How Angel Investors Think (And How to Get Them to "Yes")

Sean Weisbrot: Welcome back to another episode of the We Live to Build podcast. With the US stock market historically high and the US interest rates historically low, capital is really cheap to come by right now, and startups are raising more than ever at the earlier stages. For some reason, that hasn't changed the mindset of investors who are as prudent as ever. Whether you're an entrepreneur looking to better understand how angel investors think, or you're looking to get started being an angel investor, this episode is for you.

Sean Weisbrot: I spoke with Mysty Rusk, the executive director of the Free Enterprise Institute at the University of San Diego School of Business and the founder of the San Diego Angel conference, which seeks to activate new angel investors at a local level while committing to investing a specific amount within a specific time frame. In order to ensure great startups actually get the money they need to move to the next level. It was a lovely chat, and I specifically questioned her about what made you interested in becoming an angel investor. How do you identify who is the right person to become an angel investor?

Sean Weisbrot: What should potential angel investors be learning to become successful? What are angel investors looking for when reviewing a pitch deck? What are they listening for during a live pitch? Why you should tell a story with the path to success. What should you prepare for the due diligence process? Why you should never ask investors to sign an NDA at the beginning. Buy the terms of the deal can make or break the investment. What can stop the investment at this point and much more. So, thank you very much to Mysty and I hope you enjoy the episode.

Sean Weisbrot: What is it you do now that makes you the right person to talk about all things, Angel Investing?

Mysty Rusk: I always tell people that I started out on a cattle ranch, because everybody can make the connection between raising cattle and high-tech innovation. I know that's an easy jump, but from the time I was a little, little kid, I was pretty inventive and entrepreneurial. My first business I started when I was five. I had a series of businesses, but it wasn't until I finished grad school that I realized it was really called to do this work with startups. So, I just have a knack for it, and I have the ability to sort of connect things that seem pretty unrelated to most people.

Mysty Rusk: So, my real gift is in seeing what the application is. I can take a look at raw, you know, piece of technology and see ways that it could apply in healthcare or in agriculture or a variety of things like that. Plus, the ability to connect people together seems to be the thing that's been my little bit of magic for the last two decades. Right now, I'm in San Diego, California, and we run the San Diego Angel conference as part of some other work that we do at the University of San Diego. Our goal is to help activate new angel investors. And we do that in two ways. We help entrepreneurs get prepared and become investment-worthy, and we also help investors learn how to look at deals and evaluate those deals.

Mysty Rusk: We start out with a big prize. We say we're going to award the winning company $200,000 in angel investment, and that will draw really good opportunities out of the woodwork. And it will make entrepreneurs who are maybe kind of on the fence get real focused about getting ready for that competition, and then that does drive good deals. And then we at the application deadline, we then use those applications to teach angel investors. So, we spend three months working with the angels and helping them look at different kinds of deals, all different kinds of industries, things at different stages with all kinds of different needs and opportunities.

Mysty Rusk: And then they work together to pick a winner. So, this year we had 125 companies were down to seven right now. We're about to. In a couple of weeks, we will pick the winner. And this year we've raised over 300,000 titles. Does a winner take all? But probably what we'll do is we'll do $200,000 for the winner, and then they'll pick 1 or 2 more companies for whatever else is in the pool at that time.

Sean Weisbrot: All right. Great. Thank you for the introduction. I appreciate it. And it leads me, I guess, to ask the most logical next question, when did you know that angel investing was the thing that you wanted to do? And not only, like you said, angel investing, but in educating other people on how they can become an angel investor.

Mysty Rusk: I was in Corvallis, Oregon for a long time when I moved there. I heard that they had an angel group, and I was so excited, and I started hanging out with that, that group of people. And I went to all of their meetings, and every month they'd get together and they'd have a nice dinner and they'd hear a couple of deals, and then nothing would happen unless it was something that was really already in line with somebody in the room, somebody already had expertise or in that area, or had been in that industry for a long time. And we couldn't we couldn't fund anything except for the things that we understood really well among the investors. So, they could fund software and they could fund forestry-related things because those were the two places where that little town had made money.

Mysty Rusk: When the idea of a conference came up where we said, we're going to make it finite, we're going to give the money away on a particular day, and we're going to do this project together. And then we got 1 or 2 really great, well-rounded investors in the room who just asked great questions. That process, it was a big puzzle to figure out so that part was fun. But then the place where the change really happened, the interesting thing were, the part where I feel really pulled to is the sense of community that it builds. So, there's this tremendous thing that happens during the process of the Angel conference. At some point, people in the room realize that the next generation of business leaders is there right in front of everybody to see and that there's ways to help.

Mysty Rusk: You know, it's not just about money, it's about network and about expertise and other kinds of resources. And so not only is the next generation of business leaders emerging but also we don't need some outside program from some, you know, big governmental agency or some, you know, white horse riding across the horizon to come and save the day. The resources that we need, we already have. We just needed to figure out how to put them to use. So, it created this like really robust, cool environment where you saw this new kind of barn raising and community building, which is really, really fun. I think that's the part that I get the most excited about.

Sean Weisbrot: Okay, so I'm sure you have a lot of people applying to learn from you about how to become an angel investor, but how do you identify who is the right person to pick up and help? So, let's say, for example, you have 50 people apply for your conference to get the education. Do you take all 50 or do you take like ten?

Mysty Rusk: Angel investors to participate in our program have to be accredited. So, to be an accredited investor, you've got to have $1 million in assets that don't include your primary home, or you've got to have $200,000 in income or 300,000 as a family over the last two years. It's a more complicated definition that's put out by the SEC, but that's the most. Forward approach. That was the case until December 2020, when the rules changed. So new administrative rule by the Securities Exchange Commission. If you are working in a space where it is, you have a fundamental understanding of the risk that you're taking on, you can consider yourself an accredited investor.

Mysty Rusk: Those floodgates have opened. So, to start with the basic definition, that's the first thing that we have to do when we're looking for angel investors. And then for the conference that we do in San Diego, it's really become about the culture. So, the culture that has been created there, and the one that we work so hard to maintain is a culture of yes, because it's super easy to look at any kind of angel investing deal and get to know, like, you can imagine a way a company can fail. Right. And there are the things that are super real that you can see, like, you know, there's a hole in the management team or the go-to-market strategy isn't clean or clear.

Mysty Rusk: And there's the stuff that you can't see, like what happens when the whole world shuts down because of a global pandemic. When we're looking for investors, we're looking for investors who can see that possibility of yes, we know that there's going to be problems. And our job is to find the trouble, name the trouble, and then figure out how to mitigate it. So, if we can mitigate the risks, it becomes a workable deal. And if we can get to yes, you know, those are the companies that we really want to play with. And so, most of our time is spent on cultivating those relationships. So, people who come in and know it all, who think they have the ability to make all the decisions for the group, you know, those aren't good fits with an angel conference. It's a very collaborative process.

Sean Weisbrot: If someone wants to become an angel investor and they are accredited as the way the SEC would define it, and they have the ability to understand that they shouldn't be the decision maker, but they should be someone that can help the company in whatever way they can, things like that. What is the first thing that they should then learn? Because one is you have enough money, the other is you have the right personality. But certainly, those are not enough to be a savvy or a successful angel investor.

Mysty Rusk: We do spend some time early in the process on some what I'd consider a more structured, formalized education. We bring in speakers to talk about the legal structures and a little bit on how to review financials and what it means to have a great market opportunity and a path to a market opportunity, you know, go-to-market strategies, really critical thing. And if I'm going to say, you know, like, hey, I want to write you a $100,000 check, can you turn it into 1,000,005 in the next 18 months? That's a really hard thing. There's only really one answer to that, and it's sales.

Mysty Rusk: And if your answer as an entrepreneur is, well, if we just get 1% of the market, that's a really crappy answer. You know, a much better answer would be we've identified that you know, it's this one little subsegment, but we know exactly how to get to them. We've got lots of relationships, we've got the influencers, and we've got this path to it. If we can tackle that one, then the door is open for these other two and we know how to go tackle that, you know, once the opportunity is there. So, we're looking for opportunities for those kinds of deals. So, we're teaching investors how to look for those kinds of things.

Mysty Rusk: And then we do a couple of days of that kind of training for investors on how to review a pitch deck and how to evaluate a team. And you know, some of those. For structural things. The real learning, though, happens during the deliberations on the company. We start the first night. We give everybody access to 125 deals in San Diego. It's a record year for us with 125 deals, and then we send the investors in to look at the deals on their own for a week, you know, so they get a whole week to look at all the different deals and see what they can discover. And then we start talking about them as a group, you know, so short conversations about what people like or don't.

Sean Weisbrot: You said that you try to get them to understand how to get to. Yes. Are they spending this week trying to find reasons why they should invest in this company or potential problems that they want to have the company explain how they can resolve these problems? What are they looking for?

Mysty Rusk: Yeah, so it's a little bit of both. So, when we look at a company we start out and we look at maybe 4 or 5 different things, and we ask every investor to look at it from their own perspective. Right. So, for some investors, they want a quick return on their money. If you need a really quick, if not a 3 to 5-year return on your money, probably looking at things that are not physical, you're probably looking at things that are software, or you're willing to take a bigger risk and wait it out for a long period of time. Maybe that's a really good biotech play, you know, that you want to spend.

Mysty Rusk: I used to think it was 15 years. Turns out it's more like 7 to 9 years on a good biotech project to see it to the next conclusion. But as we're looking at things, we're looking for ways the company could fail. Right. Do we have not enough people in the company? You've got, you know, a solo founder who's trying to do everything themselves. There's a huge risk with that because there's so much to do in a startup. Is there a competition failure or is there a defense ability failure if there's something that someone else already has a patent on and you're making it in a new color or a new shape and it's covered under someone else's patent, that was what I'd call like a fatal flaw.

Mysty Rusk: Or you have intellectual property, but it's not assigned to the company. It's assigned to the person. You know, like we start to look for, for, for little things like that. And then any of those, you know, it becomes worth a conversation with the entrepreneur. Like, is this something you're willing to take a look at? Or how have you decided to mitigate that? Or among our group, we talked it over, and we've got somebody who knows somebody in this particular space, and they want to make an introduction for you. So, there's lots of ways to mitigate those risks too. We just want to find them and then figure out what the workaround is.

Sean Weisbrot: Sorry. Go back to the next part of the process of like you're-they are reviewing the decks and thinking of these conversational questions things like that. So, what happens after that or what else are they being taught to look at?

Mysty Rusk: Sure. So, the first thing we do is document review. And then we'll consider those deals for a couple of weeks. We'll have a number of conversations about them. And then we're going to vote. And we're going to decide that we're going to move a certain number of them forward. So, this year it was 30 companies. So, we try to get 24 to 30 companies. And then we invite those 30 companies in for a three-minute pitch. And we do a little bit of Q&A. We go back to the documents, look again, and see if some of our questions got answered and some of our concerns have been alleviated, or if now we have new ones and then we do that same process again, we'll talk it over for a couple of weeks. The. We vote again, and then we go down to sometimes 12, sometimes six.

Mysty Rusk: But we'll bring the next round of companies in for what I'd considered like a full pitch, like ten minutes plus Q&A. And then we picked six. And when we get down to the six, what we think are the six companies that are the most investment-worthy, then we start spending a lot of time with them. So, the first meeting is the founder, and they get a team of 8 or 10 investors, and they get three hours together for the first meeting and then site visits and customer calls and really digging into the financials and meeting some of the rest of the team for the final six. There's a very involved process of getting to know those six companies. And for us this year, it's seven.

Sean Weisbrot: Okay. So, I want to go back a little bit. You had said that there was a three-minute pitch. If you have 24 to 30 companies giving a three-minute pitch and you're taking half of them, let's say, what is it about those successful companies? What makes their pitches unique in those three minutes that makes the investors want to talk to them more?

Mysty Rusk: A three-minute pitch is really, really tough because there's no way for you to adequately describe the things that you really need to describe. For someone who doesn't understand you to make a call about whether or not there's something interesting there. So, when we ask everybody to come up with their own method for evaluating. But, you know, I kind of use five things. I look at the technical solution, which is the product market fit and the product itself.

Mysty Rusk: I look at the market opportunity, the business model, the team, and then the investment opportunity. You know, I said five things, but really there's probably 30 or 40 things that fit in those groupings and a three-minute pitch. It's almost impossible to cover those five, which means you have to be able to tell a good story about it. There has to be an emotional connection, a market opportunity that's really substantial, and a path to success. That creates the potential for a ten to 30 to 50 x return.

Sean Weisbrot: Let's say you do your three-minute pitch. Investors are interested in you. They go back and spend more time doing document reviews. So, what are they looking for then at that stage?

Mysty Rusk: We call it the due diligence process. So, in the due diligence process, we try and just find out everything. If there's something in the pitch that says the total addressable market for the industry is $40 billion or something like that, we're going to go fact-check it. Is that really accurate and true? You know, same thing with the segmentation. So, we're looking for one like third-party outside evidence that supports or disproves whatever they've told us so far. Part of it is a legal review. We want to look at all the employment contracts. We want to look at all the policies and procedures. We want to look at all the customer contracts, the organizing documents, the shares that you've held back to entice people to join you, like all of those kinds of things, to see if there's anything that we see that could be problematic.

Mysty Rusk: If there's software, a lot of times, you know, there's always this talk about, should you sign an NDA? Almost all of the entrepreneurs that come through our doors, we'll say their lawyers told them to make sure they got an NDA before they talked about this stuff. Every investor that we've ever trained, we've said, never to sign an NDA because you have no idea what you're limiting yourself to. And that will preclude you from being able to look at anything else in the future, right? So, there's a, you know, a fundamental difference there.

Mysty Rusk: The workaround is like if we're doing something like software and the secret sauce is really in the algorithms, then we're probably as an investor group, we're going to we're going to contract with an outside third party that the entrepreneur agrees with. That's not investing and is an expert in that space. And then we're going to have that person go and evaluate the software and sign the NDA. There's some ways that we can create an environment where we can, you know, we can fully understand what's going on, you know, sort of under the hood and not have to infringe on trade secrets.

Sean Weisbrot: I think it's scary for most startup founders to open their books and show all of the details, the very fine details of the contracts and everything they're doing, and not have an NDA.

Mysty Rusk: We take the confidentiality part of it really seriously. You know, once in a while we have somebody who, you know, doesn't think they can do that. We recommend that they go talk to somebody else. I always tell entrepreneurs, if you got something, you know, funky going on in the past or you know, they're going to find it, a good due diligence process is going to discover those things. So, you're much better off to put the cards on the table right from the start. One of the things that we cover in the training is that the number of hours you spend in due diligence, there's a magic spot. If you spend, you know, more than 20 hours doing due diligence, the success of the investment is going to be higher. I don't remember how much it is, but it's like a double-digit percentage higher.

Mysty Rusk: It does make a difference if you do a lot of due diligence. And so, the founder who's got a falling out between a co-founder, you know, sort of a messy breakup among early partners, you know, that happens pretty often, or a bankruptcy or a divorce where the spouse has a stake in the business. All of those things end up coming out in the wash. And so, I always just tell entrepreneurs to just lay it out, just say like, hey, you know, you're going to find this. So, we're just going to put it right out there. Here's what it is. It is what it is. And maybe there's an explanation of how you got into that and how you're getting yourself out of that, or it's been long enough that it's water under the bridge, but we almost always find the funky stuff.

Sean Weisbrot: It's definitely your right to ask those questions and to find those things out. And I don't recommend anyone ever try to hide those things. I guess the NDA was more about these are all of the things related to my business that I don't go around just telling everybody.

Mysty Rusk: If you're getting close to writing a check, the investors already figured out enough to know whether or not if it would compromise them in some way if they did that. So yeah, we do like later in the process. It's not totally unreasonable to have an NDA in play. You don't usually see it with groups though. Would be very hard for us to do an NDA. You know, with our fund we've got over 50 investors this year. It would be almost impossible to get each of them to sign an NDA and then even more difficult to try and enforce it.

Sean Weisbrot: So, after this due diligence process, trying to dig up all of the dirt and figure out what it is you're getting yourself into, what is the next step in the process of investing as an angel?

Mysty Rusk: One of the other things that happens during the due diligence process is you look at the deal terms. So, the entrepreneur is going to say. You know, like they think the company is valued at this much. And then there's going to be a discussion about whether or not that's accurate and how much, you know, what does the investment buy you in terms of stock in the company, or a convertible note that converts to stock at a later time, or, you know, any of those kinds of things. So, you know, like the next logical step towards the end of the due diligence process is team will write the due diligence reports. They'll put all of that in a document so that it's got a thoughtful flow to it and that it can be shared.

Mysty Rusk: All of the investors will take a look at that, and then it'll also include a recommendation. We recommend that this one goes forward for investment or we recommend this one doesn't. And then it's getting really clear on the terms. People talk about a term sheet. It's a worksheet that sort of lays out what everybody kind of hopes that they're going to put in and get out of the relationship. And then a team of lawyers will take those term sheets and turn them into the contracts. So once the contracts are signed, then we see the money move. Usually, I always talk about checks, but it almost never happens in a check. It's almost always a wire transfer.

Mysty Rusk: But the money changes hands from the investors to the entrepreneur. Then whatever they've agreed to in the contracting process, it could be that the investment is high enough that they're taking, you know, the investment groups getting a seat on the board or has some relationship. At the very least, there's some kind of information rights and an expectation that on whatever regular basis, they decide that the entrepreneur is going to report back to the investors about the progress of the company and financial performance and sales and those kinds of things.

Sean Weisbrot: What is the most common thing that happens at this stage that stops the investment from being completed?

Mysty Rusk: It doesn't happen very often. If you get all the way to negotiating the terms and you get to the end of the due diligence process, usually if the recommendation is to invest in the company, you don't usually see that get undone. We've got a company like this right now. The opportunities are really good. One, the valuation is really reasonable. They're investors kind of competing for that. And it's likely that that particular entrepreneur is going to have to close the round and open a new round at a higher valuation.

Mysty Rusk: And the new investors, the same investors want to come in. They're going to have to come in at a different valuation. So changes the value of what your investment is and that changes the return as well. If there's anything that stops it, probably that the entrepreneur hits the limit on what they've lined out legally in the round, and they have to pause the process and figure out how to navigate that with investors.

Sean Weisbrot: From outside of the perspective of your conference, what other advice can you give entrepreneurs who are potentially going to raise funds from angel investors?

Mysty Rusk: To be an entrepreneur? It's sort of an equal measure of persistence and tenacity and stubbornness and coachability. It's a really hard combination, like you have to be willing to be open to what everybody wants to tell you about your business, and at the same time, be clear enough on what you're doing, that you can make decisions about whether or not you take that advice or not, and staying with it. So, startup investors almost never fund solo entrepreneurs. It doesn't work that way.

Mysty Rusk: If you go back and you look at the materials you put together to talk with investors about, if you take a look at it and it reads like a sales. Pitch for the product, it's time to scrap that and start again. Investors are looking for what the upside is for the company, not the products that you're offering. So, it's not a sales pitch. It's a different kind of a pitch. So, you need to really re-task around that. And then, you know, the rule used to be I used to hear like old time investors say, oh, you got to do 90 pitches and 90 days like it takes. It's going to take that. I think that's a load of crap. I don't think that works well. I don't think it works at all.

Mysty Rusk: I think figuring out who you can get to help advise you who's got a network. Almost every community's got somebody whose role it is. It's your local economic development department or your chamber of commerce or your small business development center like almost every community's got one of those reach score chapter. If you reach out to those folks and say you're looking for help to raise angel investment money, finding somebody who can work with you and help you get that done, and always looking for somebody who can make the connections for you to the investors.

Mysty Rusk: A great mentor is not somebody who's been out of the workforce for 20 years. That's a really, really fun person to have a conversation with. But that's not the person who's going to help you make the connections. And when we're doing things, when we're looking at the companies that we serve, we're looking at like, how do we make 3 or 4 really important introductions and how do we do it before the companies are raising money? You know, because you need to develop a relationship before you can go back and ask for money. So, and there's that clever thing that people say, if you if you want money, ask for advice. If you want advice, ask for money. There's some truth to that. Getting involved. Building your network before you need it is critical.

Sean Weisbrot: So, I know we talked about this on the intro call, and you didn't want to make too big of a deal about it, but I do think it's really important to spend a minute even just to say it. Angel investors believe wholeheartedly that their investments will have an impact in some part of the world or some something. And I just want you to share real fast. One investment you made that came back to basically save your daughter's life.

Mysty Rusk: Kind of a cool story. And I think the overarching lesson is there are no coincidences. You know, I had a chance about 18 years ago to work with a group of professors that had landed in on this technology that eventually became a mechanical kidney. And, you know, at the time, I didn't know anybody who'd had kidney issues. And it turns out some years later, my daughter, about 7 or 8 years ago, developed some health problems that impacted her kidney and had full renal failure, that little grant that I'd worked on about this technology.

Mysty Rusk: Eventually, it became home dialysis. That company sold to another company, and they combined forces and created the first mechanical kidney. And the first mechanical kidney got approval to do its first human trial. And the human trials were going to be done at UCSF. So, the University of California, San Francisco Med Center, which is the number one kidney and pancreas transplant center in the world. It also happens to be my daughter's transplant center. So, there's a chance that as her kidney, because of her condition or, you know, even the new kidney is failing, there's a chance.

Mysty Rusk: That she's going to get to benefit from, you know, that work that I did almost 20 years ago to figure out how to help some professors write a grant. It'll save her life. So, it's I think if we all take the opportunity, we all have things we can point to like that things that seem completely unconnected, that there's serendipity and deeper connection, that we can't always understand why or what the outcome is going to be. But sometimes it comes back to service in the long run.

Sean Weisbrot: Thank you for sharing that.

Mysty Rusk: You don't know how, when you're just trying to do good work and help people out, how it's going to come back to save you in the long run.

Sean Weisbrot: So, what's something I haven't asked yet about angel investing that you wished I would ask?

Mysty Rusk: What kinds of projects do we see?

Sean Weisbrot: Talk about it.

Mysty Rusk: You know, I just told you the story about the thing that's going to save my kid's life. We get to do that every day. We've got projects that will revolutionize health care, that will change agriculture, that will alleviate some of the environmental impacts of having 8 billion people on the planet. So, to me, that's what really interesting stuff is. And I never see an entrepreneur who doesn't absolutely love what they do.

Mysty Rusk: Nobody's ever walked in my office and said, you know, this product really sucks, but I really think I can sell the heck out of it. Nobody says that to me, ever. Startups come in and, you know, they're really focused on making a meaningful difference and something that is important to them. There's something really fantastically special about being able to make a difference in the world and doing something that you love that can also generate wealth for your family.