In a startup’s earliest stages, the risk is typically high enough that conventional funding sources like venture capital firms are unlikely to invest. With a high need for cash flow to get the business started, founders often turn to equity financing through angel investors.
Angel investors fill in the gap that falls between bootstrapping and venture capital funds. Angel investors are often serial entrepreneurs, successful executives, or domain experts that infuse an early startup with capital and a wealth of experience that can help the company navigate its critical stages.
The advantage of an angel investor goes beyond financing and ventures into long-term viability. A study by the Kauffman Foundation found that startups who received angel investor funding were 20-25% more likely to survive after four years.
If you’re in the startup stage, here’s what you need to know about working with an angel investor and the benefits it can provide.
How Angel Investors Work & What They Invest In
Angel investors provide capital to startups in exchange for a share of ownership in the company they are investing in – typically in the form of equity (stocks) or convertible debt, which can later be converted to equity. They’re looking for startups with high growth potential that will hopefully earn them multiple times what their original investment was. The potential return will need to be high enough to balance out the risks of such an early investment.
The angel investing process is a bit like sales in that you first have to identify the right targets, perform research, and pitch your offering before potentially closing the deal.
First, you’ll need to use your personal network or online platforms to source potential angel investors you may want to work with. Then, learn more about each person to uncover their area of expertise, the investing approach they take, and their current availability for investments. You’ll likely cross a few names off your list, leaving you with a smaller selection of qualified candidates.
Then, reach out either through a reference or cold email to set up an in-person meeting where you can share your pitch deck. If the angel agrees to meet and likes the idea, you can then negotiate terms and make a deal.
The Benefits and Advantages of Getting Investment from an Angel Investor
As mentioned before, the advantages of angel investors extend far beyond the injection of capital. In addition to the cash flow, an angel investor also makes an attractive funding source due to the following benefits they provide:
- Area Expertise. Angel investors typically invest in niches where they have experience, and if they don’t have domain-specific experience, they may be an entrepreneur themselves with expertise in overcoming common startup challenges.
- Invested Support. Angels have money on the line if your business doesn’t succeed, so they have a vested interest in motivating you and adding value to increase the likelihood of your business success.
- Access to Deep Pockets. If angel investors see growth and continued potential in your business, they may make follow-up investments when you reach later funding rounds.
- Reduced Risk. Equity financing through angel investors carries much less risk than debt financing.
- Network. With an angel investor, you have access to their network of connections, which could turn into new business partners, future financing sources, vendors, or new customers.
- Long-Term Perspective. Unlike some investing sources, angel investors often have a long-term perspective and understand the ups and downs of business. They are more invested in long-term success and a profitable exit.
- Lower Barrier of Entry. Whereas it can be harder to get funding from venture capital firms and other financing sources as an early-stage company, angel investors may still invest despite the higher risk.
Why Angel Investor Funding is Crucial
Angel investor funding is crucial because it is often the first official funding a startup gets beyond using their personal funds or cash from friends and family. It provides that much-needed boost of cash at the very start of a business and can set it up for success. Unlike any other type of funding, angel investing also comes with the investor’s guidance, resources, knowledge, and network and can make the difference between a good startup and a great one.
It’s also the most readily available form of capital, especially to early-stage companies. In fact, over the past decade, total angel investment has been consistently larger than overall venture capital investments in the US.
How to Find the Right Angel Investor for Funding
There are several types of angel investors, with many of the types overlapping. MacDonald Ventures typically falls in the category of the Domain Angel, Professional Angel, and Hands-On Angel.
Getting to know the landscape of angels out there can help you discern which ones are best suited for your startup and which ones are likely not the right fit for your business.
Domain Angel Investor
A domain angel has deep expertise in their industry vertical or domain, which could be healthcare technology or internet travel, for example. They understand the space well and have likely seen it evolve over the years, giving them a unique insight to “see” potential opportunity in an early-stage startup when others may not. Because of their position, they can offer helpful advice and are often well-connected.
True Believer Angel Investor
True believers are hard to find, but they are individuals who are instant believers in a startup’s story and mission, ready to invest their own money despite the early-stage risk. True believers will be your biggest supporter, but at times they may lack a needed critical eye.
The Professional Angel Investor
A professional angel is usually an entrepreneur themselves as well as a serial investor. They take more of a coach’s role and may not be as heavily involved in the day-to-day activities due to their large number of concurrent investments. Professional angels may be one of the first to take a leap of faith and invest in you.
Hands-On Angel Investor
A hands-on angel investor usually works alone and invests a lot of time and energy in addition to capital. They take an active role in the development of the company, using their skills and experience to act as an advisor.
Silent Angel Investor
A silent angel investor falls into the background after investing capital. They will remain relatively inactive and are typically satisfied to hand over a check and hope for the best financial returns possible. They won’t offer as much mentorship or guidance to early companies who could likely benefit from it.
The Process of Getting Angel Investor Funding
Securing angel investor funding looks different for every startup. Some of my investments have reached out through our common connections, others have gone through angel investor networks, and some founders have even used events as opportunities to start a conversation.
Still, each process will go through similar stages, from identifying potential opportunities to the pitch and finalizing the terms of the agreement.
In general, getting angel investor funding follows this process:
- Identifying Potential Opportunities. When looking for new opportunities, investors will look for early-stage companies in their area of expertise, and you should look into local angel networks, search online, and ask your networks if they know of any potential connections. Once the options have been screened, the angel or the founder (but most typically you, the founder) will make the first move.
- The Pitch. You’ll set up a meeting where you can pitch your idea and share current traction as well as future projections to try to win over the angel. This process will likely involve answering follow-up questions and alleviating any concerns as well as a review of the business plan you’re using. At this point, the angel may prepare a due diligence report as well.
- Make a Deal and Establish Terms. If the angel likes the pitch and wants to invest, they’ll make an offer, and both parties will connect to negotiate and establish terms. You’ll discuss things like deal flow, deal structure, and valuation and create a final term sheet.
- Closing the Deal. Attorneys will draft final legal documents before you get the money in hand. These documents may take a week or two to develop, but once everything has been signed, money can start flowing and the angel can begin guiding the startup.
Why You Should Seek Out Angel Investors for Your Startup
Beyond all the valuable benefits they offer, like invested support and a long-term perspective, there are also some unique features to angel investing you won’t find through other investing routes.
The value angels provide isn’t just monetary, which is largely what other investment sources are limited to. They add value in a way that can’t be quantified via their years of experience and industry or entrepreneurial expertise. If you need funding for a cannabis business, you’d do better to look for someone with that industry experience. They also tend to have deep pockets, which can keep you from spreading your funding out across several funding sources that can quickly get complicated.
Angel investors also use each other as sources for new funding opportunities, so working with the right angel investor could refer you to other angels that may be able to offer further guidance and resources.
A Stanford study found that 90% of all startup capital comes from angel investors, so when you need capital and you need it quickly, you won’t find any funding source more readily available than angel funding.
Angel Investments: Combining Money and Mentorship
It’s no secret – startups with the potential to grow into something great need money to fund the costly operations necessary to get off the ground. Developing a product and expanding into markets requires significant funding, and angel investors are the most available source of funding for early-stage startups.
Fledgling companies need more than just money. They also stand to benefit from the seasoned expertise of an industry veteran or serial entrepreneur who has stood in their shoes before or helped other companies find success.
The advantage is clear. Angel investors offer the best of both worlds: the money and the mentorship.
If your tech startup is looking for a boost in both financial and human capital and your idea is like nothing we’ve seen before, you need the right angel investor by your side. Reach out to angel investor Steve MacDonald of MacDonald Ventures.