Just to recap where we are, over the last few blog posts we have discussed the difference between debt and equity funding and given examples of both. Next on our discussion list is another source of equity funding known as Angel Investing.
Angels are well-known in the entrepreneurial world as private investors that financially back startup companies. They are typically around 45 years old and have already made a good amount of money in some sort of entrepreneurial adventure. Being a successful entrepreneur, they feel that they should give back to others in that are in the same situation that they were once in. Like venture capitalists, angel investing is a high-risk, high-reward game since the likelihood that a startup will fail is so high. And just like Venture Capitalist’s, angels do not expect all of their money back from a startup they invest in.
However, there are some distinct differences between angels and VC’s. For instance, angels are not professional investors that represent an outside company. Instead, they are putting their own money into the company. As a result, angels tend to give less money to entrepreneurial companies than VC’s do. According to Venture Research at the University of New Hampshire, 2008 saw angels donate $19.2 billion into the hands of new ventures.
Angel investors finance entrepreneurs for many different reasons. First and most importantly, angels are looking for a great return on their investment. Second, an angel will sometimes back a company because they trust the entrepreneur behind it. They also believe that they can be valuable and give the startup advice and knowledge that will help it succeed. Finally, angels also invest in companies for the thrill of it. They love taking chances with their money and see investing in entrepreneurs as a higher risk game than the stock market.
What Angels Are Looking For?
Like venture capitalists, angels check to see if your company can be liquidated quickly and for a big return before they finance your company. On average, an angel investor will get about a 30% return on their investment. Therefore, a startup needs to show that it can be bought by another company or be put up for public offering so the investor can get his or her money back. An investor also checks to see if you have a strong management team, a good exit strategy, and that your asking price is not too high. But one of the most surprising statistics when it comes to angel funding is not how profitable you are to an angel, but how far you are. According to the Centre for Venture Research, 70% of all angel transactions are given to companies that are less than 50 miles away from the angel’s home or business.
The type of industry a startup is in is another main motive angels have when giving a startup their money. Like VC’s, angles tend to concentrate on high-tech startups because of their huge potential. As a result, angels like to invest in healthcare, software, biotech and energy ventures. This is not to say that angels are solely focused on high-tech, though. Actually, a good number of them focus on low-tech companies as well, such as retail and media ventures.
Pros and Cons of Angel Investing
As mentioned before, angels are not giving startups money out of the goodness of their heart. These are individuals who are counting on you to make them money. As a result, you have to prove to an angel that your business can grow, prosper and be bought in a short amount of time, which means that you have to put a lot of work in a strong business plan. Small businesses who submit their start-ups to angel groups only get accepted 2.3% of the time. Also, angel investors tend to give entrepreneurs less money than VC’s do. An average angel will invest $364,000 in a company, compared to a VC which would give millions. Angel investors are harder to find than VC’s as well. While there are some angel groups in the United States, many angel investors are not listed on websites or in directories. This means that you have to spend time at networking events in order to find a potential angel to financially back your new venture.
The key positive of angel investing though, is that your company will still get a fair amount of cash if an angel likes your enterprise. Angels can also give you a vast amount of guidance that can help you be more successful and you do not necessarily have to pay them their money back. And, as mentioned before, angels are not necessarily totally interested in profits. While money is a big factor for an angel, often times he or she is just trying to help an entrepreneur out because they have been in that spot themselves.
What Do You Need?
If you like the idea of angel funding, you are going to need these 5 ingredients to attract an investor to your startup:
- A Business Plan: Many people think that a business plan is old school and not needed in today’s world of PowerPoint presentations and flashy animations. Well, from now on take advice from those people with a grain of salt, because they couldn’t be more wrong. A business plan shows investors that you put the time in to research every possible market your company can exploit and every competitor your company will contend with. In short, your business plan lets angels know that you know what you are doing.
- Private Placement Memorandum: PPMs are fancy documents that protect you, the entrepreneur, while an outside investor is putting money into your company. Basically, a PPM includes your business plan plus a Summary of Subscription, Summary of the Offering, the risk factors involved, use of the proceeds, management compensation, principal shareholders and capitalization table, subscription agreement, and an actual subscription form that the angel signs.
- Due Diligence Documents: Before an angel gives you money, he or she will perform what is known as due diligence. Essentially, the angel is doing more research into your startup to make sure he or she didn’t miss anything. Make sure you have the following prepared so angels can perform their due diligence without a hitch.
- Background of the company
- Background of management
- The company’s business plan
- Management discussion of the company performance
- Capitalization table
- Employment agreements
- Purchase or sale agreements
- Previous letters of intent
- Legal Counsel: Make sure you hire an attorney that you are comfortable with and an accountant. These two new team members will become crucial when it comes to reviewing your PPMs and due diligence documents.
- Realistic Investment Terms: This may not be a formal document but it is a crucial step that you and your team must discuss. Unlike VC’s who have set terms, individual angels often try to negotiate with a startup. Therefore, it is important to have terms already that have been mapped out ahead of time to present to angels. Remember, keep your terms realistic! You did not create unrealistic financial projections, so go through the same process when it comes time to make these terms as well.
If you are having trouble finding individual angels, try building out your network through networking events. If someone says “no” to investing in your company, always ask if the person knows an angel that would be interested. To learn more about Angel Investor Groups, our next blog posting will explain key differences to note between individual and group angels.