What You Need to Know about Angel Investors

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Image courtesy The Orkla Group | Flickr

While many entrepreneurs think about how they can get noticed by venture capitalists, angel investors are a better option for early stage companies. Typically, angel investors are business professionals or experienced entrepreneurs who want to invest in new generations of good ideas. Generally, angel investors provide funding for early stage companies (or even entrepreneurs with clear, promising visions) in return for a piece of equity. Usually, angel investors must meet the criteria put forth by the Securities Exchange Commission (SEC) for accredited investors, meaning that they have a net worth of more than $1 million or make more than $200,000 annually. Entrepreneurs essentially sell equity to their angel investors, and the transaction is filed with the SEC.

Seeking capital from angel investors has a number of advantages. Angel investors can provide the capital needed to achieve a very specific goal, such as launching a marketing campaign or developing a product prototype. Also, angel investors often become mentors, especially if they are successful entrepreneurs themselves. Because their money is on the line, they will do everything they can to help the business succeed. On the downside, entrepreneurs may need to sacrifice 10 percent to 50 percent of equity to attract an angel investor. These investors are also looking at the end game, so they may push for public offering or acquisition before the entrepreneur feels ready.

Many entrepreneurs may find the process of securing funding from angel investors confusing or complicated. Here are answers to some of the most common questions that entrepreneurs have.

What is the best way to contact potential angel investors?

Most startups choose to contact investors via e-mail. When composing the e-mail, it is critical to explain how the potential investor was chosen. Were they referred to you  through their colleagues or friends? This reference will capture the investor’s attention.

The e-mail should also give short, concise description of what exactly the startup does, the problem that it plans to address, and any early traction that it has already gotten.

Include some information about your experience and competency in the industry at hand. It is essential that you convey your passion for the company as well. Since interested investors will want more information, it is also wise to include a two- or three-page executive summary or a collection of about 15 PowerPoint slides going into more detail about the organization.

What questions should an entrepreneur ask?

Not all potential investors will prove a good match, and going into business with the wrong person can cause the business to fail. Therefore, you first need to ensure that the angel investor is on the same page. To get a different perspective, you can ask for references from other entrepreneurs the investor has supported in the past. In general, you should ask about the level and type of involvement with portfolio companies, as well as the investor’s perceptions of the company’s chances at success. Other inquiries may include relationships with venture capitalists, other investments in the same sector, and the amount of business guidance and mentorship offered.

Which factors do angel investors consider?

Image courtesy Bundesministerium für Europa | Flickr
Image courtesy Bundesministerium für Europa | Flickr

When thinking about whether to invest, angel investors will take a number of factors into account, each of which could mean an end to the deal. The most important include potential for growth, market opportunity, and connections to you, the entrepreneur. Angel investors will also look closely at financial projections to make sure that they are reasonable, and they will assess your passion and knowledge of the company or product. Many investors will not consider startups that are geographically located far from them or that are in novel sectors. In addition, investors need to be convinced that a need for the product or service exists and that the company can differentiate itself from the competition.

Will angel investors want to see documentation?

Before signing any paperwork, angel investors will likely ask to see a great deal of documentation. You will make a great impression if you already have these documents in order. Perhaps the most important documents are the organizational bylaws and the charter, including the certificate or articles of incorporation. Investors may also ask for the confidentiality and inventions assignment agreements for employees, the organizational board resolutions, stock option plans, and indemnification agreements for directors. From a clerical standpoint, federal and state securities law filings are also critical. These documents should be prepared by a qualified legal professional.

How does a pitch to angel investors differ?

If you are invited to pitch your company to an angel investor, you should spend a great deal of time preparing. First, learn as much about the investor as possible so you can tailor the presentation to that person’s interests. If any common business connections exist, they can prove great resources for tips or advice. You should also know about all the companies already in the angel investor’s portfolio. Angel investors are particularly prone to interrupting, so it is worthwhile to practice in front of an audience that asks many questions to get in the habit of picking back up quickly. In addition, investors will likely ask some of the hardest-hitting questions (e.g., What is the appropriate pre-money valuation of the company?). You should have clear evidence to back up any claims.

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