Angel investors are wealthy individuals who fund early stage startups with their own capital. They do so for convertible debt or equity ownership. They also mentor, advise, and make introductions that benefit the business. Angel investment is best for early stage startups with traction after raising funding from friends and family.
What Is an Angel Investor?
Angel investors are wealthy individuals who invest in startups. Sometimes they are also referred to as business angels or informal investors, but the function is the same. Startups can raise money from angel investors for equity or convertible debt.
Although some angel investors are former founders, they also come from professional backgrounds such as banking, law, and accounting. They typically specialize in an industry or type of business and make investments based on that criteria. Some angel investors also organize into groups, called angel groups or networks, to pool resources and reduce their overall risk. The funding process of angel investors resembles venture capital, but the two are different.
How Angel Investor Funding Works
Angel investors are pitched by startups for funding. In exchange for funding, angel investors receive equity or convertible debt. Over the course of the next few years, angel investors will offer advice and make introductions that help the startup succeed. Once the startup reaches a liquidation event, the angel investor is repaid.
Convertible debt is more common than direct equity and gives investors the option of receiving equity instead of cash. Angel investors evaluate the potential of a startup by meeting with the founding team and analyzing past performance. They also attempt to gauge the potential growth of the startup, given their investment.
Once funding is agreed upon, founders receive a check for the entire amount. Some startups often involve several angel investors in funding. Once funding is received, founders are expected to report on the progress they make regularly. Founders can also reach out to angel investors for advice and introductions to aid their business, which is one of the benefits of angel investors.
Which Investment Profiles & Funding Opportunities Are Right for Angel Investors
Angel investors focus on early-stage startups with a large potential for growth within their area of expertise. They fund teams with proven track records and startups with customer traction. Angel investors are also interested in seeing specific plans for how capital will be spent and well-defined exit strategies.
Some opportunities angel investors are interested in include:
- Founders with previous successful startups: Angel investors often put additional emphasis on the founding team of a company. If the founders demonstrated a successful track record, they are more likely to fund their startup, even in the early stages of development.
- Startups developing a product: After a startup has identified a need, it often works to develop a product to solve that need. Angel investors are often key in providing the runway to develop and test the product. They can also refer potential partners and customers that can use the product and provide feedback.
- Businesses launching a product: Although many software products are associated with low launch costs, some physical products require significant capital. Angel investors are interested in funding these products, especially when they can help with attracting customers and securing distribution channels.
- Startups needing to grow their team: At any stage of a startup, there can be a necessity to grow the team that’s making everything work. If the need for a larger team is to keep up with orders or customers, angel investors will often be interested in investing.
- Startups that are growing quickly and need capital to scale operations: Scaling larger startups often requires venture capital, since the amount of required funding is usually large. However, angel investors are often interested in providing the funding that’s needed to get from the startup’s current position to venture capital funding.
For angel investors, deciding whether to fund a company rests with their estimation of the potential success of the startup. They can base this on the founding team, existing traction with customers, or a specific need they feel has a great amount of potential. When evaluating returns, angel investors also estimate the degree to which they can affect outcomes with their expertise and introductions.
What Returns Angel Investors Expect to Earn
Angel investors expect successful startups to return at least ten times what they invested. This helps make up for the losses of unsuccessful investments. To compensate for this level of risk, angel investors evaluate the potential for growth a startup has in the next five years. In 2017, angel investors received an average 12.2% equity when converting.
This doesn’t mean that every dollar invested into the company by an angel investor needs to earn $10 in profit. Instead, angel investors are concerned with the valuation of the company increasing tenfold. How this valuation is determined often depends on the business and industry in which the startup operates. In 2017, startups that received angel investment had an average valuation of $3.2 million.
Where to Find Angel Investors
In the past, businesses needed a direct introduction to one of the few angel investors available in their area or industry. Although this is still the case sometimes, they can now find angel investors through professionals such as lawyers and accountants, investor groups on the web, industry conferences, and networks of friends and family.
Some common ways to find angel investors are:
1. Lawyers & Accountants
Although this isn’t the first place that most entrepreneurs search for angel investors, it makes sense that professionals that often deal with startups are likely candidates for angel investment. Although most professionals won’t refer founders to their clients, many will invest in your company either directly or by accepting equity in the company for their services.
As Lou Bevilacqua, a corporate and securities lawyer at Bevilacqua PLLC, describes:
“I have been approached by founders directly through friends and family. I also will often take equity in lieu of fees to help startups get started where I am excited about the company purpose. Other investments I have made in startups came from frequenting angel events, being generally solicited online, or through an email campaign.”
2. Angel Investor Groups
Angel investor groups grew in size and popularity over recent years, as more investors are looking for the best opportunities. This is closing the gap between their funding amounts and the amounts venture capital can provide. Often these investor groups have a strong online presence, a level of exposure once reserved only for the most famous angel investors.
According to Theo Lee, who co-founded KPOP Foods and raised $150,000 in angel investor capital:
Resources like Crunchbase and AngelList can be great for finding angel investors. On Crunchbase, founders can browse recent startup funding deals in their industry. This can help them identify active angel investors in the space. AngelList, like Crunchbase, lets you list your startup for angel investors to discover. AngelList also has angel groups and syndicates that look for investment opportunities.
Networking at conferences, events, incubators, and other startup gatherings (e.g., meetups) can be a great way to meet fellow entrepreneurs and angel investors. If the startup’s industry requires special expertise, founders can attend conferences that are industry-specific. However, one of the best ways to meet angel investors is through one of the top accelerators in the country.
Cathy Connett, an angel investor with over 30 years of experience, and the founder of the Sofia Fund, an angel fund that invests in women-founded and women-led companies, says:
“We are always networking and looking for good deals. Whether people find us, or we find them at events, conferences, accelerators, or through referrals—we are always looking. Entrepreneurs need to also understand that they are competing in their product’s market for sales, but they are also competing against other entrepreneurs who are pitching angels for investment.”
Whether entrepreneurs find angel investor funding through lawyers, friends, referrals, angel networks, or through a conference, remaining focused on their business is key. Kevin Pollard, serial entrepreneur, angel investor, and adjunct professor at Tulane University Freeman School of Business, warns that:
“Far too many companies that follow pitch for money competitions lose their focus and chase the prize money versus working on their business models.”
How Angel Investor Funding Is Repaid
Startups repay angel investors with debt or equity at the startup’s next liquidity event. They define liquidity events as liquidation, new investment, an IPO, or sale of the business. Whether they choose debt or equity will depend on the circumstances of the business.
With business liquidation, startups repay investors from the sale of business assets. With no available equity, investors settle for debt repayment in cash. If there is a new fundraising round, investors may ask for cash to exit the investment. But, more often, they will take compensation in the form of equity for their investment.
The typical investment that goes on to another fundraising round works like this:
- An angel investor offers terms for a $50,000 convertible debt investment.
- The terms will have a premium of 20%, which means that the startup owes the investor $60,000 in debt or equity.
- At the next round of funding, a venture capital firm invests $1 million for 20% of the company, giving the startup a valuation of $5 million.
- The angel investor then has the option to receive $60,000 for the investment in cash or to convert it into $60,000 worth of equity at the new valuation.
Acquisitions are more complicated. Angel investors will judge the quality of the business making the acquisition. But, even if they decide to convert into equity, it may not be as easy. The acquiring company may negotiate different terms to avoid further diluting its own equity.
What Angel Investors Look for Before Investing
Angel investors examine the company, product, team, and exit strategy when making investment decisions. The company should have traction with customers and a minimum viable product (MVP). The team should have complementary skills and a viable exit strategy. Good teams can adapt to new changes in the market and make up the core of the business.
After 30 years of investing as an angel and running her own fund, this is what Cathy Connett looks for in a startup team:
“A passionate, exceptional team that can execute both strategically and tactically, rapidly adjust to new information from the marketplace, and knows their capabilities. A vision and product that has demonstrated its value proposition will almost always be more attractive than a fantastic product with a less stellar team.”
However, angel investors and angel groups won’t glance at a startup’s team profile and decide if they are a good fit. They have to believe in what the startup is doing, and one of the best ways to do this is by releasing a minimum viable product. Not only does this allow founders to present potential angel investors with a hands-on experience, but it also gives entrepreneurs valuable feedback from customers to share.
After evaluating a startup’s potential, angel investors will want to conduct some due diligence. In this process, they need to understand where past capital has come from, how the company is structured, who has ownership and decision-making power, and whether the operations are viable. This is often the longest part of the process and can delay and even sometimes prevent funding.
How Long It Takes to Get Angel Investor Funding
Some entrepreneurs get funding from angel investors after the first meeting, while others take several months. The funding times of individual angels are unpredictable. However, angel organizations, like funds, networks, and groups, have a more rigid application process that takes one to nine months for funding.
Cathy Connett indicates that:
“Given everything being buttoned up when we are introduced to a company, it is probably between one to three months before funding. The issue is not usually the time for our due diligence, but is more often driven by the company’s ability to get enough investors convinced and committed to investing, to create all the documents, and to schedule a close.”
Founders raising an angel round have to coordinate multiple investors to contribute capital at the same time and with the same terms. This increased complexity leads to longer deal times. One way to get around this is to approach an existing angel group or network that already has many angel investors. Although this process is easier, it doesn’t always lead to faster funding.
According to Kevin Pollard, who is also the former director of the NO/LA Angel Network:
“The average angel network will take six to nine months from the time an application is submitted until the time that post-approved funding is in the bank. The NO/LA Angel Network averages three to six months because it has a more sophisticated due diligence process that permits it to process applications with greater speed.”
If founders want to reduce the time to get funding from angel investors, they should focus on preparing a stellar investor proposal. This proposal should include key information about the startup, founding team, and planned use for funding.
How to Prepare an Angel Investor Proposal
Preparing an investor proposal is like writing a business plan, but it’s more condensed and takes the form of a presentation. Often referred to as a pitch deck or investor deck, it contains information about the startup, including a summary of the team, opportunity, current and projected financial position, and the requested funding amount.
Lou Bevilacqua recommends:
“Angel investors like to see a well-developed investor deck along with a detailed financial model. The deck should be professional and make sense, and the financial model should not be too aggressive. In addition, some entrepreneurs will also propose a term sheet to get things started.”
Angel investors know that the financial model is an estimate and although you can prepare a term sheet ahead of time, it’s often recommended that first-time founders discuss terms with potential angel investors first. Preparing these documents is important for all angel investors, although many formal angel networks and funds will have stricter requirements.
Kevin Pollard indicated:
“Today, most angel networks or funds use a platform called ‘Gust,’ which requires the entrepreneur to enter certain basic information before consideration at any level. That usually includes a summary, description of founder and managers, credible expression of the opportunity, very brief financial statements, and so on.”
Before founders present their pitch deck, they must pitch their startup. Commonly referred to as an elevator pitch, the pitch should be short enough to recite in an elevator ride, but still capture your business idea, target customers, and entice the listener to learn more. Then, founders need to ask the right questions to ensure the angel investors can make good partners for the startup and founder.
What Questions to Ask Potential Angel Investors
Entrepreneurs should approach angel investors as long-term partners for their business by asking the right questions. Founders should understand what value an angel investor network can bring. They should also understand the level of involvement in day-to-day decisions that their angel investors expect to have. The terms of the investment should also be clear, leaving no room for ambiguity before making a commitment.
Some questions that founders should ask a potential angel investor are:
- What have you invested in?
- Would you mind introducing me to the other founders you’ve invested in?
- How involved are you in day-to-day management?
- Do you have any requirements we need to meet to secure investment?
- Can you introduce us to other investors and strategic partners?
David Cohen, founder and co-CEO of TechStars, and angel investor recommends direct communication when discussing funding with angel investors:
“Clear conversation really matters, and if you can do that well, then there is no space for ambiguity. You know there is a soft commitment when you confirm the intent to invest with the specific funding amount and the specific conditions on which the investor might not follow through on the closing of that funding, and your angel investor agrees. Fundamentally the difference between a soft commitment and a hard commitment is that there are well-understood ways ‘out’ of that commitment, and there is magic in getting to this point.”
What Role Angel Investors Take in Businesses
Angel investors will play one of two roles in the startups in which they invest. They might contribute nothing but capital or take an active role in management and oversight of the business. There isn’t a specific level of involvement founders should target for their startups, as each type of angel can be a great fit for specific situations.
The roles angel investors take in the businesses they invest in are:
- Passive role: Some angels contribute money to a project, and nothing else. This is best for serial entrepreneurs who already have a good network to support their business. Most often, inactive angel investors will also be part of larger rounds with multiple investors.
- Active role: Investors who take an active role in management can help new entrepreneurs set goals, develop products, and speed up the growth of their company. This might be helpful if the entrepreneurs are technically focused and have little business experience.
Both types of angel investors will make themselves available to answer questions, connect founders with someone in their network, and offer advice. They will also want regular updates on how the business is doing, how their investment is being spent, and what goals and milestones the founders have hit.
At the onset, entrepreneurs should consider the angel investor involvement they will accept. This is something that founders can ask, as most experienced angel investors will know their level of involvement. Having an angel investor that a founder can work with can be one of the greatest advantages for your startup.
Pros & Cons of Angel Investors
Involving angel investors in funding a startup brings founders the advantages of capital with no monthly payments, access to their network, and an opportunity to seek advice in critical business situations. However, founder ownership is diluted in the process. It can also take a long time to get funding and there is no guarantee of a good fit.
Pros of Angel Investors
Some advantages of raising funds from angel investors are:
- Capital without monthly payments: Getting funding for a startup is critical to developing products, reaching customers, and supporting the operations that make it happen. Debt can leave startups with monthly payments that drain cash flow, whereas angel investors pledge capital that is repaid at specific future events.
- A network of other investors and founders: The old saying “it’s not what you know, it’s who you know” is true for startups. An introduction to strategic partners, future investors, and potential customers helps startups succeed in the long-run.
- Advice on business decisions: For seasoned entrepreneurs and first-time business owners, no two businesses or scenarios are the same. Having someone to turn to when especially difficult situations come up can make a large impact. Besides helping founders decide, it can also refocus the team on the business at a critical time.
Cons of Angel Investors
Some disadvantages of raising funds from angel investors are:
- Dilutes founders’ equity: Unless angel investors opt to be paid back for their investment in the form of debt, founders have to give up equity in their startups. In small amounts, this won’t affect a founder’s control of the company as long as they maintain the majority, but investors will want to be consulted on major decisions.
- May not be a good long-term match with founders: Clear and direct communication when deciding whether to work with an angel is critical to a good long-term relationship. Both parties can rush into the deal, resulting in conflicting perspectives on the company and what roles everyone plays in its development.
- Can take a long time to get funding: Although in some rare cases founders can secure angel investment quickly, the process typically takes a month. With larger networks, funds, and multiple investors, it can take as long as nine months before the startup is funded.
Accepting money from angel investors usually dilutes a founder’s equity. However, you can usually avoid a poor long-term match and extended funding times. By starting their investment search early, founders are more likely to secure funding quickly and select good long-term partners.
Difference Between Angel Investors & Venture Capitalists
Angel investors and venture capitalists fund companies at different stages of development. Earlier funding, by angel investors, is smaller and has fewer requirements whereas later funding, by venture capitalists, is larger and more structured. Also, angel investors invest their own money, unlike venture capitalists, who use the money of outside investors.
Angel investors target companies that are early into developing products and getting customers. They often invest a smaller amount of capital relative to venture capitalists. They also have fewer requirements, unlike venture capitalists who require extensive vetting, which can be a drawback to raising venture capital. In exchange, they often receive convertible debt or equity.
Venture capitalists invest in startups that already have customers and need growth capital. They invest larger sums, often several million dollars in the company. In exchange, they receive equity, as much as 20% to 30%. They are also more involved than angel investors, often taking a seat on the board of directors. This ensures there is oversight of the CEO and other management.
Although many startups will raise angel investment, not every startup needs investment from venture capital. Cathy Connett points out that:
“The line between angels and venture capital is very gray and getting grayer. There are individual angels, angel networks, and angel funds, so these groups are now able to bring much larger sums to companies. In some industries, deals may even have a couple of angel rounds and then exit without venture capital money.”
The great thing is that founders are rarely required to choose between raising angel investment or venture capital. Many angel investors are happy to work with a startup if it will seek additional funds from venture capitalists. This means a startup is growing quickly and the angel investor is likely to make a larger return. But angel investors and venture capitalists are not the only ways to fund a startup.
Frequently Asked Questions (FAQs) About Angel Investors
Will angel investors sign non-disclosure agreements?
Angel investors will almost always decline to sign non-disclosure agreements. This is because they see so many businesses and deals it would be impractical to keep track of them. However, most angel investors will honor the confidentiality of your business if asked to do so.
Do angel investors invest in ideas?
Angel investors rarely fund ideas before they are a business. At the minimum, startups should show extensive feedback from customers, a prototype, or at least some research that is defensible and applicable to the business. For idea-stage funding, raising funds from friends and family is a better option.
Do angel investors need to be accredited?
Angel investors need to be considered accredited investors by the Securities and Exchange Commission (SEC). To be considered an accredited investor, an individual must earn at least $200,000 a year for the past three years and have assets of at least $1 million. The asset requirement doesn’t include the primary residence of the individual.
Whether a startup is getting off the ground with a prototype, or it’s recruiting customers and needs capital to grow, angel investors can help. Startups got an average of $35,255 from individual angel investors in 2017 but the advice, experience, and introductions that angel investors offer often prove to be at least as important.