Career Development

Angel Investors: Definition, Advantages and Disadvantages

February 22, 2021

If you are in the early stages of a startup business, seeking funding from an angel investor can be a great way to obtain financing without taking on debt. Working with angel investors also gives you access to their knowledge and mentorship, which can be critical in the early years of business. Understanding both the advantages and disadvantages of obtaining funding from angel investors can help you determine whether this route of financing is right for your business.

In this article, we discuss what angel investors are, how you can find angel investors and the main advantages and disadvantages.

Related: Guide to Understanding Venture Capital

What are angel investors?

An angel investor is a high net-worth person who provides capital for small startups or entrepreneurs, usually in exchange for equity in the company. The financial backing they provide may only be a one-time investment, or it could be ongoing financial support to help the new company in its early stages.

Angel investors are often looking for a higher return on their money than they would get if they were to invest in the stock market. However, their interest in startups usually goes beyond just monetary return. They may be interested in working within a particular industry, mentoring a new generation of entrepreneurs or making use of their skills and experience in a new way.

Related: How to Write a Pitch Step by Step

Types of angel investors

Angel investors are usually people who have gained an "accredited investor" status, although this is not required. An accredited investor is someone with a net worth of one million dollars or more in assets or someone who has earned at least $200,000 in income during the previous two years. It's important to note, however, that someone who's an accredited investor isn't necessarily an angel investor. To be an angel investor, they must have a desire to provide capital for startups.

Unlike venture capitalists, angel investors usually invest their own money. This type of investor fills the gap between seed funding that's often provided by friends and family and funding through venture capital, which may be necessary for a more robust startup.

Angel investor is a somewhat general term, and you can find this type of investor in many different forms, including the following:

  • Friends and family: This is the most common source of funding for startups and is usually where startups begin when looking for financing.
  • Wealthy individuals: Depending on the business, people who have a high net worth, such as doctors, lawyers or successful business people, are often willing to invest a large sum of money in exchange for equity in a business.
  • Groups: Many angel investors are increasingly starting to operate as part of a group. This raises the potential for the level of investment significantly.
  • Crowdfunding: This type of funding is becoming increasingly common. It involves having large groups of people invest small amounts of money online to reach a specific financial goal.

Related: Working With A Financial Portfolio: Definition and Tips

Advantages and disadvantages of angel investors

There are both advantages and disadvantages to receiving funding through angel investors:

Advantages of angel investors

The greatest advantage of receiving funding from an angel investor is that there is less risk than if you take out a small business loan. Unlike loans, you do not have to pay back the funding from an angel investor because they receive equity in exchange for financing. Angel investors are typically experienced investors who take a long-term view and understand that they may not see a return on their investment for a long period of time. Many angel investors are also looking for personal opportunities in addition to investment opportunities.

In addition, because angel investors have a lot of business experience, they can provide mentorship for the startup. They are motivated to see your business succeed and can offer invaluable insight and guidance. In fact, research shows that startups that are backed by angel investors are more likely to have substantial growth, experience a greater rate of return and remain in business for a longer period of time.

Other benefits that a startup gets by taking on an angel investor include:

  • Credibility from being associated with the investor
  • Contacts for potential customers or employees
  • Contacts with investment bankers, accountants, lawyers and other professionals
  • Marketplace knowledge and strategies used in similar companies

Disadvantages of angel investors

While angel investors make it possible for business owners to get their startups running, there are some disadvantages to obtaining funding in this manner, such as the loss of equity. Many business owners give away between 10 and 50% of their startup in exchange for funding.

Angel investors may also expect a substantial return on their investment, sometimes equal to 10 times their original investment within the first five to seven years. This can create additional pressure for you and any employees. Before accepting funding, evaluate whether the business can grow at the rate that an investor would expect, and establish expectations for growth.

The other disadvantage is the loss of control. After investing their money in a startup, most angel investors take a hands-on approach to the business. For example, experienced angel investors sometimes like to have an exit strategy in place, such as taking a business public or selling the company to a larger corporation. They may encourage you to let go of the business before you're ready. Conversely, if you give away too much equity, they could choose to put a more experienced executive in your place, possibly removing you from the business that you originally created.

How to decide if angel investing is right for your business

If you are thinking about accepting an angel investment, here are some steps you should take:

1. Have a business plan

Before accepting funding from an angel investor—or even approaching someone about funding your startup—create a comprehensive business plan. You'll need this whether you are obtaining funding from a lender or an investor. Angel investors want to see a business plan that is both convincing and complete. That includes having financial projections, plans for how you are going to market the business and specifics about the target market you want to pursue.

2. Be clear about what the investor is offering

Put in writing what the investor is offering your business outside of funding, as many angel investors expect to actively contribute their time to startups in which they invest. This could mean acting as a mentor, taking an active role as a manager or serving on the company's board of directors. While this additional involvement and the knowledge and experience you gain is beneficial to the company, it's always best to have the expectations in writing in advance.

3. Establish roles

It's also important to develop a clear understanding of the roles that each person will have, as the angel investor may have their own ideas for how to operate your business. By establishing roles in the beginning, you reduce the likelihood of a conflict at a later time.

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