-listed basis 10% to 5% Sliding Scale - Reducing 1% per Million Invested"
I could not believe any of these amounts was worth being on stage for 10 minutes. However I still fell in the trap of believing this event would be worth attending. So he offered a "reduced" rate of $1250 to attend the conference as a non-presenter, and he would just give a one-minute introduction about my company and include copies of our executive summaries in the conference folders.
Mike Segal said there would be 150-200 investors in the room. But judging from the colored name badges, in fact only 25% of the ~200 attendees were self-identified investors. The "investors" there were clearly uninterested in actually talking to any entrepreneurs too. Even several of the "presenter" companies who paid $10,000+ said noone came to talk to them after their presentation.
The rest were service providers, investment bankers, and loads of other duped entrepreneurs like me. Of the six VCs on the "registered" list that attracted me to the event, three were no-shows, one isn't investing anymore, and the other two left early.
I felt like an idiot. I had been duped and I won't be duped again.
The Problem:
The startup world should all know that these groups exist. They egregiously take advantage of startups desperate for capital. They knowingly overpromise what service they are actually providing a startup to extract fees really meant to pay for their own salaries, large ballrooms, catered dinners, and the networking value the conference/Angel group participants (not the startups) extract out of meeting other wealthy individuals also interested in startups.
And yes, I believe certain people do outright lie to us, knowing that many of us are first-time CEOs or just desperate and don't know that better ways of getting capital exist out there. (Anybody seen ABC's Shark Tank TV show recently?)
Raising capital is a risky business for everyone involved. Perhaps some fees are justifiably charged to us startups for the time and effort it takes to gather investors together. I've been happy to pay $300 to an Angel group with serious investors, because it can yield several tens of thousands in Angel investment for me.
Investment bankers and lawyers have long taken huge fees for being the middlemen between companies and capital. So why not extend that model to startups too? Isn't it just a slippery slope from paying $1 million to $25,000 to $665 to $300 to someone who claims they will secure your company the capital it needs?
NO. The fundamental problem is that the guy charging large fees to the startup is transferring ALL the risk involved in raising that capital to the startup, who is already mired up to the neck in serious, palpable risk. He gets all the reward if you happen to come upon capital, but none of the downside if -- what do you know! -- his capital-raising service does not yield actual results.
A larger company could handle that risk. Give us too much risk and we startups die, just like a person living on $3 per day has to starve when he loses his income for just a week. This is morally outrageous and flat-out corrupt.
The Bigger Problem:
It doesn't stop with one or two groups in New York City like Joshua Capital and Tri-State PIN either. This practice is systemic to an old way of doing things, particularly on the East Coast. People learn in their MBA programs or their investment banks or their Sales training on the street that they can extract the highest pay by putting themselves between the money and the people who need it. They look down upon startups as young mavericks who need to be taught a lesson by the older, wiser generations.
They're fundamentally threatened by the newer way of doing things posed by the West Coast, where entrepreneurs are judged more by the products they can build with their own two hands than with their connections or ability to talk up a storm. These are the same people who laugh now at Twitter's $1B valuation just as they laughed at Facebook when it demanded a valuation higher than $10M in its early days. Just young, dumb kids who don't know anything about business! The web can't make any money, ha!
The result on the East Coast and in many Angel groups across the country is a generational divide, a divide between investors and entrepreneurs, and a payment scheme that reflects the belief that entrepreneurs should fund the investors who would deign to field their pitches, not the other way around.
It's time for some of these investors to acknowledge that THEY are the ones with the money. THEY should be the ones to internalize the riskiness of finding good investments. We entrepreneurs are already busy working our asses off trying to build something out of nothing. Don't make it even harder on us.
The Lesson:
To Entrepreneurs reading this, just take away one lesson as you go out and raise your desperately-needed capital:
Be wary of those who put themselves between you and the money you deserve. They will tell you you need them to get it because of their strong network, and thus they deserve the exorbitant "administrative" or consultant hourly fees. But chances are you're being duped to their benefit -- if they really believed in your business, they would invest their own money in YOU, not the other way around.
Angel investors and anyone in the investment community reading this:
Be candid about your intentions with us entrepreneurs. Are you or your group or conference attendees really considering investing their own money? Or are you really looking for fee-based consulting opportunities? Or to be hired by that startup? Or nothing, you're just curious what the company is doing? These are very different, non-overlapping things. Don't use your lofty position as our "potential financier" to obscure what your real intentions are.
Individuals like Mike Segal, Ellen Sandles, and others in the business of taking money from startups that you know in all likelihood will gain nothing from your service:
Stop doing what you're doing altogether. Find a real job that offers real value to those you claim to serve.
Postscript:
You might wonder who I am and why I wrote this anonymously. The answer: Unfortunately some investors read the signals of other investors to judge a startup's potential. They would read into the fact that I was duped by a few shady Angel groups and that I struggled for capital that my business must be a bad one. In fact we're doing quite well and have succeeded in many ways, and you've might have even used our site -- but that's just not the way the investment world all thinks just yet.
