2.03 – Getting Yourself an Angel
The second most common source of capital for starting and growing a business is an angel, also known as a private investor. Angels are part of the informal risk capital market, the largest pool of capital in the United States. Finding an angel investor can be challenging because they tend to keep a lower profile compared to other investors.
Entrepreneurs typically find angels through referrals. This is why networking within your industry is crucial when starting a business. Building a strong personal network can help you when it’s time to seek private investment capital.
Spotting an Angel: The How-To
Angels today resemble professional venture capitalists more than ever before. They typically look for the same credentials that a venture capitalist would:
- A business plan
- Milestones
- A significant equity stake in the business
- A seat on the board of directors
The convergence between angels and venture capitalists emerged during the late 1990s bull market when venture capital funding reached astronomical levels. Venture capitalists, flush with cash, stopped considering deals under $3 million to $5 million, allowing angels to step in with the promise of quicker returns.
Traditionally, angels were middle-aged, former entrepreneurs who operated solo and invested locally, typically funding deals under a million dollars and staying invested for several years. Nowadays, angels come in all ages, including 20-something Internet entrepreneurs who found success with their first ventures.
Angels often band together to increase their investment pools and take on larger deals. Networks like The Tech Coast Angels in California consider themselves seed venture capitalists. They have become as sophisticated as professional venture capitalists, performing due diligence and sometimes seeking quicker returns, which can conflict with the long-term growth plans of entrepreneurs.
Dealing with Angels
In many ways, dealing with angels is similar to dealing with professional venture capitalists. Begin with a good referral from someone who knows the angel well. Then:
- Align Goals: Ensure your goals and the angel’s goals align. Avoid angels seeking quick exits (three years or less) as this can conflict with your business plans.
- Perform Due Diligence: Investigate the angel’s background and ask for references from other companies they’ve invested in. Speak with those entrepreneurs about their experiences.
- Seek More Than Money: Look for angels who offer industry contacts, potential board members, and strategic assistance, not just capital.
- Agree on Milestones: Get the angel’s commitment to help you achieve agreed-upon business milestones.
Getting ready to deal
Negotiating the best funding deal requires understanding the needs of the other party, knowing what you want, and knowing your alternatives. Here’s a checklist of information to have when negotiating for funding:
- Funding Needs: How much money do you need for start-up and for years one through five?
- Use of Funds: How will you use the funds?
- Funding Sources: What sources of money will you seek and why?
- Collateral: If seeking debt funding, what will you use as collateral?
- Personal Guarantee: Are you willing to personally guarantee the debt?
- Current Investments: What funds have been invested to date and by whom? Are these funds debt or equity?
- Investor Returns: If you have received outside investment capital, what did the investor receive in return?
- Approached Investors: Which outside investors have you approached or will you approach? What were the results?
- Legal Structure: Under what legal form is the company organized, and how does this benefit principals and investors?
- Tax Benefits: What tax benefits does the legal structure provide for the company, principals, and investors?
- Financial Vehicle: What financial vehicle is being offered to the investors?
- Payback Period: What is the payback period for the investor and the projected return on investment (ROI)?
- Exit Strategy: What is the proposed exit strategy for the investors and principals?
- Financial Review: Have your financial projections been reviewed by an accountant?
- Current Agreements: What leases and loan agreements do you currently have?
By thoroughly preparing and understanding these aspects, you can effectively negotiate with angel investors and secure the capital needed for your business’s growth.
