When it comes to navigating the difficulties of raising capital for startups, "Angel Investors" are God-sent (no pun intended). This is because they allow entrepreneurs to diversify their investment options beyond debt financing. Angel investors are seed investors who pump their own personal capital into startups. Startups in their infancy can thus secure funding before they are equipped to raise venture capital. According to the Angel Capital Association, Angel investors provide 90% of outside investing for startups. Apart from supporting an innovative idea, these investors are looking for a return on their investment once the company starts to grow.
WHAT IS ANGEL INVESTING?
An example of a typical debt financing scenario would be an entrepreneur borrowing money that will need to be repaid at some point down the road. Angel investing takes a different approach. When an angel investor provides funding, it typically does not result in a debt which needs repayment. Instead, in exchange for the Angel's investment, the investor acquires equity in the company, the exact amount of which may vary depending on the capital provided. The amount of equity received is different for every angel investment: the greater the amount of capital that is provided, the larger the share may be.
ANGEL INVESTORS VS VENTURE CAPITALISTS
What differentiates angel investors from venture capitalists is that they use their own personal wealth as opposed to that belonging to an investment fund. Also, they are more mentally prepared to invest their money for a longer period of time provided that a return on their investment is likely at some point in the future, either through a public offering or by way of an acquisition. That being said, some angel investors might just back a startup with no immediate profitability prospects because they find the idea behind it revolutionary and intriguing. Angel investors tend to invest in very early-stage ventures which are much riskier than what a venture capitalist would tolerate.
WHO CAN BECOME AN ANGEL INVESTOR?
In order to qualify for being an angel investor, it is imperative to be an accredited investor. This simply means that the investor's income must be over $200,000 for the past two years (if single), and over $300,000 jointly with a spouse. Alternatively, people can also qualify if they are able to prove that their net worth exceeds $1 million in investable assets, not including their residence. The restriction stems from the fact that angel investments are high risk, and accredited investors have a higher tolerance and financial ability to handle loss.
Prior to the enactment of the Jumpstart Our Business Startups Act of 2012, the concept of angel financing was once limited to accredited investors only. However, this act removed some of the regulations surrounding angel investors. For example, Title Ill of the JOBS allows non-accredited individuals to invest through crowdfunding platforms.
Before finalizing their investment, most investors will want to take a good look at the business in order to gauge its potential. To improve its chances of attracting angel investors, a business should be able to paint a convincing picture about their future; entrepreneurs who don't have everything in order risk losing investors since there are a plethora of investment opportunities available in the market.
The average size of investment varies from $25,000 to $100,000. This milestone can either be achieved through a series of smaller investments, which can be more time consuming since there are more parties to meet and network with. However, it is easier to convince people to invest a small amount rather than a large amount, which is where this approach might prove to be beneficial. Alternatively, entrepreneurs can aim at securing a few larger investments to meet their target. This might prove to be less time consuming since there are fewer stakeholders to deal with, but it will definitely require more persuasion to make them part with a larger sum.
SOURCES OF ANGEL INVESTMENT
- Friends and Family: The first resource to tap for funding are friends and family of the startup owner. Angel investors in the friends and family round have to be listed on the company's subscription agreement as a non-accredited investor.
- Networking: Do not hesitate to ask someone within your existing professional network for an introduction to a new potential investor.
Although it may seem awkward to ask, raising a decent amount of capital will require you to step out of your comfort zone.
- Angel Groups: Groups of people can come together with smaller chunks of investment capital, review and agree on a common startup to invest in and invest in that startup.
- Syndication: A syndicate is comparable to an angel group, except that in this arrangement one angel is making the final decision on which investment opportunity to pick. Syndicates are often comprised of experienced and well-seasoned investors who have better deal flows. Syndicates fund companies on a mass level. The leader of the syndicate gets a 20 percent fee based on the success of the business.
PROS and CONS of ANGEL INVESTING
From the startup's point of view, the obvious advantage of angel investing is that it allows them to raise capital without overburdening themselves with debt. However, the additional capital does not exactly come without strings attached. Realistically, investors might be tempted to meddle in the business and their meddling may cause clashes between themselves and the entrepreneur.
From an investor perspective, although angel investing comes with higher risk, the profit potential is also significantly greater than it would be with most other investments. The key thing is to invest in businesses that you know a lot about- either by virtue of your profession or as a result of extensive market research. Even then, the threat of losing everything is very real.
Another issue with angel investing is that it is not a liquid investment.
Even if the startup has a solid business plan, it could take years before it starts generating profits, and even longer for the angel to realize any tangible profits.
Despite certain potential disadvantages highlighted above, angel investment remains one of the most popular methods of funding a startup. In order to avert the risks that come with angel investment, it is best to work with professionals. Alamo Angels and Beam Network in San Antonio are great organizations for accredited investors to engage the startup community here in South Texas to support our local startups.
Disclaimer: This article is made available for educational purposes only, to give you general information and a general understanding of the law, not to provide specific legal advice. By using this article, you understand and acknowledge that no attorney-client relationship is formed between you and The South Texas Business Lawyers, nor should any such relationship be implied. This article should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.
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