To raise early-stage funding, entrepreneurs may self-fund their businesses, use credit cards to finance their ventures, apply for business loans, and turn to family and friends. When this funding runs dry, seeking an angel investor is often the next step. Angel investors are wealthy individuals who invest personal funds in startups that resonate with them.
Securing funding from an angel investor takes work, but it can be a viable way to grow. We’ll explain everything entrepreneurs need to know about finding and working with angel investors.
To find and attract investors, understand your company mission, develop your brand voice, and meet with as many potential investors as possible.
What is an angel investor?
Angel investors are typically accredited investors who earned over $200,000 in the last two years. If the angel investors are a couple filing their taxes jointly, they need an annual salary of at least $300,000. In either instance, the accredited investor must have a total net worth of $1 million or more.
Angel investors tend to invest in companies in their neighborhood, region or industry. They can invest independently or as part of an angel investor network. And they don’t just throw money at the next big thing — there’s usually more meaning behind what they choose to invest in.
“Angel investors want to invest in something they have an affinity for,” explained Adam Burrows, co-founder and managing partner at Range Ventures. “It may be something in their own backyard, a local business or [an] industry they are passionate about.”
How is an angel investor different from a venture capitalist?
Angel investors and venture capitalists (VCs) are both considered alternative funding sources. However, angel investors and venture capitalists differ in the following ways:
- Angel investors usually have an emotional connection. Angel investors tend to have an emotional connection to the companies they fund. They typically work with companies that have personal meaning to them. In contrast, venture capitalists focus more on extracting a profit from their investments. They seek fast-growing startups that will disrupt an industry.
- Angel investors provide seed money. Business owners typically seek angel investors after exhausting personal funds and funding from family and friends. At this stage, angel investors provide seed money — typically tens or hundreds of thousands of dollars. In contrast, venture capitalists invest in more established companies. When VCs are involved, you’re more likely to see million- or even billion-dollar valuations.
- Angel investors use their own money. Angel investors use their own money to bet on companies they think have potential. They take money from their own bank accounts to fund a business, which is often a risky proposition. In contrast, VCs raise money from outside investors. They usually work for a firm or fund and use other people’s money to invest in companies. If a VC makes a bad bet, only the outside investors lose money.
- Angel investors are OK with a lower-level role. Angel investors are comfortable taking a lower-level role in a company. In contrast, VCs usually want to play an intimate part in growing the company. They often request a seat or two on the board of the companies they invest in.
Both angel investors and VCs want to mentor and guide the companies they invest in — and expect an equity stake in return. However, an angel investor’s terms may be less rigid.
Angel investors invest their money as they see fit. What traditional funders may consider a high-risk business loan may not concern an interested angel investor.
How does angel investing work?
Angel investors can invest on their own, as a network sharing information and investment ideas, or through a fund where everybody in a group puts up money. In the latter case, the funding group decides which companies to invest in and how much to contribute. With a network, the angels can make their own investment decisions.
Why do angel investors invest?
Angel investors often invest for personal reasons. “A lot of angel investors were entrepreneurs themselves and want to give back to the local community. They like the mentoring aspect,” explained Patrick Gouhin, CEO of the Angel Capital Association.
While angel investors care about the companies they invest in, they’re not entirely altruistic. They’re also looking for a return on their investment.
Angel investors make their money when either of the following events take place:
- There’s an IPO. An initial public offering (IPO) is one way angel investors profit from their investment. However, Gouhin shared that only 2 percent to 3 percent of startups become publicly traded companies.
- The business is acquired. It’s more likely that angel investors will make money when the business is acquired. “For the majority, the exit is through an acquisition from a larger company,” Gouhin explained. “That’s where angels and founders get a return on their investment.”
Angel investors are along for the ride — but they want out eventually. “The only way angel investors get paid is if there is an exit,” Gouhin noted. “One of the early questions entrepreneurs get is, ‘How far can you take it, and who is going to buy it?'”
Debt and equity financing differ. With debt financing, you must repay the money. Equity financing doesn’t require repayment because the investor gains a portion of your company.
What are the pros and cons of angel investors?
Angel investors play a vital role in building the big companies of tomorrow. However, this funding avenue isn’t for everyone. There are pros and cons to working with angel investors.
Pros of working with angel investors
Raising capital from an angel investor has several advantages over other funding methods.
- It’s easier to get funding with angel investors. Banks, lenders and venture capitalists have specific criteria businesses must meet to receive capital, such as having customers and sales. They won’t lend you money based on an idea. In contrast, angel investors are more willing to take risks. They have the cash and are willing to spend it. They don’t have to answer to higher-ups in the firm or meet underwriting criteria. If they like you and your business idea, nothing is stopping them from investing in you.
- Borrowing from angel investors is low-risk. Tapping angel investors to fund your business lessens your risk. Angel investors are betting on you. They don’t expect you to pay them back if things go south, which isn’t the case with banks and lenders.
- Angel investors offer advice and assistance. Angel investors provide mentoring and counseling. Many angel investors have been there, done that, and are a treasure trove of advice. They want you to succeed and won’t mind rolling up their sleeves to help you get there. “Angel investors often contribute their experience, expertise, and contacts to help drive the business forward and help increase their chances of success, which is obviously in everyone’s interest,” explained Mike Lebus, founder of Angel Investment Network.
When presenting your idea to investors, explain how it solves a critical customer problem. Demonstrate how your product or service is better than existing competing alternatives.
Cons of working with an angel investor
Working with an angel investor isn’t an ideal scenario for all entrepreneurs.
- You give up some control with angel investors. Angel investors typically want at least a 20 percent stake in your business. When you accept an investment in exchange for equity, that means you have someone else to answer to. “Whenever you raise equity funding — whether it’s from family and friends, angel investors, or venture capital firms — you now obviously have shareholders, which brings added responsibilities, admin, and pressure,” Lebus explained. If you are wary of giving up control but need the capital, Lebus advised agreeing in advance on how involved the investors will be in your business.
- Angel investors invest smaller amounts. Angel investors arrive in the early days before the business has much in terms of customers and sales. As a result, the investment tends to be smaller than it would be with venture capital. Typically, companies raise around $250,000 from angel investors. Later-stage startups can easily raise millions from a venture capitalist. “We generally advise companies to raise enough funding to give them a 12-to-18-month runway,” Lebus said. “Fundraising can be time-consuming, so it’s not something founders should be doing too often, as they’ve obviously got a business to run.”
- Angel investors have limited areas of investment. Like VCs, angel investors are discerning about the companies they invest in. In addition to being regional or locally focused, angel investors tend to stay away from mom-and-pops and family-owned businesses.
Popular areas of investment for angel investors include biotech, e-commerce, fintech, green tech and healthcare technology.
How to find an angel investor for your business
Angel investors are everywhere. However, finding one might feel like searching for a needle in a haystack, particularly if this is your first rodeo. Here’s some advice about finding angel investors:
- Browse angel investor networks. According to the Angel Capital Association, more than 200 angel network groups across the country accept pitches from business owners and share information. The Angel Investment Network website is an excellent resource where you can search for angels and upload your business pitch. Gouhin recommends starting with the networks in your local area and spreading out from there. “Keep working outward until you find the right group and the right time that has an interest in your product,” he said.
- Tap into your network. Burrows advised raising capital through your personal and professional networks. Your contacts already know you and your business and are more likely to hear you out. Reach out to them to gauge their interest, pick their brains about potential investors, and enlist them to endorse you and your business. If you’re in a niche industry, reach out to business leaders within your niche through an introduction or a cold call on LinkedIn.
- Be prepared. Prepare to sell your story to investors during your outreach while demonstrating your entrepreneurial motivation. Have a startup marketing plan and create a slide deck that includes your financial projections, elevator pitch, and growth opportunities. Having advisors on your team who bring credibility and experience is vital. Burrows advises bringing them on as mentors or offering them equity. The more qualified you and your team are in the eyes of investors, the better your chances of securing funding.
Stay tenacious when seeking angel investors
At the end of the day, Burrows said, tenacity is the key to raising capital.
“Fundraising is difficult. It doesn’t matter if you are trying to raise $10,000 or $10 million; it’s a numbers game. You’ve got to talk to a lot of investors,” Burrows advised. “You can’t take rejection personally. You have to know it’s going to be difficult but go after what you want anyway.”
Jennifer Dublino contributed to this article. Source interviews were conducted for a previous version of this article.