One of the biggest challenges for most startups is securing funding.
Having a brilliant idea is one thing, but raising funds to make money is another.
Founders make endless funding applications, present countless pitches, and receive frequent rejections. For many entrepreneurs, angel investors may be the solution.
Unlike traditional financing options like banks, or new online methods such as crowdfunding, raising capital via private equity is now an established process for funding startups. And angel investors are the most likely source of that funding.
So, what are angel investors? We’ll answer that question in this guide, and explain how they differ from venture capitalists. We’ll also cover the pros and cons of angel funding, and how to choose the right investor for your business.
What is an angel investor?
An angel investor is someone who invests their money into a business, usually in exchange for convertible debt or ownership equity. They typically invest in startups when other mainstream investors won’t, but they may also invest in mature companies with growth potential.
Angel investors (also known as “angels”) choose businesses with products or market sectors they know or a leadership team they trust to deliver the returns they want. And they often provide mentorship and advice as well.
Angel investor vs venture capitalist: What are the main differences?
Angel investors and venture capitalists both provide money to companies, but they operate differently.
Investment criteria
Angel investors and venture capitalists (VCs) focus on businesses at different life cycle stages. Angels usually invest on startups and early-stage businesses after founders have put in money themselves and after any funding from friends and family. On the other hand, VCs prefer to invest in more established and well-managed businesses with long-term growth potential.
Funding source
Angel investors are usually:
Successful business people
Serial entrepreneurs
High net-worth individuals
They invest their own funds in businesses that personally appeal to them. There are also groups of angel investors — called flocks — that sometimes work together to invest more significant sums.
Meanwhile, venture capitalists belong to a venture capital firm that sources investment funds from insurance companies, investment banks, pension funds, and other financial institutions.
They typically invest a larger stake than angel investors because they have an investment fund to manage. Generally, they are more aggressive with their investment strategy, as they need to achieve a positive return for all parties.
Funding amount
Venture capitalists usually invest higher sums than angel investors. They also typically take a 25-50% stake in the company and play a hands-on role in growing the business.
Angels invest less money than venture capitalists because they are investing their own money on smaller, early-stage businesses where they see potential. Their investment may be between $50,000 and $250,000, for example.
Level of involvement
Although angels are less likely to take an active role in a business, they may provide contacts, mentorship, or specialist industry expertise.
VCs usually provide more hands-on guidance and leverage their professional networks to propel the company forward. In most cases, they want a board position so they can be involved in all strategic decision-making and steer the company in the right direction for their investment.
Benefits of angel investing
Angel funding has several advantages over other types of investment:
Open to higher-risk companies and industries
Unlike banks and venture capitalists, angel investors are more open to taking on higher-risk companies and industries. They do, of course, want a stake in the company and involvement in it to add value and get the return on investment they’re looking for.
Fast funding approval
Angel investors don't have to worry about getting approval from institutional investors, shareholders, or board members. As a result, they tend to move through their approval and due diligence process quickly.
Further, they can decide when and how to provide funding, such as lump-sum or monthly payments.
Access to knowledge and experience
Angel investors also bring a wealth of knowledge and experience since they typically operate in an industry or market they are familiar with. So, as well as money, startups can access sound business advice and tap into their contacts.
Increased working capital
Angel investors can provide lump sum investments, which gives the startup larger amounts of working capital to grow the business quickly. In contrast, other funding is more likely to be spread over time.
Less hands-on than venture capitalists
Since angel investors are not managing other people’s money, they do not need the same level of governance that venture capitalists do. They may be less hands-on, but will still want involvement in company.
No repayment of interest obligations
As an investment rather than a loan, angel investors provide funding in exchange for equity in the business - usually around 10%. If the company grows as expected, the investor can sell their stake at a profit. If it doesn’t, angels do not get their investment back.
Credibility by association
Angel investors are typically industry experts and entrepreneurs with a track record of launching multiple successful businesses. By partnering with these investors, startups gain credibility and can experience significant growth as a result.
Potential drawbacks of angel funding
Aside from the advantages of angel funding, there are several possible downsides:
Loss of equity
Angel investors want a stake in your business in return for their money. When deciding whether it's right for your business, you must weigh the investment against the loss of equity and future earnings.
Loss of control
Although angel investors don’t usually want to control your company as much as venture capitalists would, you may still lose some control. They will likely want to have a say in the critical decisions that affect your organisation’s success. Or, at the very least, you’ll have to answer for your decisions. Carefully consider how much control you’re willing to cede.
High expectations
Angel investors want a strong return on their investment, so it’s worth finding out what their expectations are and making sure your strategy aligns. For instance, it’s not unusual for an angel investor to expect 10x their original investment within 5 to 7 years. Some entrepreneurs may find it too challenging to live up to these targets.
How to choose the right angel investor
Not all angel investors will be suitable for your business. They all have different experiences, preferences and available investment funds. So, here are 4 things to look for when choosing an angel investor:
1. Look for angels with industry experience and connections
The angel investors you choose should have the relevant industry experience and connections to guide your company through the challenging early stages. They should also have a successful track record of investing in other startups.
2. Look for angels who can afford to lose the money
Angel investors know that many of the companies they invest in will fail. That’s why it’s essential to look for angels who can afford to lose the money. If they’re not relaxed about their investment, they’ll likely pressure you to make decisions that generate a quick return on their investment at the expense of long-term growth.
You want an angel who is willing to invest in your business for the long term and accept the associated risks. Investors willing to take on such risks are more likely to help your business grow. But if your angel expects to make money immediately, that can create a stressful situation.
3. Look for angels who have realistic expectations
Make sure you look for angel investors who are realistic about how long it will take to grow your company and achieve your stated goals. If you have a five-year plan, they need to be prepared to wait that long for a return on their investment.
Additionally, make sure they have realistic expectations about your company’s profitability. Over-inflated expectations may result in poor short-term business decisions rather than long-term benefits.
4. Look for angels with a history of successful investment
Finally, you should pick angels with a history of successful investment rather than first-time investors. Examine their previous investments to determine if they have the experience to work with you.
Is angel funding the right fit for your business?
Angel investment isn’t suitable for every business.
You’ll have to share your owner’s equity, give up some control of your business, and live up to the expectations of your angel investors.
If that’s what you want, make sure you choose an angel with relevant industry experience and connections, realistic expectations, and a history of successful investments.
Be sure to weigh up the pros and cons of angel funding and decide whether it’s the right fit for your business.
Learn more about other types of new business funding.
Disclaimer: Information provided in this article is of a general nature and does not consider your personal situation. It does not constitute legal, financial, or other professional advice and should not be relied upon as a statement of law, policy or advice. You should consider whether this information is appropriate to your needs and, if necessary, seek independent advice. This information is only accurate at the time of publication. Although every effort has been made to verify the accuracy of the information contained on this webpage, MYOB disclaims, to the extent permitted by law, all liability for the information contained on this webpage or any loss or damage suffered by any person directly or indirectly through relying on this information.