An enormous first step for getting a small business off the ground is exploring all funding options. Self-financing can be a difficult prospect, and a traditional bank loan is no longer necessarily the best option. But the money has to come from somewhere.
One method that can be a solution is seeking angel investors. These are often wealthy individuals looking to invest in promising young companies and new startups.
Angel investing can be a difficult road. Here are some tips for how to navigate it for an aspiring entrepreneur.
Do some digging
Some research is in order in looking for angel investors. The Wall Street Journal advises that these investors will want to know the ins and outs of a prospective business, so the entrepreneur should study what kind of investors to target.
“Be thoughtful in approaching potential investors,” the Journal writes. “Biotech investors, for example, don’t want to hear about a clothing manufacturer. A scattershot approach is likely to turn them off. Industry associations, local trade groups or, in some states, business-incubator centers can help point to potential angels.”
Investors also can work in angel networks, according to the Journal: “These provide due diligence, extra research, access to potential deals and shared expertise that one person operating alone generally doesn’t have. For instance, one member of an angel group might have background in a particular industry or the know-how to set up deal terms, sharing that knowledge with the other investors.”
Different kinds of angels
The phrase “angel investor” might bring to mind an image of a tycoon that plays with investing like a board game. But there are a variety of people that can qualify. Todd Vernon, CEO of VictorOps, analyzes several such types in a story for Inc.com.
First, there are family investors, relatives that just want to help. These are Vernon’s “least favorite investor,” he says, “because the investment is totally emotional and personal.”
The relationship investor is someone who is familiar with the entrepreneur through previous business dealings, Vernon writes. There’s a track record there, and an additional benefit: These investors can be “wildly supportive in terms of finding employees and other resources,” he says.
Among the other types Vernon describes:
Idea investors: These are ideal, he writes, because of their familiarity with the business concept. “Their investment is based on the idea and there is little emotion around the table (always a good thing),” he says. “If you can get them onboard they can open doors into partner relationships and give good advice.”
Once-removed investors: As the label implies, these are not direct contacts, but connections through a relationship or idea investor. “They likely don’t know you, and don’t have a clue if your idea is good or bad,” Vernon says. “They trust someone else to bring them successful investment opportunities.”
What they’re looking for
An entrepreneur’s big idea may not be enough for an angel investor to jump on board. In a story for Forbes, Richard Harroch examines what investors are seeking, including the passion and integrity of those involved, along with the market opportunity, the business plan’s clarity, technology aspects, potential progress and future financing.
Among the things investors “like to initially see” from entrepreneurs, Harroch writes, are a clear elevator pitch, an executive summary, prototypes and early interest from customers.
There is risk on both sides of the angel investor concept. In a story for startupgrind.com, Murray Newlands writes that angel investors understand the risk, and “can usually ‘smell’ a good idea and a good deal,” which can make their contributions superior to a bank loan.
The expectations of the investor will also be high, he notes.
“They are in business to earn money, and as there is a significant quantity of funds on the line, they are going to want to witness a payoff, just like anyone else is. It isn’t unusual for an angel investor to expect a rate of return that equals 10 times their original investment inside the first 5-7 years. When you are being held to this type of standard, the pressure to generate may be intense.”
Success and control
Beyond the dollars involved, investors often have experience that can benefit a startup. If the investment includes a seat on the company’s board, or just a significant advisory role, the guidance that can result from it is another potential advantage.
The other side of the coin is the entrepreneur will have to give up some amount of control over the entire operation. This can be a tough pill to swallow, as Newlands writes.
“If you are expecting them to take a hands-off approach, you might be in for a rude awakening,” he explains. “It is more likely that the angel is going to want to take an active part in making decisions which affect your organization’s outcome. Even if they give you control, you will still be accountable for explaining the reasons behind some of your decisions.”
The entrepreneur will need to ponder such scenarios in the early stages, and understand the trade-off that angel investing brings, he writes: “… You must ensure that you are at ease with permitting somebody who isn’t intimately familiar with you or your business to play a role in how it is run.”
Entrepreneurs will likely face tough moments in the search for funding, and angel investing is no exception. In Harroch’s piece for Forbes, he explains several reasons why angels will decline to get involved. The market size may be too small, he says, or the financial projections don’t make sense. There may not be enough passion evident from the entrepreneur. Maybe the business isn’t in the area of interest for the investor, he says, or not locally based.
Perhaps the two most important reasons in Harroch’s list, which can serve as a sign that an entrepreneur should go back to the drawing board:
- “The investor wasn’t convinced of the need for your product or service.”
- “The investor was not convinced that your company was going to differentiate itself from competitors.”