Angel investors, which are also known as business angels, private investors, seed investors etc., are individuals who provide capital for a business start-up, usually in exchange for convertible debt or ownership equity. Basically, they support start-ups at their initial moments, when the risks faced are high, and when most investors are not prepared to back them.
They offer promising startup companies funding in exchange for a piece of the business, usually in the form of equity or royalties. While figures vary on an annual basis, as recently as 2017 angel investors put approximately $25 billion into 70,000 companies.
Angel investors may or may not be accredited investors, a classification given only to investors with very high incomes or net worth. With the passage of 2012’s Jumpstart Our Business Startups Act, the criteria for startup investors was expanded to include more everyday retail investors, including crowdfunding campaigns.
Angel investors provide more favorable terms compared to other lenders, since they usually invest in the entrepreneur starting the business rather than the viability of the business. Angel investors are focused on helping startups take their first steps, rather than the possible profit they may get from the business. Essentially, angel investors are the opposite of venture capitalists.
Advantages and Disadvantages of Angel Investors for Business Owners
The big advantage is that financing from angel investments is much less risky than debt financing. Unlike a loan, invested capital does not have to be paid back in the event of business failure. And, most angel investors understand business and take a long-term view. Also, an angel investor is often looking for a personal opportunity as well as an investment.
The primary disadvantage of using angel investors is the loss of complete control as a part-owner. Your angel investor will have a say in how the business is run and will also receive a portion of the profits when the business is sold. With debt financing, the lending institution has no control over the operations of your company and takes no share of the profits.
Angel Investor Advantages
• No obligations.
Because they haven’t applied for a new line of credit and most angel investing involves equity deals, business owners don’t have to pay the angel funder back if the company goes belly up.
• An angel investor is usually an entrepreneur, too.
Angel investors often have an abundance of business knowledge and experience. “Especially valuable are financial backers who have established effective organizations on their own,” says Garett Polanco, an accredited angel investor who’s funded 29 companies.
• Less administrative work.
Organizations that raise financing from angels are free from onerous investment filings with the U.S. Security and Exchange Commission (SEC) and state regulators that they might have to if they decided to hold, for example, an IPO to raise money.
• More cash down the line.
When angels fund a company, they’re often in for the long haul. “They often make another cash injection later on,” says Polanco.
Angel Investor Disadvantages
• Less control.
Companies who work with angel partners may need to give up some amount of equity in their business. While that’s normally a small amount, angel financial backers may decide they want a bigger role in business decisions.
• A hit in the pocketbook.
Angel investors require compensation for their funding. “That typically comes in the form of equity, which could be more expensive than debt financing,” Lavinsky says.
• Potential for novice investors.
A big con of taking on angel investing is winding up with an inexperienced angel investor who offers poor advice or who hounds business owners for status updates. That can especially be the case with new angel funders who steer large amounts of money into a company.
It’s important for any business person thinking about accepting an angel investment to be very clear about what the investor is bringing to the deal besides money, such as expertise in business operations or access to good suppliers, for example. You would also want to develop an understanding of what the angel investor would be like to work with since this person could have their own conflicting ideas for how your business should be operated.
It’s also important to have a comprehensive business plan in place. As a small business, you’ll need it in order to secure financing from lenders or investors.