Using their own money, angel investors specialize in providing financial backing for small-business owners and entrepreneurs during the startup phase and beyond. These investors can sometimes mean the difference between an idea becoming an empire or never getting off the ground. You know how real estate investors purchase up tons of land? Angel investors are very similar, only they deal in ideas and businesses.
The Pros and Cons of Angel Investors
All funding comes with risks, however. For example, seed investors can result in you having to report to numerous stakeholders. Unlike seed investors, a sizable loan from the bank means you’re only held accountable by the bank. But a bank loan often translates into hefty interest rates and in many cases, less money than you’d get from an investor.
Like other forms of financing, angel investors have their own pros and cons. Let’s take a look.
Pro: Angel investors are willing to take risks
Angel investors are often established entrepreneurs who understand the degree of risk involved with establishing a small business. Unlike banks, angel investors aren’t afraid to throw investment capital at an idea that seems like it has potential. This is generally the result of several things:
- They have an investor network and can get multiple people to invest.
- They’re well-versed in business development and have the foresight a bank lacks.
- Because of their entrepreneurial background, they know a good investment opportunity when they see one.
- They have private equity to spare and don’t have the same concerns as a bank.
Con: Angel investors may set the bar higher
An angel investor’s higher risk tolerance may come with the expectation of a high return. They’re in business to make money, and when there’s a substantial amount of capital on the line, they’re going to want to see a payoff. It’s not unheard of for angel investors to expect a rate of return equaling 10 times their initial investment within the first five to seven years. An unhappy angel investor could mean no more funding from them in the future.
Again, with a bank you’d be paying interest every month on your loan. This is simply the tradeoff you make by going with an angel investor. There’s no interest now, but the angel investor comes with the expectation that their angel capital will grow into something larger.
In short, the pressure to deliver can be intense. (Hey, angel investors became wealthy individuals with large net worths by being smart and aggressive.)
Pro: The money isn’t a loan
When you take out a small-business loan, the bank expects you to pay it back, regardless of whether your venture actually succeeds. Angel investors operate under a different set of rules. They provide you with the money you need to get going and, in exchange, they get an ownership stake in the business. If your startup takes off, then you both reap the financial rewards. If the business fails, the angel investor doesn’t expect you to pay them back.
Note: This does mean the angel investor might have an exit strategy in place if things aren’t looking good. The wrong decisions can doom early-stage companies very early on. In which case, the remainder of the angel investment might be pulled.
Con: There are strings attached
Even though you’re not technically obligated to repay the investor the money they chip in, there’s a catch. When you hand over equity in your company as part of the deal, you’re essentially giving away part of your future net earnings. The percentage of ownership an angel investor asks for typically depends on how much they’re investing.
If you expect your business to be wildly successful, it could add up to a lot of money you won’t be able to claim. When you’ve got an offer on the table, review the terms carefully to make sure the amount of ownership the investor is requesting doesn’t infringe on your own ability to make a profit.
Pro: Your odds of success increase
Typically, angel investors bring years of experience to the table, and they already know the ropes when it comes to starting a company. (Remember, these are often people with numerous business ventures under their belt.)
If you’re seeking advice and guidance in addition to funding, an angel investor may offer a wealth of valuable knowledge. With the right angel investor and mentor, you could end up a part of the next generation of angel investors.
Con: You’re not in total control
Because angel investing comes with so many risks, some angel investors may want partial control over your company as well. Seasoned venture capitalists may see a great opportunity in your business but may also want more say in how things are operated. (If you’re looking for guidance on setting up your new business, check out our guide to business structures.)
Even if they leave the reins in your hands, you may have to explain the reasons behind your choices.
Quick tips for securing an angel investor
If the pros and cons sound fair to you and you’re still interested in finding an angel investor, you’re in luck. Securing an angel investor is no walk in the park, but it’s also not impossible in the age of social media and networking.
Follow these tips and you could be on your way to finding the investor you need.
Create your dream angel investor
Before you do anything, it’s important to have an idea of what kind of angel investor you want. Is this person involved in numerous industries or only yours? How much money are you looking for? What kind of control are you prepared to give this person?
These are all questions you need to answer ahead of time, so you’re ready when you’re on the spot.
Join an angel network
There’s a social media network for everything. Angel investors are no different. There are numerous angel networks out there, from Angellist to more regional networks based in your city or state.
Join a few and see what kinds of people are posting in them. If you feel good about one of the networks, start building some relationships and see if you find the right person.
Find a local angel group
Unlike online angel networks, local angel groups can have less competition and be more personal (unless you’re in a major hub like New York, in which case you may want to branch out).
Find a local angel group and go to a few of their gatherings. Then see if you hit it off with any potential investors.
Consider equity crowdfunding
Equity crowdfunding is the act of sourcing numerous investors or funds, generally online. Think of this like Kickstarter, but in the more general startup investing sense. Equity crowdfunding can be a great way to raise capital quickly. Be warned though: just like seed investors, this can result in you having numerous people to report to, and increase the stress you’re under. (Related: Self-employed? Check out our small business tax guide.)
Angel investor: Is it worth it?
Launching a business is hard work from the moment you draft a business plan to the day you open the doors of your new business. Finding an angel investor is no different. It takes hard work, networking, and some sacrifices.
Still, finding your business angel could mean your new venture gets the chance to take flight — all without the tradeoffs that come with being a public offering. (You don’t want to worry about pleasing shareholders already, do you?)
Remember: angel investing is a high-risk gamble for the investor, so be prepared to make some sacrifices if you decide to go this route. Do your due diligence when vetting investors. Don’t sell yourself short: Wait until a worthy individual comes along. You’ll know when you’ve found the right person. And when you do, it’s all worth it.