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How Angel Investors Can Fund Your Business

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This post is part of a series called Funding a Business.
Raising Money For Your Business Through Crowdfunding
How to Raise Money From Venture Capitalists

If you’re looking for funding for your business, the answer may lie with an angel.

No, we’re not talking about divine intervention. Angel investors are wealthy individuals who invest in small companies, hoping that one of them becomes the next Google or Facebook. If you can attract one, they can provide a much-needed injection of cash for your company.

In the previous tutorials in this eight-part series on Funding a Business, we’ve looked at funding a business by drawing on your own resources, by borrowing money and by asking the crowd.

Now it’s time to start looking at the equity route. All of these options work in the same basic way—you receive cash from an investor, and in return you give that investor an equity (ownership) stake in your business. But there are significant differences in how they work in practice, so we’re going to look at each one in detail, starting with angel investing.

The goal of this tutorial is to give you a clear idea of how angel investing works, and the advantages and disadvantages of this method of funding your business. You’ll also learn how to find angel investors, how to pitch to them successfully, and how to work with them after you’ve secure funding.

1. What is Angel Investing?

“Angels” are people with money available to invest in small businesses. Often, they’re successful entrepreneurs themselves, looking to invest some of their wealth in promising ventures.

If you secure an angel investor for your business, here’s what will happen:

  1. The angel investor writes you a check for the amount you agreed upon. It could be anything from a few thousand to a few million dollars. The average deal size is $520,000, according to the Halo Report.
  2. In return, the angel gets a share of your business, say 10%. He or she now owns that portion of your company, and gets a cut of any future profits. It’s also possible for the investment to take the form of a loan, but an equity stake is more usual.
  3. The angel’s objective is usually to sell his or her stake later on, say five years down the line, for a significant profit. If your business fails, you don’t have to pay back the money the angel invested, as you would with a loan. All the angel is entitled to is 10% of the company’s value, whether that’s millions of dollars or a big fat zero.

As you can see, it’s a high-risk strategy from the angel’s point of view. If your business fails, they could end up losing all their money. Because they often invest in young, unproven companies, angels do lose out on some of their investments. But when it works, the returns can be spectacular. Their aim is to make a big enough profit on the successful deals to cancel out their losses on the duds.

Angel investing is often associated with Silicon Valley, but in fact there are angel investors all over the country. The Halo Report says only 20% are in California, and the fastest-growing region recently has been the Great Lakes. There are angel investors outside the U.S. too. The popular AngelList site features angel investors in Ireland, Singapore, Colombia, India and many other countries.

Angels invest primarily in small businesses with high growth prospects, often tech firms, but also in other fields like healthcare and energy.  What’s important to an angel investor is not so much what industry you’re in, but what your growth prospects are.

2. Advantages of Angel Investors

If your business has high potential but limited funding, angel investors can provide the fuel for spectacular growth. Here are some of the advantages of funding your business through angel investors.

Availability of Funding

Angels will often step in where other investors fear to tread. They’re looking to “get in on the ground floor” with the successful businesses of tomorrow, and are comfortable taking risks that other investors might not want to.

Mike Markkula, for example, invested $250,000 in Apple Computer back in 1977, when the company was less than a year old and had only sold a couple of hundred computers. Other funding routes would not have been available to such a young company. In return for his money, Markkula got ownership of one-third of the company and became its third employee.

So one main advantage of angels is that you might be able to secure funding from them when banks, venture capital and private equity firms won’t touch you.

Flexibility

Banks and investment firms often have very strict criteria about how much funding they’ll provide, how big a company has to be, and so on. Angel investors are often more flexible, investing anything from a few thousand dollars to a few million. This means that angel investing can be a viable option for a wide range of businesses, from very small startups to companies with much larger ambitions.

Expertise and Contacts

Mike Markkula didn’t just bring money to Apple. He also provided business expertise, and helped the company obtain credit and venture capital funding. Co-founder Steve Wozniak said Markkula was more responsible for Apple’s early success than either himself or Steve Jobs.

Many angel investors play a similar role, drawing on their own experience to help the companies they invest in succeed. They often have a wide network of contacts, which can help you obtain new customers or partners.

Better Success Rate

Research by Harvard Business School found that firms funded by angel investors had higher survival rates, faster growth, and were more able to achieve additional fundraising than other firms.

Of course, not all angel investments work out. But the money and the expertise provided by angel investors can certainly help companies survive the early years and achieve the growth they are aiming for.

3. Disadvantages of Angel Investors

Angel investors got their name from Broadway productions in the early 20th century, when money for new plays was hard to come by, and the wealthy businessmen who put up the funds seemed like angels.

Angels can still have that aura for a struggling business today, but it’s important to bear in mind that, despite the name, they’re not doing you any favors. They’re business people looking for profit. Here are some disadvantages of working with angels.

Investor Expectations

Angels take big risks, and are looking for large returns, something along the lines of ten times their original investment. That’s not because they’re greedy: it’s because many of the companies they invest in will not deliver any return at all, so they need to strike it big on the successful ones.

So if you want to find an angel investor, you need to have a business that can deliver explosive growth with the right funding. And then you have to deliver that growth, otherwise you can expect to come under a lot of pressure.

Loss of Control

When the deal is struck, the angel investor becomes a part-owner of your business. That means that he or she will also have a say in how it’s run. The details of what the angel can and can’t do will be spelled out in your agreement, but expect to lose at least some control of your own company, and to be answerable to your investor for some of your strategic decisions. You’ll also lose a big chunk of future profits. If you do make it big, that stake you’ve given to the angel investor could be worth a lot of money.

Limited Funds

While the money that angel investors provide can seem like a godsend to many small businesses, their investments are small compared with some of the other options we’ll look at in future tutorials, like venture capital and private equity.

It’s also usually a one-time deal. An angel is unlikely to want to keep pouring money into the business, unless you can show strong profitability. Generally, you need to make good use of the initial funds, because there’ll be no more to draw on when it runs out.

4. How to Find and Work With an Angel Investor

Finding an Angel

If you think you might want to work with an angel investor, the first step is to find one. There are several web platforms that aim to connect companies with investors, for example AngelList, SeedInvest, FundersClub and DreamFunded.

But despite this, the Halo Report says that in three quarters of angel investing deals, the investor and the company are based in the same state. So as well as looking on the web, it’s also worth searching locally.

Many states and cities have their own local “networks” of angel investors, for example ARCHAngels in Ohio, The Angels’ Forum in Silicon Valley, and New York Angels in—yes, you’ve guessed it, New York. The Angel Capital Association has a useful list of local networks.

You can also find an “angel” who doesn’t call herself an angel, and is not part of a network or listed in directories. Look for prominent local business people in your field, attend industry conferences, join your local Chamber of Commerce, and start to network with people who might have the funds and expertise you’re looking for.

Pitching to Angels

Making a successful pitch to an angel investor is about knowing what they are looking for. This should be done on an individual basis, looking at the deals they’ve done in the past, and researching anything they’ve said or written about the companies they like to invest in. But here are a few general guidelines.

The first thing angels are looking for is strong growth prospects. But don’t stretch your business plan to provide the ten-fold return you think they want. Your forecasts have to be realistic and achievable. Angel investors typically see hundreds of business plans from hopeful company owners, and can easily recognize padded estimates. Demonstrate exactly how you think you can make your forecasts, and include best case and worst case scenarios.

Beyond the financials, angels are looking for a compelling idea, clearly expressed. Google’s concept was so persuasive that angel investor Andy Bechtolsheim wrote its founders a check for $100,000 before they’d even finished their presentation. Even if you’re not the next Google, you need to have a concept that investors can grasp, and express it in a way that demonstrates its value and long-term potential. What important problem does your business solve?

You’ll also need to show your potential investors an exit strategy. Angels are not looking for a lifetime commitment. They want to invest in your company for perhaps five years, and then exit with large profits that they can plow into other companies. Show them clearly how they can do that.

Working With Angels

After the successful pitch, it’s not the end: things are just beginning. You’ll now have to work with that person for at least the next few years. Some angel investors are “hands off,” while others want to be involved in the running of the businesses they invest in. It’s important to clarify up front what the parameters are.

That means reading the initial agreement carefully to see how much power you’re giving up, and talking with the angel investor to get an idea of how much they plan to be involved.

Keep in mind that although you don’t want to lose control of your own business, angel investors can often play a very positive role. They’re usually experienced, and many have run successful businesses of their own, so they can help you with everything from strategic direction to pricing and marketing. They often have large address books full of useful contacts that can help take your business forward. And they’ve got their own money on the line, so have a strong stake in your success. So although you’ll want to retain ultimate control, don’t be too resistant to their attempts to get involved.

5. Next Steps

So now you know what an angel investor is, how to find one and make a successful pitch, and how to work with one successfully. You’ve also seen the pros and cons of dealing with angels, so you’re in a better position to know whether it’s right for your business.

The next step, if you choose to go down this road, is to start researching angel investors in your area, working out what sort of investment you need, and getting your pitch together.

If you’ve decided that an angel investor is not for you, then stay tuned for the remaining tutorials in this series on Funding a Business. We’ve got three more options to look at: venture capital, private equity and IPOs.

Resources

Graphic Credit: Angel designed by Luis Prado from the Noun Project.

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