For many small business owners and start-up entrepreneurs, the idea of an angel investor seems nearly divine – it’s right there in the name. Angel investors offer financial backing for infant businesses, many of which have a hard time finding funding from traditional sources.
The money an angel investor provides can be the difference between making your idea a reality or having it to keep it stored in a desk drawer. However, an angel investor is not going to dump a bunch of money in your bank account without any expectations. There are clear trade-offs that any business owner just starting out should be aware of.
Probably the most exciting part about an angel investor is that the money they offer is not a loan, unlike funding you would find from a traditional bank or even from family. Instead of providing a loan of a specific amount of money, an angel investor buys an ownership stake in your business. Hopefully, the venture succeeds and both you and the investors make money. If your business never gets off the ground or fails to be profitable, the investor won’t expect money back. A bank, of course, expects a loan to be repaid no matter whether your business sinks or swims.
An angel investor, though, will not just hand you a check and leave you alone to do whatever you wish with the money. Angel investors will typically take a relatively active role to ensure the business grows toward profitability. This input can lead to conflict with a business owner. Also, by giving away equity, you are reducing the amount of money you would earn if the business is successful. It may not seem important when a business isn’t earning money, but that will quickly change once you’re profitable. Carefully review and understand any angel investor agreement; be sure to look at it with the lens that your business will earn a lot of money someday soon.
Famously, angel investors believe in extremely risky ventures on the cutting edge of technology and industry. They are far more willing to back risk than a traditional bank because they don’t expect their money back if you fall flat. Even if you get a bank loan, the bank might restrict the amount you can borrow at once to reduce the chance they won’t get their loan back. Most angel investors have years of experience working with small business owners, so they have a sense for good ideas and quality people, even if a business concept seems outlandish now.
Ultimately, an angel investor wants his or her stake in your business to become profitable as soon as possible. Therefore, an angel investor’s funds come with the expectations that you will expand and grow on a timetable that might not match your own. Perhaps profitability is not your primary motivation – maybe you want to sell tasty cupcakes in an underserved area or create a new social media platform. You might find yourself in conflict with an angel investor fast because your goals don’t align. Before accepting any agreement, make sure you understand and harmonize with an angel investor’s long term plan for your business.
Angel investors, especially the deep-pocketed Silicon Valley firms, have a lot of money. Depending on the size of your business, an angel investor can infuse your company with cash usually ranging from $25,000 to $500,000. Better yet, they can provide this money quickly and usually with no expectations that it will be returned. This investment can be critical for a business to hire the employees and buy the equipment necessary to get a venture off the ground. Because it is not a loan, the business owner does not have the added stress of worrying about how to repay the investment.
Of course, the stake an angel investor wants in your business is considerable. It is normal for an angel investor to want a 25% return on their investment. This expectation means that once your company turns a profit, an entire quarter of these profits will go to the angel investor. This amount can grow exponentially if your business takes off. Because they stand to make so much money, angel investors may seek to control more of your business than you like. Additionally, angel investors are usually not interested in first-time small business owners, no matter what the pitch is. They want to know that you know how to run a business before handing over thousands of dollars.