In small business finance, angel investors are high-net-worth individuals who act as a source of funding for startup companies in exchange for ownership equity. If you’ve seen the hit TV show “Shark Tank,” then you’ve seen angel investors at work. The show’s regular cast members are angel investors who look to invest their own money in promising early-stage small businesses.
What Are Angel Investors?
As much as 90% of all seed and startup capital comes from angel investors. So, angel investors can help fill the gap between businesses’ initial startup funds and more formal venture capitalists. Like venture capitalists, angel investors want a high rate of return. Unlike venture capitalists, however, angel investors invest their own money in early-stage startups in exchange for equity, or part ownership of the business.
Often, they get personally involved with helping their investments on the path toward profitability. While some angels invest purely for profit, many want to make an impact in causes and industries they’re passionate about. For example, angel investors might champion eco-friendly sustainability or education.
There are several types of angel investors, so learn about each one and consider which is the right type for your business. Doing so can be one of the most important decisions you make as a small business owner or founder.
Many angel investors are accredited investors. The Securities and Exchange Commission (SEC) defines this status as an individual with a net worth of $1 million or more in assets. And that $1 million in assets does not include personal residences or income of $200,000 for the past two years. While angel investors are often accredited investors, not all accredited investors are angel investors.
Angel financing increasingly comes from angel groups. Angel investors form angel groups as a syndicate, and each angel investor contributes funds to invest. All members may share in the due diligence necessary for any major investment, though sometimes a professional syndicate management team chooses the investments. This collaborative operation allows the funders to draw on one another’s experience and expertise. By sharing the workload and pooling their money, angel groups raise their overall potential investment level and may command more favorable terms for the group’s investors.
Venture capital (VC) funds are different from angel groups. As pools of other people’s money, they’re managed by professionals, meaning the individual investors are not directly involved in their investments. In fact, VC money can come from:
- Pension funds
VC’s also typically make larger investments than angel groups.
Friends and Family
Friends and family are the most common source of funding for startups. This may be because friends and family are the only options for many founders. Yet this type of angel capital is often considered high risk because personal relationships are at stake, especially if the business is not successful. As an entrepreneur, be upfront about any risks, especially when communicating with investors with whom you have a personal relationship.
Are Angel Investors a Good Idea?
Startups are often cash-strapped. This is part of the reason angel financing has grown steadily over the past few decades, becoming a primary source of funding for startups. Many early-stage businesses find angel financing more appealing because they don’t yet have enough cash flow to secure a business loan. Working with angel investors also offers entrepreneurs a lower-risk option than going into debt to finance their business, even if they can secure a loan. We’ll get to that in a minute.
Some, however, may see a “catch” for this no-debt route. Business owners typically give up complete control of their business when they make a deal with angel investors. Why? Because, in exchange for the invested capital, they sold equity in their business. Their angel investor now gets a say in how the business is run. But that doesn’t have to be a bad thing. In fact, angel-funded startups often have a higher chance of survival. Besides bringing money to the table, an angel investor often brings guidance and expertise in a relevant industry. He or she may also have access to good suppliers and strong business connections that can help support a startup in its early stages.
Some angel investors may even want a more active role that goes beyond offering advice, connections and guidance. So, before you look for an angel investor, consider whether you just need financing or a partner. If you find an angel investor whom you’d enjoy working with on a regular basis, including making important decisions together, then it may be a match made in financing heaven. If you don’t want to relinquish any control, however, then you may want to reconsider angel financing or look for an angel investor with a more hands-off style.
Do You Have to Pay Back Angel Investors?
Unlike a traditional loan from a bank, you do not need to pay back angel capital if your business fails. Angel investors know that the business could fail during the early stage. And, if that happens, they understand that they’ll lose their investment. This risk explains why angel investors typically look for a 25% or higher rate of return on their invested capital. It’s also the reason many professional angel investors are more eager to invest in businesses with a defined exit strategy such as a public offering, which we’ll get to more in the next section.
How Do You Attract Angel Investors?
Angel investors are often inspired by innovation and entrepreneurship, so they usually want to be involved in their investments. Again, this can be a bonus beyond financing your small business because angel investors often come from unique backgrounds and can offer perspectives that help your small business. When trying to persuade a potential angel investor, approach them with a thoughtful pitch. Let them know why you’re reaching out. Capture their interest and inspire them to join your mission. To find the best angel investors for your business and get them on board, use the following tips.
Never Underestimate the Power of Networking
Entrepreneurs should always network, especially because most angel investors come through personal connections. If in-person meetings and events aren’t your favorite part of being a business owner, keep faith. It’s possible to overcome your aversion to networking, even for introverts. And doing so can help you meet the right people to build a successful business.
Not sure where to start? Check out your local chamber of commerce or small business development association. There are also online databases such as AngelList or Gust that connect angel investors with entrepreneurs. Many angel investors invest in people more often than they invest in ideas, so the best way to find an angel investor may be through a personal introduction from a colleague or friend. Try using LinkedIn. Look up your target investor’s profile to discover whether you have any mutual connections. If you do, then reach out to your mutual connection and ask for a warm introduction.
Do Your Research (Know Your Industry)
When seeking angel financing, it’s imperative to know your industry. So take time for extensive market research. You must know the competitive landscape, who your customers are, and all potential risks and opportunities. Your market research may even lead you to angel investors in your niche – a retired executive or industry consultant, perhaps.
Doing your research will also prepare you for questions that an angel investor is likely to ask. These include queries related to detailed financial projections, the lifetime value of a customer and your marketing strategy.
Present a Solid Business Plan
Most angel investors will want to see a well-thought-out business plan before deciding whether to invest. That means you need to consider and present all potential risks. You should also avoid being overly optimistic about revenue estimates. If you can, include early evidence of traction toward your plan, such as initial sales numbers or positive customer feedback.
Keep in mind that most angel investors are more keen on opportunities that have a defined exit strategy. This shows them a clear path leading to their target rate of return on their investment. Exit strategies for your company could include being acquired or aiming for an initial public offering.
Your business plan may be fluid as you continue to make progress toward your goals, so set expectations accordingly. Be realistic. After all, business ownership is a marathon, not a sprint. And angel financing can be an integral piece in your race to success. Once you’ve determined which type of angel investor makes the most sense for your business, refine your business plan and prepare your pitch. Then, network to find a source of angel financing as well as support that will foster innovation and propel your business forward.
Next Steps: Want to learn more? Sign up for the Small Biz Ahead newsletter to receive a weekly roundup of the latest tools, trends, and resources.