It is always thrilling to start a business. However, as it was confirmed in this year’s Xamk *Ship Startup Festival most entrepreneurship students launching a new startup lack sufficient funding for their growth. As they attempt to finalize their product, ramp up sales and achieve traction, it becomes more difficult for them to set aside time to raise funds for their business.
To take some strain off their finances, startup founders often rely on private investors. And the first avenue to explore, above all if you are in the early stage of validation of your minimum viable product (MVP), is often to turn to angel investors.
Who are angel investors?
Angel investors are wealthy entrepreneurs with usually an exit in their past. They want to leverage their own wealth by investing in projects they are passionate about, especially startups at the early stages that may have difficulty accessing more traditional forms of financing. Many angel investors are successful founders themselves, as well as corporate leaders and business professionals.
They usually offer mentoring and advice alongside capital. Often angel investors pool their money with other angel investors, forming an angel syndicate.
How does raising private investments from angel investors work?
Angel investors put relatively small amounts of money into startups, typically ranging from a few thousand euros to as much as a millions. They often invest at the local level, with ”local” being as narrow as their own country, region or city.
Angels are often one of the more accessible forms of early-stage capital for founders and as such are a critical part of the fundraising ecosystem. Angels often look at the wider scope potentials of a startup rather than specific metrics, like for instance financials, which is what characterizes investments from venture capitalists (VCs).
There is no definitive limit on what a single angel investor can invest, but a typical range would be from as little as €5,000 to as much as €500,000 although on average angels invest around €25,000.
Angels may also invest incrementally, offering founders a small investment now with the opportunity to follow-on at the next round with additional investment, or invest only if some other investors are taking the lead (anchor), thus becoming minority investors.
Three main types of angel investments
- Equity stake
An equity stake (or share) is when an investor exchanges their money for ownership in a startup. Equity investors often like to be involved in the decision-making process of the business. Their portion of the stake in the startup depends on the ownership size.
The amount of equity the investor receives will depend upon the company valuation that the investor and founder agreed upon. So if the founder valued the company at €1,000,000 and the investor put in €150,000 of cash, the investor would get a 15% equity stake in the company. This is something which needs to be put in what is called a shareholders agreement.
- Convertible note
Sometimes the investor and the entrepreneur cannot agree on exactly what valuation the startup has today, because many variables are at stake i.e. financial projections, sales pipeline etc. In that case, they may opt to issue a convertible note that lets both parties set the value of the startup at a later stage, usually when more outside money comes in.
A convertible note is set up as a loan to the company. So if the investor put in €150,000 as a convertible note, it would mature and come due at a specific date in the future, e.g. a year from now. During that time it will likely accrue interest. At the maturity date, the angel investor can choose to either ask to be paid back in cash or convert that money as equity into the startup based on a valuation determined at that time.
- Subordinated debt
A subordinated debt is debt that is unsecured and/or ranks for interest and repayment after the senior debt of a company. In the case of default, creditors owning a subordinated debt will not be paid until the senior debt holders are paid in full.
Subordinated debt is riskier than any other type of debt. It can be any investment that’s paid after other debts and loans are repaid.
Advantages of working with angel investors
One big advantage of working with angel investors is that they are often more willing to take a risk than traditional financial institutions, like banks.
Additionally, while the angel investor is taking a bigger risk, the founder is taking a smaller risk, as private funding from angel investments typically don’t have to be paid back if the startup fails.
As angel investors are typically experienced business people with many years of success already behind them, they bring a lot of knowledge to a startup that can boost the speed of growth. As a result, they often invest not only money but also ”sweat” equity, in the form of their active involvement, and often request a board member position in the startup.
Disadvantages of working with angel investors
The primary disadvantage of working with angel investors is that founders give up some control of their startup when they take on this type of private investment.
Angel investors are purchasing a stake in the startup and will expect a certain amount of decision making power as the company moves forward. Unlike VCs, angel investors do not usually have a website as such and it’s often difficult to know their investment criteria or portfolio of past investments in advance.
Another disadvantage is that individual angel investors can often not cover the full ticket size of the investment by themselves (like VCs or private equity forms would do) and need to come together in a syndicate. Of course when larger groups of investors are involved, the terms of the deal become more difficult to arrange.