The Pros and Cons of Angel Investors
Find out if an angel investor is right for your small business
An angel investor is a person who invests in a new or small business venture, providing capital for start-up or expansion. Angel investors are typically individuals who have spare cash available and are looking for a higher rate of return than would be given by more traditional investments. An angel investor typically looks for a return of 25 percent or more.
Angel investment is a form of equity financing–the investor supplies funding in exchange for taking an equity position in the company. Equity financing is normally used by non-established businesses that do not have sufficient cash flow or collateral with which to secure business loans from financial institutions.
Angel investors fill in the gap between the small-scale financing provided by family and friends and venture capitalists. Attracting Angel Investors is not always easy, but there are things you can do. First, consider whether angel investing is truly for you and your business.
Advantages and Disadvantages of Angel Investors for Business Owners
The big advantage is that financing from angel investments is much less risky than debt financing. Unlike a loan, invested capital does not have to be paid back in the event of business failure. And, most angel investors understand business and take a long-term view. Also, an angel investor is often looking for a personal opportunity as well as an investment.
The primary disadvantage of using angel investors is the loss of complete control as a part-owner. Your angel investor will have a say in how the business is run and will also receive a portion of the profits when the business is sold. With debt financing, the lending institution has no control over the operations of your company and takes no share of the profits.
Typical Sources of Angel Investors
Angel investor is a somewhat general term, and you can actually find these types of investors in a few different forms. Angel investments normally come from:
- Family and friends: This is by far the most common source of funding for business startups that are interested in finding business start-up money and is the only option for many. Given the high rate of failure with new businesses, it is also risky in terms of the possible impact on relationships if the business is not successful. It is important to be upfront about the risk of failure.
- Wealthy individuals: Another good source is successful business people, doctors, lawyers, and others that have a high net worth and are willing to invest up to (typically) $500,000 in return for equity. Often this is done by word of mouth through business associates or associations such as the local Chamber of Commerce.
- Groups: Angels are increasingly operating as part of an angel syndicate (a group of angel investors), which raises their potential investment level accordingly. Investors contribute funds to the syndicate and a professional syndicate management team chooses the investments.
- Crowdfunding: A form of an online investing group, crowdfunding involves raising funding by having large groups of individuals invest amounts as small as $1,000.
Communicate Before Deciding
It's important for any business person thinking about accepting an angel investment to be very clear about what the investor is bringing to the deal besides money, such as expertise in business operations or access to good suppliers, for example. You would also want to develop an understanding of what the angel investor would be like to work with since this person could have their own conflicting ideas for how your business should be operated.
It's also important to have a comprehensive business plan in place. As a small business, you'll need it in order to secure financing from lenders or investors.