(Editor’s note: Jason Cohen is an angel investor and the founder of Smart Bear Software. He contributed this column to VentureBeat.)

As someone who has both sought venture capital and distributed it, I’m lucky to have a pretty unique perspective on what works and doesn’t work.

As I mentioned in the first part of this list, the mistakes don’t seem to change over time. And people who make them often walk away not only empejectedty handed, but clueless about what killed their chances of getting funding.

What follows are four additional problems I see all the time:

Have a big monthly burn.

This depends on the type of business, but most software companies nowadays can be built with almost no expenses except wages – and even then, the founders should be taking a nominal salary until there’s revenue.

Huge expenses at the beginning are scary because expenses only go up. An angel-funded business lives and dies on how fast you can get to profitability, so big expenses means you’re already behind.

This is especially true of founders’ salaries. An angel wants to fund a company, not put money directly in founders’ pockets. If the founders aren’t willing to put in money now (in exchange for far more money later of course!), that’s already a bad sign that either they’re not committed to the venture or that they’re not in a good place in their personal lives to be taking a chance on a startup.

So how do you address expenses?

  • Break out: wages, overhead, COGS at least. I don’t want to see every line-item, but wages show founder’s draw, overhead is the biggest barrier to profitability, and COGS helps me understand how many customers you need before you’re not burning cash. If any one of those is out of whack, then we can dig in.
  • Explicitly talk about how founders will be deferring cash for themselves. The more committed you are, the happier I am. Once the company is profitable, I don’t care if the founders make good money.
  • If you do need to spend big money, justify. For example, is this one-time R&D that gives you an unfair market advantage? Good. I this for inventory? Good. Is this for in-house servers because you don’t trust Amazon? Bad. Is this for A+ office space because you think it will impress customers? Bad.

Pretend this isn’t risky.

You’re at the earliest, riskiest stage of a business. Every choice is suspect, every plan is really a guess – and there’s a great chance the angel is going to lose all her money.

Pretending otherwise comes off as naive (at best) or ignorant (at worst).

There’s a difference between being confident in your ideas and in the clarity of the market opportunity, and coming off like this is going to be easy.

Remember, angels know this is a crap-shoot, and we’re here anyway! So of course it’s OK that it’s risky. The thing I want to hear from you is what you’re doing to address risk. The worst thing you can do is ignore that it exists, because then I think you don’t know the risk exists – and that means you won’t attack it. And there’s no way I invest in that.

Here’s how you can address risk while still giving the investor confidence:

  • Here’s your mindset. Angels are gambling, yes, but there are different kinds of gambling. Money on the roulette table is a pure, random guess, and the house wins more often than not — that’s not the kind of bet we want to make. Instead, I want you to be a card-counting shark playing at a blackjack table with a single deck. Sure, you can still lose, sure there’s plenty of luck, but you have an unfair advantage, and I’ll bet on that. So when you’re addressing risks, think “unfair advantage” and “luck, but with a bias,” not “it’s out of my hands.”
  • List the known risks so I can evaluate them. In my experience, no matter how massive the risks are, if you’re honest about them I’m very likely to believe they’re a good risk, just because I can see you’re honest and you have both eyes open.
  • Show me how you’re addressing risk and reducing risk, rather than how there isn’t risk. Show me how you intend to deal with the unknown or uncontrollable, not “how in control” or “in the know” you are.
  • Show me you’re open to new ideas. When we talk about risk I’ll probably have ideas too. Some of them will be stupid, but some will be useful. If we can brainstorm and categorize those, I’m comfortable.

Don’t interview me.

Most pitches come off as begging. You need money and you’ll do or say anything to get it.

But answer me this: If you don’t act like you’re valuable and that I should be thrilled for the privilege of giving you money, then why should I believe you’re valuable and that I should be thrilled for the privilege of giving you money?

This is a two-sided interview. And if you can’t walk away from this arrangement, you’re not in a negotiating position, and I can tell.

Here’s how to do it:

  • There’s a difference between confidence and arrogance. The latter is a turn-off, the former is a turn-on.
  • Tell me which other investors you’re talking to. Make it at least appear you’re in demand. But remember angels often know each other or can find each other, especially in the same city, so you can’t lie about anything. So don’t lie – talk to lots of angels at once.
  • Interview the angel investor. Ask things like:
    • What else have you invested in? (Then follow up later; are those are good companies?)
    • Tell me your philosophy on startups. (Make sure this matches your own)
    • What companies have you founded and run? (If “none,” this person probably won’t be of much use.)
    • What will you bring to my company besides money? (Usually this answer will feel unsatisfactory to you; that’s because usually angels don’t have much to offer. If you just want money only, that’s fine of course, but if you’re expecting more — like direction or advice — grill them here. If they say “I have connections,” that’s crap. You don’t need introductions, you need action!)

Don’t have an exit strategy.

It’s too early, of course, to say exactly how this company is going to make us both rich, but I want to know the ways we can get out of this deal.

Remember, the angel is here to make money. Changing the world, thrilling customers, getting an ego-boost – that’s for founders. Investors need money, only. So you have to address how that’s going to happen.

Some founders want to be “king” instead of “rich;” no exit strategy means you might be one of those. That’s fine for you – nothing wrong with that! – but it’s not good for the angel.

Here’s what I want to see in your exit strategy:

  • Explain the type of company who would purchase you, why they would and list some names.
  • Give me various ways to get out, not just one.
  • Tell me that if you get profitable and for whatever reason stock isn’t liquefying, that the investor has an option of just getting a good return on her money. This is usually in the form of a balloon loan or convertible warrants — in your pitch I don’t care what the mechanism is, just tell me that you’re up for that option too. After all, not all companies should or will be sold, and if you can give the investor a good return and you get to remain “king,” that’s wonderful for all parties.
  • Don’t tell me about valuations or multiples. Angels already know about these things, and they probably know more than you do, which means you’re walking into a mine field. If you’re too low, your company looks worthless. If you’re too high, it makes you look silly and naive. The truth is that valuation is highly variable, and that’s OK! That’s what the angel is getting himself into, so don’t worry. Stick to the paths to success rather than absolute dollars.

Photo by SD Dirk via Flickr

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