Scrambling to find seed money is one of the most challenging aspects of launching a new business. Even seasoned entrepreneurs struggle to find banking institutions willing to take a risk on a startup. And for those businesses already burdened by loans, getting money to expand the business through established lending channels may be impossible. When traditional financing methods fail, angel investors can be a godsend. Many business owners, however, aren’t exactly clear on what angel investors are or how they work. When it comes to these kinds of investors, there are both advantages and disadvantages to putting the future of your business in their helping hands. Let’s look at how angel investors can keep your business afloat in those crucial first years when profit may be hard to come by.
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What is an angel investor?
Angel investors provide capital to fledgling ventures either for startup or to grow the existing business. These folks want an investment with a higher return and are willing to accept some additional risk built into the bargain.
They don’t necessarily contribute their capital due to any sense of the higher good, however. Although they could be impressed with your entrepreneurial spirit or your innovative business model, their motives are most often to make profitable investments.
Angel investing is a form of equity financing where the investor expects to have a say in business decisions and a share in the profits in exchange for their financial contributions. While angel investing means selling shares or ownership in your company, it can be a good tradeoff for those without the collateral to secure a traditional business loan.
Do angel investors have to be accredited?
According to the US Securities and Exchange Commission, the term angel investor applies to an accredited investor that meets specific income and net worth thresholds. However, many start-ups informally refer to family and friends who pitch in to help start their business as angel investors. These benefactors may be doing a virtuous thing, but they don’t technically meet the definition of accredited angel investors.
Should you use an angel investor?
Not every business or start-up is a good candidate for an angel investor. And there are certainly tradeoffs that some entrepreneurs are unwilling to make. But the following considerations are what drive many small businesses to seek out angel investment to fund their ventures.
1. Support start-ups
These investors get a bigger share of the profits because they’re taking more risk. There’s no guarantee that your venture will be profitable, and in fact, roughly half of small businesses fail within five years. But these investors are more likely to reward innovation and initiative and are less concerned about initial profitability.
2. Offer expertise as part of the bargain
Often, angel investors have experience in starting businesses and creating connections in the industry in which you’re operating. And they’ll bring that expertise and influence to the table. When you sign on with an angel investor, you may be giving away some of your share of the profits, but you’ll get back a larger window of opportunity in return.
Because they are involved in business decisions, try to scout out someone who shares your vision. Otherwise, you may find yourself mired in conflict with someone who has control over the direction of the business.
3. Don’t get paid back when the business fails
Unlike the bank, you won’t be on the hook with an angel investor if your business folds. While banks usually require plenty of collateral to back your business loan, angel investors back entrepreneurs with promising potential. The success of an angel investment is tied to the success of your business venture.
Remember, though, that they aren’t exactly acting out of altruism. When you sell the company or go public, they’re banking on picking up plenty of profit and cashing out their shares.
4. Aren’t venture capitalists
While these investors and venture capitalists have similar objectives, venture capitalists are investing much larger sums of money in return for a bigger share of the profit. Because they’re fronting so much capital, venture capitalists typically choose more established companies. Angel investors, on the other hand, provide smaller amounts of financial support in exchange for between 10% and 40% of the profits.
5. Networks offer more opportunity
Accredited angel investors are individuals or groups with a net worth that tops one million, but investors that don’t meet that criteria can pool their resources with angel investment networks. This approach is similar to crowdfunding, but network managers usually select the investments.
6. Can lend credibility to your business
Angel investors don’t front money based on a good conversation or a gut feeling. They require a detailed overview of your business model and financials to ensure viability. Additionally, these investors lend your business credibility to other investors who know you made it through the vetting process. Being accountable to an angel investor also forces transparency about financials, driving you to generate reports and use reliable data in your business decisions.
How to find your angel investor
If angel investing sounds like the divine intervention you need, get started scouting prospects either through angel investor networks or at your local chamber of commerce. Before applying, perfect your pitch and go over your business plan with a fine-tooth comb. Gather records, prototypes, and anything you might need to demonstrate the viability of your venture.
Remember that this investment is also a two-way street, so screen for compatible partners as part of the process. The best investment matches aren’t made in heaven but come from careful consideration and compromise.