Anyone who has seen the Shark Tank or Dragon’s Den reality television series might have seen examples of angel investing over the years. These programs entail startups or entrepreneurs looking to receive funding from investors. It’s a unique activity that allows small s to receive help while giving investors a new way to use their funds.
Startups can benefit from the support of an angel investor. Angel investing is a practice where an individual or can provide financial support for a startup in exchange for company equity. The added funds can help a business grow and succeed.
Investors looking to enter the market can also benefit from providing their funds to other s as angel investors. By investing in a business in exchange for equity, an investor can possibly receive significant returns.
Angel investing is an exciting venture to explore, but it has risks. Prospective investors and companies interested in this measure should explore how this practice works.
What Is An Angel Investor?
An angel investor is a person or that provides capital to a startup or entrepreneur. The capital can entail funds or other assets necessary for business operations.
Angel investors are typically business operators or other wealthy people who have the funds necessary to afford to enter this effort. Wealth Pursuits reports that around $24 billion are spent on angel investments involving more than 60,000 startups each year as of 2022, suggesting that these investors are wealthy people ready to support businesses of all sizes.
Angel investors are not to be confused with venture capitalists. While angel investors and venture capitalists can help fund small businesses, an angel investor will use one’s own money, whereas a venture capitalist will use funds from other individuals or corporations that the capitalist works with. Angel investors also typically invest in operations at earlier stages while providing smaller amounts of money on average.
The Angel Investing Process
How Does Angel Investing Work?
While Shark Tank gives an idea of what angel investing is about, the show doesn’t provide all the details. Here’s a closer look at how angel investing works.
- A high-value investor will identify a startup one wishes to support. In most situations, a startup will contact the angel investor for help, and the investor will choose to support the startup if necessary.
- The angel investor will conduct a thorough review of the startup to see if it fits one’s interests. Sometimes the startup will have to provide a presentation or offer to further illustrate one’s work.
- The investor will then prepare a contract where that investor will provide financing to the startup in exchange for equity in the business. Sometimes the angel investor will also request to have a seat on the company board.
- After both sides agree to the deal, the angel investor will provide funds to the startup. This effort can be a one-time investment, or it could involve ongoing contributions.
- The startup will use the funds for various operations. Most recipients of angel funds will use the money for research and development or for finding a target market.
- The angel investor can provide additional funds as the startup evolves and moves into the next steps of operation, including producing a finalized product or service.
The angel investor can start supporting a business at any point, but such investors often start providing their funds when a business only has a beta test or a brief business plan it wants to grow upon. The investor also enters the knowing it will only receive a return if the startup is successful.
Finding and Choosing Startups To Invest In
Startups can contact various parties like the CapCompass when searching for alternative means of raising funds. Angel investors can check with startups listed with such entities to find information on different startups they can support.
But angel investors aren’t willing to invest in just any startup. An angel investor will search for different startups by using a few points:
- The potential for a positive return
- How much capital or control a startup is willing to provide to the investor
- The industry or market the startup operates in; investors want to diversify their portfolios and will desire unique opportunities in many fields
- The positive impact a startup will provide, including how the startup provides positive economic and social developments
Investment Structures and Terms
The terms for an angel investment will entail one of three specific securities:
- Common Shares – Shares similar to what a startup’s founders will hold
- Convertible Preferred Shares – Fixed-income securities an investor can convert into common shares after a specific timeframe or on a certain date
- Convertible Debt – The money the investor loans to a startup will be converted into equity shares, allowing the investor to keep from applying a valuation until a later financing round
Other terms for an angel investment can entail:
- Formal representation on a board of directors
- Preferred returns involve how much the startup will return to the angel investor before sending further payments to other stakeholders
- Due diligence terms, including different measures and activities a business should utilize
Benefits and Risks of Angel Investing
While angel investing can appeal to many startups and investors, it is also not without risk. There are a few factors to explore surrounding how angel investing can work:
Potential for High Returns
Angel investors often experience substantial returns on their investments. Growthink writes that angel investors can often see returns worth two or three times what they initially invested over five to seven years. It takes time for an angel investor to see a profit on one’s investment, but the potential returns will be worthwhile. The specific amount someone can earn from an investment will also vary, so investors will have to review what potentials are open.
High Levels of Risk and Uncertainty
While the return is great for many angel investors, there’s no guarantee it will be successful. While s supported by angel investors are more likely to succeed than those that don’t receive this help, that doesn’t guarantee success. The market is often unpredictable and hard to figure, so there’s no guarantee an investment will provide a profit. This point makes it critical for angel investors to be cautious and selective when searching for investment opportunities.
Importance of Due Diligence and Strategic Decision-Making
Due diligence is critical for all angel investors, as they will need to ensure the entities they are supporting will be worthwhile. The best angel investors will use multiple measures to improve their chances of success while having thorough plans for how they’ll support an entity:
· Angel investors will review key risks surrounding a startup’s plans, including how much competition and market uncertainty persists.
· An investor also has to review the entire investor pitch deck to see what the startup has to offer. The pitch deck includes details on a product or service, how it will solve a customer’s problem, the possible competition, development stages, and various financial points.
· The investor also has to review the balanced logic involved with the deal. Everything the investor hears in a proposal should be realistic and backed by evidence.
· The deal’s investment thesis or the general premise of a deal is also critical to analyze. An investor will be more likely to support a startup if the premise is understandable.
· The goals between the investor and startup must also align. Cases, where these goals clash with one another, can result in a rough relationship that could break apart.
Proper communication is also necessary when getting a deal ready. Both sides should consistently stay in touch and share information on what they are doing with a project. Teamwork can help both parties in a business succeed and understand what they have to do to make their work more viable.
Opportunity to Support Entrepreneurs and Innovation
One reason angel investors often enter the field is because they want to support entrepreneurs that they find interesting. They want to search for entrepreneurs that are innovative and want to make a difference. Whether it entails advancing the industry in new directions or supporting startups representing marginalized communities, angel investors will often look for possible opportunities that are more interesting.
A Final Word
Angel investing is an exciting opportunity for people to explore. Investors can find exciting ways to make more out of their assets, while startups can receive help from various parties. But anyone who wants to get into an angel investing opportunity should be aware of the risks while figuring out what they want from their work before going forward.
About CapCompass
CapCompass has become a go-to partner for entrepreneurs and business owners looking to secure debt capital to fuel business growth. We work closely with our clients to identify and develop a compelling narrative to present to potential lenders. The CapCompass program includes the buildout of a detailed proforma projection model and presentation materials to detail the growth opportunity of our clients. We evaluate our database of over 150 lenders and leverage our banking relationships to facilitate the discussions from original expression to funding. Our team has closed over $16 billion in total transactions, and we provide experienced market analysis throughout the due diligence and negotiation process. CapCompass’s team of experienced professionals is dedicated to providing all the necessary expertise to close and fund successful credit facilities.