The Pros and Cons Of Angel Investors
Are angel investors the right funding source for you? It depends. As a startup founder, especially in the earliest stages of your business, you’ve probably heard about angel investors. If you need external funding – and more than 60% of all startups do to get off the ground – angel investors can be a great source in your pre-seed and seed funding rounds.
As an angel investor myself, I’m a bit biased in my belief that we can give fledgling startups the kind of support they need most as they’re just getting started (hint: it’s more than just capital.) But I also understand that working with angel investors isn’t for everyone or every startup.
Just like with any funding source, there are pros and cons to angel investing. It can be a more flexible and informal way to raise capital compared to venture capital firms, and there’s little to no direct, upfront cost for founders. However, it can also dilute founder control and provide less funding than other sources.
Read on to find out if and when approaching an angel investor might be right for your startup.
What is an Angel Investor?
Have you ever seen an episode of Shark Tank? Then you’ve seen a (highly dramatized) version of founders pitching their business idea to angel investors.
An angel investor is an individual who uses personal funds to finance startups, particularly in their pre-seed and seed stages. Many angel investors are accredited, meaning they have a net worth of at least $1 million or make a minimum of $200,000 in annual income.
Angel investors are often successful entrepreneurs or businesspeople in their own right, bringing experience and mentorship to their investments just as much as they bring capital.
While angel investments are typically smaller than venture capital injections, the size of angel investments can vary widely, ranging from several thousand to millions of dollars. Angels provide capital in exchange for a share of ownership in the company, typically in the form of stock, but possibly in the form of convertible debt, which can be converted to equity at a later date.
While angel investors are similar to venture capitalists in some ways, such as their focus on early-stage companies, angel investors invest their own money while VCs invest other people’s pooled money.
Pros of Using an Angel Investor
Angel investors bring a lot to the table. We’re comfortable investing with higher-risk startups, aren’t limited to certain areas or industries, keep things a bit informal, and can provide you with guidance and assistance in addition to funding.
Need more reasons to seek angel investor funding? Here are the top pros of working with an angel investor:
Early Startups are Welcome
The innate flexibility of angel investing means that early-stage companies, which carry the highest level of risk, are eligible for funding and typically aren’t an issue. Angels welcome the risk, knowing that the potential reward could be just as high.
Just be prepared to accurately demonstrate your business’ early growth, as well as provide projections for even more growth, so angel investors know when they expect to see a return on their investment.
Any Location or Industry Is Considered
While some angel investors may prefer to work within certain niches where they have experience (for example, I tend to stay near my sweet spot of innovative tech-powered startups throughout the fintech, SaaS, real estate, and cannabis spaces), there aren’t any rules that dictate where they can invest or the kinds of companies they’re limited to.
Certain cities, like San Francisco and New York, are startup hubs, but angel investors can select startups located all across the U.S. They typically choose businesses that personally interest them, and with so many varied angel investors, nearly every industry has the potential to receive funding.
Minimal Paperwork and Payments
With any kind of funding, you’ll need to produce a pitch, a business plan, and your financial projects. But other than that, there’s not much paperwork to close an angel investment deal, especially when you compare it to a loan, which also requires regular repayment. Since angel funding is not, in fact, a loan, you’ll have greater short-term cash flow that you can use to support your business. When your business eventually gets acquired, goes public, or raises additional funding down the road, that’s when your investor gets repaid.
More Than Just Money
Angel investors provide more than just money. Founders also gain from their knowledge and experience. An early-stage startup can leverage the skills and industry expertise of their angel investor starting with some of the very first decisions they make, which can help steer them toward a path of success.
Angel investors also often provide access to their robust networks, which could include potential clients, investors, or vendors. Having a direct connection to these individuals and businesses can remove much of the work that usually comes with finding new investors or strategic partnerships down the road.
Potential for Future Funding
If an angel investor gets on board from the beginning and sees firsthand the progress your startup is making, they may invest more in future funding rounds or tap into their network of investors to expedite the process.
Cons of Using an Angel Investor
Working with angel investors isn’t for everyone. It can require more work to acquire the funding initially, and there’s always the chance you won’t find an angel who’s willing to invest. Giving up some equity in your company early on will also reduce the founder’s control, which can be tough for some. And if you’re looking for a massive injection of cash, you may find more through VCs than angels.
Not sure if an angel investor is the right funding source for you? Here are a few disadvantages to consider:
Time and Effort to Prep
There’s a lot of work that goes into pitching for an angel investor. On top of the pitch itself, you’ll also need to prepare your financial projections, cash flow statements, income statements, balance sheets, and bank statements. If you’re not up for the work, you may want to seek funding elsewhere.
Potential Rejection
After all of the work you do to prepare for your pitches, there’s still a chance of rejection. Even if you see your startup as the next great unicorn in the making, angel investors might not see it that way. They’re investing their own money, and each investment is highly risky, so they’re going to be quite particular about where they invest.
Reduced Control
If you do convince an angel investor to sign on to your startup, the exchange of cash for a stake of equity in the company will effectively reduce your control over it. Since they’re shelling out a significant amount of money, they understandably want to have some say in the decisions that are made within the company.
While getting additional input from experienced angel investors can help put you on the path to success, it could also lead to a slightly different path than you anticipated. There could also be a bit of conflict if there’s a power struggle between the founding team and investors.
Funding Amounts Are Less Than VC On Average
If the amount of funding is the top priority for you as a founder, then you may be able to find more through a venture capital firm than through angel investors. According to a 2021 study, more than 70% of angel deals were for less than $200,000, with the average angel deal size around $392,000. While you may be able to secure an angel investment of as much as $1 million, your deal is more likely to fall closer to that average amount.
For some founders, this is fine, as more capital can be raised with later funding rounds. For others, when you compare this amount to 2020’s median size of early-stage VC deals at $4.5 million, angel investing just can’t compete with the potential financial gains of VC deals.
How to Find an Angel Investor
After learning about the downsides and advantages of angel investor funding, you may feel confident that angel investors are the right fit for you. How does one go about finding the right angels to pitch to?
Typically, angel investors are found through a combination of tapping into your network, the many online networks/platforms designed for angel investors and founders like AngelList, as well as local incubators or accelerators that can create potential investment connections.
Some of the best angel investors for startups can be found through online research if you’re not well plugged into a local entrepreneurial scene. If you do have personal connections, such as friends, family, or friends of friends who might know a potential angel investor, ask for them to make an introduction. And if you are looking for support to get your startup off the ground as well as potential angel investor connections, applying for incubators or accelerators may be a smart and strategic choice.
Should You Get an Angel Investor?
Choosing the right funding choice is foundational to the success of your startup, especially when you’re just taking off. There are many benefits of angel investors to consider, including their slightly less formal and more flexible approach, the added guidance and mentorship they often provide, and their willingness to take on high-risk startups in their earliest stages. However, the downsides should be faced honestly. Working with an angel investor might not lead to the highest funding amount and will limit some of your control as a founder, and these cons may be enough to steer some founders elsewhere.
With a full understanding of the pros and cons of working with an angel investor, you can make the right decision for yourself and your startup. If an angel investor sounds like the perfect fit, and you’re working on a world-changing new idea, reach out to Steve MacDonald of MacDonald Ventures.
