To raise early-stage funding, small business owners often turn to family and friends. When that resource is tapped out, next up is angel investors. Angel investors are high net worth individuals who invest money in local startups. Unlike venture capitalists, who raise funds from investors to pour into new businesses, angel investors have skin in the game and often an emotional attachment to the companies they fund.
"A lot of angel investors were entrepreneurs themselves and want to give back to the local community. They like the mentoring aspect," Patrick Gouhin, CEO of the Angel Capital Association, told business.com. "Most like to invest locally and are using after-tax dollars of their own, unlike a venture capitalist, who uses other people's money."
Securing funding from an angel investor takes work, but it can be a viable way to grow.
What is an angel investor?
Typically, angels are accredited investors, which means they earned more than $200,000 in the last two years. If it's a couple filing jointly, they need an annual salary of at least $300,000. In either instance, the accredited investor needs a total net worth of $1 million or more.
Angel investors tend to invest in companies in their own neighborhood, region or industry. They can invest on their own or as part of a network of angel investors. They aren't just throwing money at the next big thing; there's usually more meaning behind angel investing.
"Angel investors want to invest in something they have an affinity for," said Adam Burrows, co-founder and managing partner at Range Ventures. "It may be something in their own backyard, a local business, or industry they are passionate about."
How is an angel investor different from a venture capitalist?
Angel investors and venture capitalists both seek startup companies to back, but there are some key distinctions between the two investor groups.
Take the stage at which they invest for starters. Business owners typically look for angel investors after they've exhausted funding from family and friends. At this stage, it's called seed money, which is typically in the tens of thousands or hundreds of thousands rather than millions. Venture capitalists invest in startups that are more established. It's when VCs are involved that you see the million- or even billion-dollar valuations.
The makeup of venture capitalists and angel investors is also different. VCs usually work for a firm or fund and use other people's money to invest in companies. Angel investors are individuals or groups that use their own cash to make investments. Both want to mentor and guide the companies they invest in and expect an equity stake in return, but the terms may be less rigid with an angel investor.
Angel investors are also more comfortable taking a lower role in a company than a VC. VCs usually want to play an intimate part in growing the company and often request a seat or two on the board of the companies they invest in.
Venture capitalists and angel investors both want to make money from their investments, but with the latter group, there is emotion attached to their decision. VCs are looking for fast-growing startups that will disrupt an industry. Angel investors find companies that have meaning to them personally.
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. With a network, the angels can make their own investment decisions.
What is the primary source of funding for angel investors?
Unlike other investment groups, angel investors use their own money to make bets on the companies they think have potential. This is their main difference from venture capitalists, who raise money from outside investors to launch a fund.
Angel investors are taking money from their own bank accounts to back a business, which is riskier. If a VC makes a bad bet, nobody other than the outside investors is losing their own money.
Why do angel investors invest?
Angel investors care about the companies they invest in, but that doesn't mean they're completely altruistic. They're looking for a return on their investment too.
"The only way angel investors get paid is if there is an exit," Gouhin said. "One of the early questions entrepreneurs get is, 'How far can you take it, and who is going to buy it?'"
An initial public offering is one way angel investors make a profit on their investment, but Gouhin said only 2% to 3% of startups become a publicly traded company. What's more likely is that the business is acquired.
"For the majority, the exit is through an acquisition from a larger company," Gouhin said. "That's where angels and founders get a return on their investment."
What percentage of the company do angel investors want?
Angel investors aren't greedy. They want equity in the company in exchange for their investment dollars, but they don't want to harm the company they're backing. They want the founder and management team to have the ability to lure recruits, and too much dilution can hurt those efforts. Gouhin said the sweet spot for angel investors is a 20% to 30% stake.
What are the pros and cons of angel investors?
Angel investors play a vital role in building the big companies of tomorrow, but this type of funding isn't for everyone. As with everything in life, 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. The big one is that the risk-taking nature of angel investors makes them more willing to invest. Banks, lenders and venture capitalists have certain criteria businesses must meet to receive capital. They aren't going to lend you money based on an idea, just as VCs won't work with you unless you have customers and sales. Angel investors are risk-takers. They have the cash and the willingness 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.
Tapping angel investors to fund your business also lessens the risk to you. When you receive an investment from an angel investor, they're making a bet on you. They don't expect you to pay them back if things go south. That's not the case with banks and lenders.
Outside of the capital, a big benefit of partnering with an angel investor is the mentoring and counseling you get. 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 achieve that.
"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," said Mike Lebus, founder of Angel Investment Network.
Cons of working with an angel investor
One of the biggest disadvantages of working with any investor, including an angel investor, is that you give up some control, which can be difficult for an entrepreneur. Angel investors typically want at least a 20% stake in your business. By accepting the investment in exchange for equity, you now 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 said.
If you are wary of giving up control but need the capital, Lebus said, it's important to agree in advance on how involved in your business the investors will be. Everyone should be on the same page from the beginning.
Angel investors get in on companies 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."
Like VCs, angel investors are discerning in which 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, said Gouhin. He said 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, but finding one might feel like searching for a needle in a haystack, particularly if this is your first rodeo. These are some ways to find an angel investor:
Browse angel investor networks.
These networks are a popular way to put your business in front of angel investors. According to the Angel Capital Association, there are more than 200 angel network groups across the country. These groups accept pitches from business owners and share information with each other.
Angel Investment Network is another resource to find investors. You can search for angels and upload your business pitch on the site. 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 own network.
One of the quickest and easiest routes to raise capital is your personal and professional network, said Burrows. Your contacts already know you and your business, so they are more likely to hear you out. Reach out to them to gauge their interest in your product or investing, pick their brains about potential investors, and enlist them to endorse you and your business. If you are in a niche industry, you could reach out to business leaders within your niche through an introduction or a cold call on LinkedIn.
Prepare to sell your story to investors during your outreach. Create a slide deck that includes your financial projections, elevator pitch and growth opportunities. It's also important to have advisors on your team who bring credibility and experience. Burrows said to bring them on as mentors or offer them equity. The more qualified you and your team are in the eyes of investors, the better your chances of securing funding.
At the end of the day, Burrows said, the key to raising capital is tenacity.
"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. You can't take rejection personally. You have to know it's going to be difficult but go after what you want anyway."