What do Steve Jobs, Matt Mullenweg, Microsoft founder Bill Gates and Mark Cuban have in common with you? Chances are, they all started their business with help from angel investors.
Angel investing is an important part of the startup ecosystem. It allows entrepreneurs to take a step towards their dream of owning their own business and creating jobs.
And while there are different ways of raising funds — pre-seed, seed and series round — only a few hold as much promise as angel investing.
Here, we’ll review how angel investing works, provide insights into what to look out for when selecting an angel investor, potential warning signs when dealing with an investor, and ways to find the perfect angel investor for your business.
Let’s jump in.
Who are Angel Investors?
Angel investors are people who invest in startup companies for equity ownership. They’re typically high-networth individuals, often wealthy entrepreneurs themselves, who have the financial means to invest in startups that interest them.
Unlike venture capitalists, who often invest other people’s money, angel investors use their own funds. And unlike banks and other traditional lenders, they don’t require collateral or repayment of their investments.
Also, angel investors come into play when a company is too early for traditional funding but needs more resources than friends and family can provide. They can be the difference between a small business growing and staying stagnant.
In addition, beyond monetary investment, angel investors can also provide advice, guidance and contacts that can be beneficial to the growth of your business.
How Does Angel Investing Work?
An angel investor might approach an investment opportunity differently than a venture capitalist, but ultimately, the process is similar.
Here are the steps involved:
- Prospective investment opportunity is presented to investors
The first step of this process is to pitch your idea, business plan, or proposal to prospective investors.
This may be done through a referral from a mutual contact, cold-calling or emailing the investor directly or by using angel groups.
- Investor evaluates the opportunity presented
Next, the angel investor may ask for additional information about the business and its owners, like financial statements or résumés.
After this initial review, if they’re interested in moving forward, they’ll schedule a meeting where you’ll get to know more about their personalities and investment styles.
- Due diligence is conducted on the business
The due diligence process gives investors a detailed understanding of your business and its potential for growth before they decide to invest.
It involves research and interviews to get an understanding of the business’s financial position and plans, as well as its value proposition, management team, and market opportunity.
- If the investor decides to invest, a term sheet will be drafted
If the angel investor like what they see after conducting due diligence, they may provide a term sheet that outlines their offer.
The term sheet is simply an agreement between two parties that details the terms of a potential deal. If a deal goes forward, the term sheet would be replaced by a binding contract.
The term sheet stipulates the following key items:
- Amount of capital to be invested
- Percentage equity stake in the company
- Valuation of the company (although this is flexible and not on paper definitively)
- Amount of capital to be raised at this stage
- Amount of capital to be raised for future rounds
Cash flow projections are also usually attached to show how the funds from this round will be used, as well as how much cash would be available for future rounds.
- Contract is signed and the funds are transferred to the business
If you’re both satisfied with the details of the term sheet, a contract will be signed and with it the agreed funds.
To be on the safe side, get your lawyer to go through the details of the contract before putting pen to paper. Your investor’s lawyer isn’t your lawyer and they won’t be on your side.
Recommended Reading: Y Combinator 2022: How to apply and succeed at YC
How Do You Determine if an Angel Investor is Right for You?
Now that you’re up to speed, let’s talk about how you can determine if an angel investor is right for your startup.
This list is inexhaustive. However, it touches on some of the most important questions you should ask when selecting an angel investor:
- What’s your investing style?
Many angel investors have a “niche” they like to invest in and won’t consider companies outside of it. This pickiness can frustrate you, but it’s good to know upfront what an investor is looking for.
- Have you invested in companies like mine and how did they do?
If someone hasn’t invested in the type of company you’re building, that may be a red flag.
Also, ask about the fate of other companies they’ve invested in. If most have failed, you’d want to think twice about taking their money.
- Do you know anyone else who might be interested?
Many deals are syndicated with two or more investors working together. If an angel is interested in your business but doesn’t have all the cash you need, they may bring others into the deal.
- What specific skills or experience do you bring to the table?
Besides money, angels should bring other valuable skills to your business such as technical expertise, knowledge of a particular sector or market, experience raising capital, network of contacts etc.
- What is your investment philosophy?
Some angels think of their investments as financial instruments, while others see them as opportunities to mentor young businesses and help them succeed.
The latter type of angel investors may be more helpful in the long run.
- How much funding do you typically invest per company?
Some angel investors prefer to invest small amounts of money in many companies. Others prefer investing sizable sums in just a few companies.
Which option is best for you? If you only require a small amount of seed funding, then an angel investor who prefers spreading their investments around might be perfect for you.
On the other hand, if you have big plans that require significant funding, then find an angel investor with deeper pockets.
- What is your timeline for investing?
Some investors only invest in early-stage companies, while others prefer to wait until later in the game to get involved.
Again, this can help you eliminate some investors who may not be the right fit for your business.
- What kind of exit opportunities do you look for when investing?
Some investors like to get involved with companies that have a specific exit strategy in mind, like an IPO or acquisition by a larger corporation.
Other investors are open to all kinds of options and want to see what opportunities present themselves along the way.
Knowing where each investor stands on this matter can help you determine if their investment goals match up with yours.
5 Red Flag to Avoid When Dealing with Angel Investors
Angel investors can help you grow your business by providing the capital, contacts, and confidence that you need to be successful.
But finding investors isn’t easy, and the process can lead to many pitfalls if you aren’t careful.
Here are some key warning signs to look out for when dealing with potential investors:
- Poor track record
If an angel investor has a history of losing money on their investments, it may not be the best bet for your portfolio.
While you may be able to turn the situation around with your business, it’s best to evaluate the risk before proceeding.
- No track record
In most cases, you don’t want to be the first person an angel has invested in.
There’s nothing wrong with being a trailblazer, but if you’re considering taking part in an angel’s first deal, make sure that individual has a lot of relevant experience in other areas and has done thorough research on the company and the industry.
- Non-disclosure agreement (NDA) requested
The last thing you want is for someone who’s getting a look at your confidential information — such as financials, customer lists and strategic plans — to suddenly become direct competition because they stole and copied your ideas after investing in you.
Be wary of angel investors who require you to sign a non-disclosure agreement before sharing their information with you.
- Investor doesn’t ask relevant questions about your business model
A good investor will want to learn as much as possible about your business — how it makes money, the risks, and opportunities it faces, and the competitive landscape.
If the investor shows little interest in these issues, they may not be worth your time.
- They want too much control
If an angel investor wants too much control over your company, this could also be a sign that they aren’t right for you.
Angel investors usually want board seats or observer status so that they can make sure that their investment is being used correctly.
But if they want to have full control over everything in your company, then they probably aren’t the right fit for you.
5 Ways to Find the Perfect Angel Investor
The best way to find an angel investor isn’t by putting out an ad online or in a newspaper, but by connecting with people face-to-face, talking to them and showing them what you offer.
Here are a few ways you can connect with potential angel investors:
- Speak with family and friends
Family and friends can be your first stop when looking for angel investors. They know you; they trust you, and they’re most likely going to want to help you achieve your goals.
But just because they know you don’t mean you don’t have to do the usual things that come along with finding an investor — such as creating a business plan and a pitch deck.
- Attend networking events
Networking events, especially those that are geared toward startups, can be a great way to meet people who are interested in investing in promising new companies.
To make the most of these events, research which ones will attract the investors you’re looking for (some may cater more toward tech startups while others may focus on startups in other industries), prepare your pitch and bring along any sales materials that could help convince potential investors of what you offer.
Also, be sure to follow up with anyone who expresses an interest in your company, so you can keep the conversation going.
- Join angel networks
There are many angel groups available online and in-person who can help you connect with potential investors. AngelList has a great database of angel investors and groups by location nationwide.
You can also try searching for local angel groups on Meetup. Other examples include tech coast angels, golden seeds, band of angels etc.
- Connect with investors using social media
Twitter and LinkedIn are great tools for connecting with like-minded entrepreneurs and potential investors. Make sure your profile is updated and professional so that you can make a good first impression.
When engaging with potential angel investors on social media, mention something about them or their company (whether it’s positive feedback or constructive criticism) so that they’ll know you’ve done your research before reaching out.
- Try cold emailing/calling
If you’re interested in an investor but don’t know anyone who can make an introduction, consider cold emailing or calling them directly.
Keep in mind that these investors are busy, so provide some context on who you are and what company you represent in the subject line of your email.
Send a pitch deck along with your email if it’s concise — no longer than 10-15 slides. Finally, explain why you think they would be interested in investing in your startup.
Wrapping Up
Angel investors are a great way to help bridge your startup or project funding gap, plus they have the experience and expertise to help guide your business in the right direction.
However, keep in mind that investors of any kind carry similar risks. Be sure you do your homework before deciding whether or not an angel investment is right for your business.