Most new businesses need money to get off the ground. But where can founders find the money they need? Lenders, such as banks tend to shy away from startup businesses that do not already have sufficient cash flow to cover the payment of principal and interest on a loan. And despite all the publicity surrounding venture capital funding, only 0.05% of new businesses ever obtain money from VCs. Often, the answer for many startup businesses is angel investors.
What are Angel Investors?
The term “Angel Investor”, also called just “Angels” comes from the theater, where a wealthy investor often came to the rescue and provided the money necessary to bring a play into production.
Angel investors fund over 63,000 startups a year, for a total of more than $23 billion, according to the Center for Venture Research at the University of New Hampshire. Most angels are not full-time investment pros. They use their own money, although they typically provide funds through an LLC or a trust, and focus on fledgling firms.
Most angel investors acquired their investment funds through a profitable exit event and were able to capitalize on the success of their companies. Many of these successful entrepreneurs feel they have the “Midas Touch” and can repeat their success as an investor vs. a business owner.
How Angels Invest
Rather than investing in a single business like the one they once owned, they look to diversify their portfolio by investing in several businesses. The chances of a high return on any one investment is often slim, therefore angels are investors willing to take an educated bet on across several angel investment opportunities.
Angel investors provide funding to startups in exchange for either convertible debt (bonds), equity (shares) in the company, or a combination of both.
After a founder works through the first two stages of the 5-step funding plan with bootstrapping or funds from friends and family, usually the first sources of funds when the startup is working through the idea and proof of concept phases, angel investors are a likely source of funding as the business goes through the product design and product development phases.
Most angel investors are what the SEC calls accredited investors. By definition, an accredited investor is someone with an annual income of over $200,000 ($300,000 for joint income) for the last two years or a net worth exceeding $1 million in investable assets (excluding the primary residence), either on their own or with a spouse.
NOTE: Angel investors don’t have to be accredited investors anymore thanks to the Jumpstart Our Business Startups (JOBS) Act of 2012, which allows a non-accredited investor to invest in startups via crowdfunding platforms.
For non-accredited investors investing in a startup via a crowdfunding platform, the amount they can invest is limited by their income and net worth. For example, if an investor’s annual income or net worth is less than $107,000, they can invest either $2,200 or 5% of the lesser of their income or net worth, per year. Also, businesses can only raise $1 million over a one-year period from a crowdfunding source.
What Angel Investors Look For
Angel investors share a few common traits in what they look for in an investment.
Founding Team – Angel investors not only look at the product or service but the passion, and business acumen the founding team brings to the venture.
Seeking Safety in Numbers – Most angels don’t like to fly solo in a deal. Often, angels operate in what’s known as angel groups, where they can pool their capital along with other angel investors, to raise the total investment need of the business and reduce their personal exposure to any one single deal.
There are more than 400 angel groups around the country. They’re typically organized by geography. Check your local public library as they likely have a list of these organizations.
Besides that, there is the Angel Capital Association that can help connect founders to angel investors.
According to the Halo Report, most angel investors focus on certain fields and industries. The top four are:
- Information Technology
- Consumer Products and Services (B2C)
- Business Products and Services (B2B)
Return on Investment – Angel investors look for returns of about 25% or more over a period of five or so years via a successful exit, most typically when the business is bought out as part of an acquisition from a larger company.
Advantages of Angels
The advantages of a business getting funding from angel investors are as follows:
No debt. Since the business did not have to borrow money, the business is not saddled with principal and interest payment requirements while they are still in the pre-revenue phase or when cash flow is tight, which is often the case with startups. Having no debt is especially helpful if the company does not prosper.
Access to expertise. Angel investors are often what I would call smart money since angels have expertise and connections that the fledgling business desperately needs.
Access to growth capital. Once an angel invests in a pre-revenue business, there’s a pretty good chance they’ll add another cash infusion later on as the business scales.
Disadvantages of Angels
Creative tension. Most successful entrepreneurs get personal satisfaction learning how to conquer a specific industry. Angel investors are no different, but they often invest in ventures that are somewhat foreign to them. While many of the business lessons they learned can apply to any business, each industry has its unique set of challenges to success. This mismatch often leads to creative tensions between founders and angel investors, which drives many founders to try to succeed on their own.
Loss of control. Founders have to give away anywhere from 10% to 50% of their business to the angel to make it worth their while. That also means losing some say on how the company is run, as investors are entitled to play a role in business decisions since their money is at risk.
Hard to get. According to data gathered by Southern California’s “Tech Coast Angels”, about 500 companies apply each year for funding. Of that, about 25% make it to the screening process and 10% of companies make it to due diligence. Although each year varies, they typically fund between ten and twenty new ventures per year. Therefore only 2 to 4% of all founders looking for an angel investor are successful in obtaining funding.
Can your business benefit from an investment from an Angel Investor?