This article is part of a larger series on Business Financing.
Angel funding is a more flexible and less formal way to raise capital, especially compared to more professional investors, such as venture capitalists, and angel investing isn’t right for every business. You may find that getting startup business loans—or an alternative to startup business loans—may make more sense.
Before you begin the process of pursuing angel funding for your business, we have listed seven pros and seven cons for you to consider.
|Startups are no problem||Availability is based on who you know|
|All locations and industries are eligible||Terms can be ambiguous and funding can be slow|
|Paperwork is minimal||Average amounts are less than venture capital|
|Monthly payments aren’t required||An option for investors to convert debt to equity is required|
|Guidance and support are included||Angel investor support and guidance may be limited|
|Networking opportunities are provided||Founder control is reduced and roles may be unclear|
|Assistance with future funding is available||Rapid growth is expected|
7 Pros of Using Angel Investors to Fund Your Business
For a business that might be unable to get a small business loan, whether because it’s too new a business or in a higher-risk industry, angel investors are a good alternative funding option. Here are seven reasons why angel investors might be right for your startup business.
1. Startups Are No Problem
Because angel funding is less formal and more flexible than other types of startup funding, angel investors make excellent backers for startup businesses. Before investing, however, angel investors will want to see the business is growing and projects rapid growth.
2. All Locations & Industries Are Eligible
While many startups come out of large cities, such as New York, Boston, and San Francisco, there are also successful startups in every small town in between. Angel investors are finding those startups all across North America. A 2021 report by the Angel Capital Association (ACA) showed there were almost 8,500 members of the ACA located in 30 states and two Canadian provinces.
In addition, because angel investors choose businesses that interest them, almost every industry can receive funding. That same 2021 report showed industries supported by angel investors included technology, financial, health care, consumer goods, education, government, and energy.
Angel investors are also willing to take on higher-risk companies or industries if they have the potential for a high return on investment. Those investors can step in and finance industries that banks and venture capitalists might find too risky.
3. Paperwork Is Minimal
While you’ll need to come up with a pitch, financial projections, and a business plan, you won’t need a lot of paperwork to close an angel investment compared to a business loan. Usually, a convertible note—which is a short-term debt that has an interest or discount rate, a valuation cap, and maturity date—is used to finalize the investment. Investors can execute a convertible note into preferred shares on a specific date or event.
4. Monthly Payments Are Not Required
Because angel funding isn’t a loan, it doesn’t require monthly payments This can help your short-term cash flow since you won’t be adding a monthly loan payment to it. Angel investors are repaid eventually at either an acquisition or when new funding is raised.
5. Guidance & Support Are Included
Not only are you receiving funding from an angel investor, but you’re also gaining their knowledge. This can be crucial for a startup, as you can lean on the investor’s knowledge when making business decisions, leading to greater success.
6. Networking Opportunities Are Provided
Angel investors can network you with potential clients, helping grow your business. Investors can also network you with other startups they have supported, which can help form strategic partnerships. Some of those other businesses might want to make a strategic investment in your company, possibly leading to acquisition down the road.
7. Assistance With Future Funding Is Available
Because angel investors get repaid when your company goes through future funding rounds, there’s an incentive for investors to help get your company to that point as quickly as possible. Angel investors will network with other investors to help expedite the process, leaving you time to run your business instead of looking for future investors.
7 Cons of Using Angel Investors to Fund Your Business
While there are benefits to using angel investors to fund your startup business, it isn’t the right choice for everyone—and you might not even be able to find an investor. Plus, you’re giving up a portion of the equity in your business, which can bring additional problems. Here are seven reasons why angel funding might not be a good fit.
1. Availability Is Based on Who You Know
While there are online resources to find angel investors, like AngelList and FundersClub, it isn’t easy to get investors. In many cases, your best chance to get angel investing is to have an existing business connection with an investor. They already know you and your business, which gives you an advantage over other startups. If you’re relying on angel investors that you don’t know, the odds of convincing one of them to invest in your business are significantly lower.
2. Terms Can Be Ambiguous & Funding Can Be Slow
Because angel investing is less formal than other types of startup funding, negotiating terms for the potential deal can be complicated. Both sides want to ensure they get a good deal, which can often lead to a verbal back-and-forth but never a finalized agreement. Try to get terms drafted into an agreement as you try to push the process through to completion.
3. Average Amounts Are Less Than Venture Capital
While the amount invested in an angel deal can be as much as $1 million, this is uncommon. More than 70% of angel deals listed in a 2021 study published by the American Capital Association were for less than $200,000. You may end up needing to go forward with another round of funding soon after receiving angel investing.
4. An Option for Investors To Convert Debt To Equity Is Required
Angel investors typically receive convertible debt at a premium of 20%. At the next valuation, investors can convert debt into equity. The more times you raise funds, the more equity you give away in your company. In some cases, original owners become minority owners due to the equity given away in angel investments and venture capital investments.
5. Rapid Growth Is Expected
Angel investors want a return on their investment as soon as possible, as investors expect startups to grow rapidly within three to five years. This means those investors will be pressuring you to continue growing your company, even if that’s against your company’s long-term plans. And although you intend to keep your business small, those desires might go against the expectations of angel investors.
6. Founder Control Is Reduced & Roles May Be Unclear
As you continue to raise funds through angel investing, you continue to give up equity in your company—and this means investors increase control of your company. While having more experts to consult can lead to business success and decision-making, it could also lead to a company going in a different direction than you intended. Additionally, having investors may make defining leadership roles within the company difficult—and a power struggle between owners and investors might bring your business down.
7. Angel Investor Support & Guidance May Be Limited
While many angel investors are also experts in the field they invest in, this might not always be the case, as each angel investor brings a different level of expertise. You should take a look at the investor’s credentials before agreeing to the investment.
In addition, an angel investor may have invested in so many startups that they might not be as available to help you as you would like—and they may even have their own business interests that keep them from assisting you. If you’re counting on guidance from an investor, make sure those expectations are stated clearly before agreeing to funding.
There’s a lot for you to consider before turning to an angel investor to fund your business. There are many positives, including gaining expertise that can elevate your business. Risky companies and industries are less of a problem with angel investors, and you may be able to use investors to network to find future investors.
However, you’re giving away equity in your company and, therefore, some of your decision-making power. Investors will expect a rapid return on investment and use their influence to make that happen. Also, you might not find an angel investor at all.
Consider all of the factors above, in addition to speaking with your financial and legal advisors before moving forward with angel investments into your business.