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The word “angel” as a business term started off on Broadway to describe wealthy people who provided backing for theatrical productions. Today’s business angels have coalesced into groups that turned their attention from the bright lights and the roar of the crowds to a playbill focused on diverse industry sectors.
The United States has about 350 of these groups, including Cherrystone Angel Group, Rhode Island’s first such collection of investors and now an important springboard for launching startups to bigger and better things.
Before Cherrystone was founded in 2004, fledgling Rhode Island companies looking for investment used the oft-tried yet often-flawed system of word of mouth. “It worked on the basis of if you knew someone who knew someone,” said Cherrystone Executive Director Peter C. Dorsey Jr. The local investment world was unorganized, and entrepreneurs whose funding needs were too small for venture-capital groups were hamstrung.
Enter angel investors, who are frequently retired entrepreneurs or executives. Their motives may go beyond ROI, preferring instead to keep a finger on the pulse of current developments in a particular business arena, mentoring a fresh generation of entrepreneurs or just lending their experience. What they bring to the table in the form of management advice and contacts is as important as their financial commitment.
Robert Manning, Cherrystone’s chairman, says the group’s brain trust – from 23 at the start to 62 now – is the bedrock of the company’s success. “In our members, we have deep veins of talent from which to mine,” Manning said. “These are participatory investors, who play a huge role in our due diligence process when assessing a potential business. When we get involved, we ask for observer rights on the company’s board to watch its evolutionary development, and if we don’t have the knowledge in-house, so to speak, we’ll bring that in from outside.”
Fine-tuning its deal-making processes describes in large part the story of Cherrystone’s decadelong existence. This includes learning, refining and recognizing the red flags. “We’ve gotten smarter along the way,” Manning added. “Some of the deals we made in our first three or four years … 50 percent of them we wouldn’t make today.”
During its 10 years, then, Cherrystone has championed 22 local companies, injecting $9.96 million into prospects such as SmartCells Inc., Respiratory Motion Inc., NuLabel Technologies, Advanced Image Enhancement, and the more sexy but most unlikely member in its portfolio, Narragansett Brewery.
More important than the initial $10 million of investments in its portfolio companies is the $60 million Cherrystone has amassed for its hatchlings for their second and third rounds of additional financing. Here is where A-round investment groups throw in the most amounts of their time and financial clout. A startup’s success is measured by the number of successive financing rounds it generates.
“They must meet those benchmarks to guarantee that funding continues,” Manning said. In order to get the size of capital required to take a company with a watertight plan, a prototype, and established set of beta customers to the next level, Cherrystone will normally raise anywhere from $300,000 to $750,000 for that first kick-start. Then it gets other angel groups to chip in.
“If we need funding that is in the $1.5 million or $2 million range, we have to break it up into small pieces and syndicate it,” said Manning. Here is where members’ experience and fat Rolodexes come into play. Syndication is cooperative work among angel groups. But in Cherrystone’s case, working alongside Boston-based angel groups like Boston Harbor Angels, Launchpad and Mass Medical Angels has not been a tale of the little brother seated at its older brothers’ tables.
“Success is measured in many ways,” said Manning, “one which the company is proud of is that when it comes to deal-making, Cherrystone is usually approached to be the lead negotiator by other angel groups.”
But what does success for an angel group look like? Aside from the obvious, how is it measured?
After the 2008 financial meltdown, the investment landscape shifted. “After 2008,” said Manning, “most exit strategies designed for startup companies exchange one investor base [Cherrystone, say] for another [like a GE or Stryker], moving the startup company from break even to market share.”
For Cherrystone, companies such as SmartCells, which develops diabetes treatments, went on to become part of Merck, and Horizontal Systems, a software design company, was sold to Autodesk. It’s a three- to five-year commitment ending with an A-round buyout. The company shoots for a return that is six times the value of its investment.
“We’re not a grant-making fund,” said Dorsey. “The relationship we have with our companies needs to be a win-win situation for both us and them. What we are looking for are heat-seeking companies … those who are able to evolve during the different rounds and not take their eyes off the prize.”
In 2012, the Wall Street Journal reported that the National Venture Capital Association estimates that 25 percent to 30 percent of venture-backed businesses fail after their fourth year – that is, after investors stop injecting more capital. It is a testament that in the game of high risk and high reward, Cherrystone has done more than survive; it has emerged as a leader. Its golden rule has been never to invest in companies that it cannot drive. Cherrystone emphasizes that once it backs a company it is in the game deep.
“Cherrystone has been instrumental in the creation of an organized investor marketplace, and in doing so has made it easier for risk capital to get to early stage companies,” said Manning. “The equation for success is forming a support mechanism. When you get investment from an angel group, you get access to information; it’s the personal side.”
Angel capital was once the domain of friends and family, who put their hard-earned cash and a bundle of belief into something dear to someone they knew well. This “gifting” was sometimes known by the acronym FFF for “friends, family and fools.” In its lifetime, Cherrystone has acted like a friend to its startups, while being honest with them to an extent that friends seldom are.
It has built a family of investors, blending its hard-gained experiences to support winning business plans that have staying power. And it has survived through economic turmoil and shaky market confidence to cement the idea that, yes, any fool can invest, but true investors are anything but fools.