What Is An Angel Investor? When Is It The Right Choice For Business Startup Financing?
In the mythology of startup culture, no figure looms quite as large as the angel investor. These fickle, godlike beings can become so enamored by your entrepreneurial genius that they come down from heaven and offer you vast sums of money to help manifest your dreams.
But are they mostly just hype? How do you get their attention if you want to work with them? What kinds of businesses are they a good fit for?
Below, we’ll pull these mysterious figures out of the clouds and see what they’re made of.
Table of Contents
- What Is An Angel Investor?
- How Angel Investing Works
- The Difference Between Angel Investing & Venture Capital
- Is Angel Investing Right For You?
- If Angel Investing Is The Right Fit: Next Steps
- Learn About Other Types Of Financing For Startups & Entrepreneurs
What Is An Angel Investor?
An angel investor, or sometimes just “angel” in the investment world, is an individual who reinvests some of their wealth into startups that are very early in their development process.
Prior to 2012, these were specifically accredited investors earning more than $200K a year or who owned over $1 million in assets. Now, thanks to the JOBS Act, the term also includes less wealthy people who, with or without accreditation, invest in a company through crowdfunding platforms.
These investors may act independently or as part of a network of angel investors. In 2019, angel investors accounted for around $228 million in startup investments.
How Angel Investing Works
The classic catch-22 for startups is that they don’t have money to begin operations, but they can’t get loans because they aren’t yet generating any revenue. You can hardly blame banks and other lenders for not wanting to take that gamble. The failure rate for startups is extremely high, somewhere between 75% and 90%, depending on how you define them. They simply don’t fall into traditional risk models.
Angel investors aren’t offering money in exchange for debt. Instead, they’re buying equity in your business. The percentage of your business they’ll ask for will vary from angel to angel and deal to deal. Typically, the more money they’re offering, the larger the share of your company they’ll want in return. You will be giving up at least some control of your company, though frequently less than you would if you received venture capital. For the angel, this is a high-risk, high-reward investment. Statistically, they’re likely to lose their investment, but the rewards that come from investing in a successful startup can be enormous.
Angel investors may invest in your company as:
- Individuals: Essentially, the angel will invest in your company, along with any of your friends and family who are trying to help your business get off the ground.
- As A Group: Nowadays, many angels pool their resources into groups that can then collectively review and examine business proposals. This may also include certain types of crowdfunding, where the funders are getting equity and not just, say, a product or reward.
The Difference Between Angel Investing & Venture Capital
So wait a minute, these are people who invest in startups early in their lifecycle? That sounds a lot like venture capital. What exactly is the difference between an angel investor and venture capital? Are they the same thing?
No, but they swim in many of the same pools. For starters, venture capital tends to come from venture capital firms that pool resources from different individuals, funds, banks, and other entities. Venture capitals tend to specialize in specific types of are startups, developing some expertise in the lifecycle of, for example, mobile software application startups. Many VCs are even more specialized than that, focusing on specific phases of early business development.
Angel investors, even if they have their fingers in some venture capital organizations, invest their own money directly in a startup. Not only that, but they tend to invest at earlier stages of business development than venture capitalists. They specialize in investing in companies that aren’t yet at the stage where they can raise venture capital.
Finally, while both angel investors and venture capitalists will take shares in your business, angel investors tend to not be as hands-on with the day-to-day operations of your business. Where venture capital firms will demand a formal role in your business (such as a seat on your board), angel investors often take on more of an advisory role.
Is Angel Investing Right For You?
There are a few factors to keep in mind when you’re evaluating whether or not angel investing is a good way to fund your startup.
Do You Want To Give Up Equity?
Equity financing may seem like a godsend when you aren’t generating any revenue. It’s almost like free money.
Don’t let the “almost” fool you. You are selling a percentage of any future revenue you generate, and if your venture is successful, it may be worth far, far more than the debt you would have paid for a loan. Not only that, but the angel investor will likely want to have some input into how your company is being managed. This isn’t always a bad thing, as many angels are experienced entrepreneurs themselves and may be able to offer valuable advice. On the other hand, they may have a different vision than you do, and you may end up having to manage their expectations in addition to your business.
Do You Want To Put In The Time To Find An Angel?
It’s no coincidence that they’re named after a mythical entity — angels don’t grow on trees. Be prepared to make a lot of cold calls, attend a lot of unproductive meetings, and shake a lot of hands. Angels tend to want to invest in industries in which they have some expertise, so not only do you have to connect with an angel investor, you have to find one who invests in your type of business.
How good are you at schmoozing?
Is Your Business Plan A Good Fit For Angel Investing?
Angels are looking for a big return on a high-risk investment. They’re prepared to wait a few years to see it, and they’re even willing to risk losing their investment.
What they’re probably not going to do is invest money in a business with a slow, conservative growth plan that will pay out comfortable but modest wages for the management team. They’re looking for intriguing intellectual property and gigantic markets for your product.
They’re looking for exit plans, so make sure you have some enticing ones.
Are You Located In A Community With A Thriving Angel Investor Scene?
With the advent of crowdfunding platforms and similar networks, this may not be as big a deal as it once was. However, whenever you’re talking about any kind of hotshot investor, it immediately conjures a handful of big cities known for generating startups. There’s simply more local investing infrastructure in places such as New York City, Los Angeles, San Francisco, and Austin than there are in most other cities as well as more of a “risk-taking” culture.
That doesn’t mean you can’t find it elsewhere, only that you may have to be more creative about how you go about seeking angel investment.
Can You Deal With The Consequences Of Failure?
You can breathe easy; I’m not talking about broken kneecaps and Molotov cocktails. Angel investment is, by and large, very safe. Just keep in mind that angel investors form networks and talk to each other at great length about the businesses they’ve funded. If you develop a reputation as a poor investment, it’s likely to get around and make it more difficult to secure angel investment in the future.
If Angel Investing Is The Right Fit: Next Steps
If you think angel investment is right for you and that your startup idea fits the profile of a company that angel investors would be interested in, you’ll be wanting to know what’s next.
1) Highlight Your Leadership Skills
Angel investors are going to prefer to work with a known quantity and someone who has experience successfully bringing a product to market. If you look like you know what you’re doing, you’ll have an easier time raising capital.
2) Touch Up Your Business Plan/Proposal
Make sure you’re emphasizing elements that will catch an angel investor’s eye. Highlight the size of the market you plan on reaching, the value of your IP, and your exit strategies, including possible acquirers.
3) Find Some Angels
Now you need to find some investors. If you aren’t lucky enough to be networked in with the angel investment scene, you’ll want to hit up some online networks. These include groups such as AngelList, Gust, and even more generalized platforms (e.g., LinkedIn). Be sure to also check with groups in your local business scene; you never know who might be able to make an introduction for you.
Learn About Other Types Of Financing For Startups & Entrepreneurs
While many startups would love to work with an angel investor, keep in mind that there are other ways to finance your business should they prove elusive. We’ve already talked a little bit about venture capital, which is another type of equity financing commonly used by startups. If you’ve never heard of venture debt, it’s worth keeping in mind if you need to fund working capital or equipment expenses along the way. You may also be interested in crowdfunding in a more general context.
Finally, if you don’t think your business model is a good fit for equity financing, you may want to look into using a personal loan for business expenses.