Angel investment is a manner of equity financing where an investor invests financial funding against acquiring an equity position in the company. Equity financing is normally used by businesses that are young or have been set up with limited resources or are non-established in the terms of financial backing and therefore do not have sufficient cash flow or collateral with which they can obtain business loans from financial institutions.
An angel investor (also known as a private investor, an informal investor, seed investor, business angel, or angel funder) is a person with high-net-worth, who invests in a new or small business venture or provides financial backing to small startups or entrepreneurs, typically in exchange of ownership equity in the company or a convertible debt. An angel investor also helps in providing capital for the start-up or expansion of such a business setup.
Angel investors are typically individuals who have spare cash available in hand and are looking for a higher rate of return in comparison to what would be provided in the traditional investments that generally investors make. An angel investor typically looks for a return of around 25 to 60 percent and that too quickly, in between 3-5 years. That is the reason, often; angel investors established entrepreneurs and/ or members of their family and friends. While most angels are ascribed, the definition of angel investors now has expanded, with more and more people now showing interest in the expansion of their investment portfolio.
The funds that angel investors provide may be a one-time investment to help the business get off the ground or an ongoing insertion like a loading investment that helps to keep the business afloat and to support and carry the company through its difficult early stages of financial crunch.
Angel investors can be of different forms and therefore can be from different backgrounds and may have any of the following sources of investment:
● Family and friends: This is the most common source of investment for business startups that are interested in raising money to fund their business operations, finding business start-up money, and is the only option in some cases. Being a high risk investment and a possibility of high rate of failure with the new businesses, if the business doesn’t make it, it makes a very difficult investment manner. It is important to be upfront about the risk of failure.
● Affluent individuals: Another good source is successful business professionals, doctors, lawyers, and individuals that have a high net worth. These should be willing to invest in return for equity. Often this business is carried out by peer to peer marketing or word of mouth with business associates or some other associations.
● Groups: Angel groups are becoming increasingly popular as the angel syndicates where a group of angel investors raise their potential investment level by investing in a group. Investors contribute funds to these syndicates and a professional syndicate management team chooses the investments.
● Crowdfunding: A form of an online investing group, crowdfunding involves raising funding from large groups of individuals who are interested in investing amounts as small as $100.
Venture Capital Funds and Angel Investors, both are investors that invest in other companies to finance them for their growth and take stakes in the business. But both of them are not the same.
● Angel investors invest in very early stages of companies, ventures or startups. These investments are based on the future potential of growth they see in the company depending on their present performance and the core idea. On the contrary, the Venture Capital Funds invest in the later stages of any company. At the stage when the company has already proved its potential, has passed the stage of proof of concept, and is beyond the level of angel investing. Also the amounts that are invested by VC are comparatively higher than that by Angel Investors.
● Venture Funds usually have a lifespan of 7 years, and the maximum amount is invested in the first 3 years. After the investments are made, VC funds give direction and look for an exit through an IPO, Strategic sale or an M&A. On the other hand, Angel investing continues as long as the individual investor wishes to invest. They, however, look at a 2 to 3 year exit and the most common exits are strategic buyouts / mergers & acquisitions.
● Angel investors invest their own finance and are generally entrepreneurs themselves. VC Funds have people with expertise in various domains/ or any experience or leadership in a particular sector where they have experts to advise them, and they use that knowledge to nurture companies.
● Venture Capitalists usually have targeted investments in very specific areas / sectors. Angel investors are sector agnostic and invest in many sectors and areas depending upon their own expertise and research.
● VC funding is a much more complex process as opposed to angel investing. They handle more funds and have a strong lawfully and carefully woven framework within which they function. Angel investing, as deals with startups and companies of small levels, thus provides for a more humble process. Angel investments are an alternative asset class for companies and the angels invest directly in the investee companies.
A startup should know that depending on the presentation and position of the startup in the market, anywhere from 3 months to 9 months can be spent on the process of acquiring the investment by the startup. During this period, DFAN will be in contact with you while your application is processed and evaluated within the committee and other members.
How does Angel Investing work?
Typically, in debt financing, a startup borrows money from an investor, and this investment is repaid in the future with interests. Angel Investing is particularly different from this. When an Angel Investor funds a start-up, no debt is created, and thus, no money is to be repaid.
In Angel Investing, the investor becomes an equity shareholder in the company depending upon the capital he invested. Most of the time, the businesses that get Angel-funding already have their revenues and cash flows in place. They require the new investments to jump-start their business midway and take it to the next level. Therefore, these are the ideas that already are viable in the market and are looking for a better level to attain.
It is very important to understand what the angel investors choose and where do they prefer to invest their financial backing. Generally, they back early-stage startups that have high growth potential and high risk. Angels are high net worth individuals who want to expand their investment horizons and that’s the reason they prefer backing the startups that are based on profitable risk-taking, a novel idea, and show promise in terms of working, consistency and profitability. These type of investments are dicey and typically do not represent more than 10% of the angel investor’s portfolio.
It is widespread and prudent for Angel Investors to be drawn towards industries and businesses that they understand and might even have preceding experience in.
The market research also states that angel investors generally migrate to startups in their early stages rather than being late to invest, and be benefitted by speedier reaps.
Angel investors present more positive terms compared to other lenders in the market because they usually invest in the entrepreneur starting the business rather than the viability of the business itself. Many Angel investors are more focused on helping the startups take their first steps, rather than the possible profit they might get from the business. Primarily this is the reason that angel investors are the opposite of venture capitalists.
Some angel investors invest through crowdfunding platforms and/or part of angel investor networks to pool capital together.
The angel investors characteristically use their own money. Generally, unlike venture capitalists who take care of pooled money from many other investors and place them in a strategically managed fund, angel investors work individually when it comes to financial investments.
Though angel investors usually are individuals, the organization that will actually provide the funds may be a Limited Liability Company (LLC), or a business, or a trust, or any kind of investment fund, among many other kinds of vehicles.
Angel investors bridge the gap between the small-scale self financing provided by the startup owners and their family and friends and the venture capitalists. Drawing in Angel Investors is not always an easy task, but there are things that can help. First and foremost, the startup holders need to evaluate and decide if angel investing will work for their startup or not.
Advantages and Disadvantages of Angel Investors for Business Owners
The biggest advantage of angel investing is that financing from angel investors is much less risky than debt financing. Unlike a loan, invested capital is not needed to be paid back in the event of business failure. And, most angel investors understand business, risks, and take into account a long-term view. Also, an angel investor is habitually looking for a personal opportunity as well as making an investment.
The main disadvantage of using angel investors is the loss of absolute control as a part-owner. After investing, the angel investor will have a say in how the business will be run and will also receive a pre-decided percentage of the profits when the business is sold. With debt financing, the institution lending the finance has no control over the working manner of the company and takes no share of the profits.
An Elevator Pitch is the presentation that the startup owners will present to the DFAN committee for investment. The entrepreneur needs to prepare a basic presentation consisting of the start-up’s objective, value proposition, fund requirement, team etc. This EP provided by the entrepreneur will go through multiple rounds of evaluation by the core committee to finalize with a presentation to the DFAN core team. After shortlisting, the startup owners are invited for a detailed presentation on the company in front of our angel members for the further process.
It’s important for any entrepreneur to decide when the enhancement and expansion of a startup is necessary, and for investment the entrepreneur thinks of acquiring funds through angel investment. But before deciding about angel investment finalizations, it is impossible to verify what the investor is bringing to the deal besides money. Angel investors generally come with acumen and expertise along with experience in the field the startup is in which they invest, and such an expertise in business operations or access to good suppliers, or skills like those can be utilized by you. As angel investors get the right to be a part of the business because of the equity acquired, it is very necessary to develop an understanding with the angel investor about the work. Conflicting ideas for how the business should be operated can cause problems in the future for both, the owner as well as the entrepreneur and leave a bitter aftertaste.
It’s imperative to have a working business plan in place. As a small business, it is important so as to secure financing from lenders or investors.
There are many ways through which we receive deals for evaluation of startups. Following are the details and hierarchy of the deal inflow. Digital Futurists Angels Network is a widely known angel network. Our members actively seek out positive events that help market DFAN. The primary inflow for the network comes through the members. The network members personally assess funding such proposals. In addition, they might create some startup opportunities with entrepreneurs. All such recommended opportunities are then presented at the Network’s monthly forum as ‘sponsored’ deals. Sponsored deals are the ones in which a member personally assesses the deal and if feels that it is worthwhile takes it forward and proactively does so. Some deals come directly and are not sponsored by any member. These are handled via an Elevator Pitch (EP) session that helps prepare and shortlist such deals for the purpose of presentation to the Network as a whole.
DFAN charges a very minor fee for application and for management after the investment by any DFAN member is finalized. Also the company will have to bear the cost for Due Diligence and preparation of the documents for the investment process. This cost is to be incurred by the company once finalized.
This decision lies solely on the owners of the startup applying for the process. If there would be necessity of any legal consultation prior to, through or for the full term of investment, will be decided by the company owners and cannot be contested against by DFAN.
Initially, as angel investors receive many applications, we will review the application within the community. On later stages, when the investment process is finalized, the investors will sign a non-disclosure agreement with the startup owners in order to protect the confidentiality of the business. Also this process can be substituted with a non-disclosure clause added to the investment contract signed by both the parties and hence protecting the business.