Small Business Financing 101: What Is an Angel Investor?
If you decide to start a small business, your idea for the company might appear out of thin air, but the money to support it certainly won’t. You’ll need small business financing — and early on, when that business is just a concept or in a bare-bones operational stage, it’s difficult to show would-be investors much of what they want to see to convince them to commit capital to your cause.
No wonder, then, that the earliest investors in a business are referred to as “angel investors.”
Let’s discuss what angel investors are, how they work, and what small businesses need to know about them before seeking them out.
What Is an Angel Investor?
Angel investors are defined in a few different ways depending on who you’re reading at the time. But we think the best definition is the broadest one: Angel investors are simply the earliest investors in a company.
Angel investors can be high-net-worth individuals (HNWIs) and/or accredited investors.
But they don’t have to be. If any of your family or friends fork over significant capital to get you started, they’re an angel investor.
Why Do Businesses Turn to Angel Investors?
Angel investors fill a vital gap in the funding spectrum. Banks often require collateral and proof of profitability: two things that startups rarely have. Even venture capital firms tend to look for businesses with traction, scalability, and a proven market.
That’s where angels come in. They’re often more willing to take a chance on a promising idea or an unproven founder.
Some angels are entrepreneurs themselves and understand firsthand the risks and challenges of starting from scratch. They might be motivated not only by the possibility of financial return, but also by a desire to support the next generation of innovators.
Others, like friends and family, simply want to back up their faith in a person with their money.
How Much Does an Angel Investor Invest?
If you look at enough sources to find out how much of a financial commitment it takes to qualify as an angel investment, you’ll see a wide range of numbers, from between $1,000 and $250,000. The range is so wide that it’s virtually meaningless.
Perhaps a better definition would be “enough capital to make a meaningful impact.”
But in addition to money, some angels — often those with relevant industry or entrepreneurial experience — will also provide some level of guidance and mentorship.
What Do Angel Investors Expect in Return?
Angel investors don’t give out money for free. Typically, they expect equity (an ownership stake) in your company in exchange for their investment.
Debt transactions are extremely rare at this stage. When it happens, it’s often through “convertible” debt, which starts as a loan but can convert into equity later, often when the company raises its next round of financing.
Beyond financial terms, angels sometimes want to play an active role in the company’s development. Again, that could mean offering guidance or mentorship — but it could also include making introductions to potential partners or even taking a board seat.
For many entrepreneurs, this mentorship and networking can be just as valuable as the funding itself.
Pros of Working With Angel Investors
- Access to capital early on: Angels are willing to invest in businesses that are too risky for banks or too small for venture capital.
- Flexible terms: Because they’re investing personal funds, angels might be more open to negotiation than other financial institutions.
- Mentorship and expertise: Many angel investors bring industry knowledge and connections that can accelerate your growth.
- Validation: Having an angel’s backing can make it easier to attract future investors.
Cons of Working With Angel Investors
- Equity dilution: You’ll likely need to give up a portion of ownership in your company.
- Potential for conflicts: If the investor wants more involvement than you’re comfortable with, tension can arise.
- High expectations: Angels take on significant risk, so they typically want a significant return, often aiming for anywhere between five to 10 times their initial investment.
- Not always easy to find: While angel networks exist, finding the right match can take time and effort.
How to Attract an Angel Investor
If you’re thinking about approaching angel investors, preparation is key.
You’ll need to have a solid business plan, for one. Clearly outline how your company expects to make money, what market need it will address, and why your team is capable of executing.
Angels are looking for businesses with the possibility of scaling, so you’ll want to highlight your growth potential. And investors want to see that you’ve invested your own time and resources, so you’ll need to find ways to demonstrate your commitment.
When it comes to actually reaching out, many angels prefer “warm” introductions, so you’ll want to tap into professional associations, incubators, or local startup groups.
And don’t overpromise on returns. Angels know early-stage ventures are risky. And honesty builds trust.
Angel Investors vs. Venture Capitalists
It’s easy to confuse angel investors with venture capital, since both provide funding to growing businesses. The main differences lie in scale and timing:
- Stage: Angel investors usually come in at the earliest stage, often before a company has significant revenue. Venture capitalists tend to invest later, when there’s more proof of concept and some established operations.
- Source of funds: Angels usually invest their own money; venture capitalists often manage funds from institutions or wealthy clients.
- Amount invested: Angels’ investments are typically measured in thousands; VCs can commit sums in the thousands, but their investments’ range goes up to the tens of millions.
A good way to think of angel investors is as the bridge between self-funding and venture capital.
Ready to Explore Your Financing Options?
Deciding how to fund your business is one of the most important choices you’ll make as an entrepreneur. Angel investors can provide more than just money — they can bring expertise, mentorship and validation to help your small business take flight.
If you’re interested in seeking out angel investments or you’re not sure what source of capital is right for you, you should talk to professionals who understand the world of business financing.
McManamon & Co. is an accounting, tax, fraud, forensic and consulting firm that serves small and midsize businesses. Our consulting team can help you assess your financing options, prepare investor-ready financials and understand the long-term implications of bringing in outside capital.
Call us at 440.892.8900 or contact us online today to see how we can help your business grow with confidence.
Tags: financing, McManamon, McManamon & Co., small business, small business financing | Posted in Financing