Which Type of Financing is Right For Your Startup? The Pros and Cons of Angel Investing
Having a great idea for a business is one thing. Getting the financial backing to grow, scale and make it a success is quite another.
Most entrepreneurs approach funding in stages, starting by dipping into their own savings, going cap-in-hand to friends and family, taking advantage of government grants, crowdfunding and potentially seeking angel and venture capital.
The best funding option depends on the business, its track record and growth plans. Some companies stay self-funded forever, while others need the capital injection and expertise from outsiders. Getting the right investment, in the right sums at the right time can often make the different between a startup’s success or failure.
Techvibes has put together a list of common investment options for startups, and pros and cons or each. It will cover the following:
- Government grants
- Angel investing
- Equity Crowdfunding
- Venture Capital
The term “angel” was first associated with funding decades back when, as the story goes, it was used to describe wealthy people who provided financial backing for Broadway theatre productions. Then, in the late 1970s, professor William Wetzel, founder of the Center for Venture Research in the U.S., used the term in a pioneering study on entrepreneurship to describe investors that gave seed capital to startups.
Angel investors remain a godsend for many startup founders to this day. These are private and by law accredited investors who invest their own money into a company in exchange for ownership equity or convertible debt. The accredited investor exemption allows startups to raise any amount from qualified investors (see accredited investors link above). “In addition to the accredited investor exemption, there is a separate exemption that is specific to non-arms length relationships (family and friends),” says Yuri Navarro, CEO and executive director at the National Angel Capital Organization (NACO). “This means it’s not illegal to take money from your dad if he’s not accredited (love money) but it is to take from someone you met at a party for example.”
Angel investors often include friends and family members or already successful entrepreneurs looking to make a bet on the next generation of startups.
There are also a growing number of angel groups that have become a “fairly well established part of the Canadian entrepreneurial ecosystem,” according to NACO’s recently released 2015 Report on Angel Investing in Canada. While its impossible to track all angel investment activity in the country, the report says angel groups tracked invested more than $130 million in Canada in 2015, a 48-per-cent increase from 2014.
“The big increase in the amount invested in 2015 was largely accounted for by follow-on investments, which more than doubled over the previous year,” the report says.
Almost every startup relies on an angel at some point in their history. Some continue to use it through various stages of growth. Below are the pros and cons of taking money from angels:
There are a lot of potential angels: An angel investor can be your parents, friends, other entrepreneurs or even complete strangers, if they have the money and meet the qualifications or exemptions (see accreditor investor qualifications and exemptions above) and willingness to back your big idea. Typical angel investments are between $25,000 and $1.5 million, according to Entrepreneurship.com.
You’ve got backers: If you have an angel investor it means someone else believes in your idea, and is willing to put their own money behind it. That can be very motivating and empowering for entrepreneurs.
“You have capital that is at risk with you,” says Navarro. “This investor is taking a bet on your idea and ability to execute and the team you built. They are in it with you: If you lose, they lose. If you win, they win. There is a very direct incentive.” What’s more, if one or more of your angel investors is an entrepreneur with experience in the trenches, you can benefit from his or her experience and advice.
The money comes quick: When you’re startup you need money now. Angel investors usually invest quickly and provide lump sums that can be used immediately to help grow the business.
They’re hands on, maybe to a fault: Don’t expect to get money from an angel investor and then never hear from them again. They’ll most likely want to know what you’re doing with the funds overall, including every penny they provided. Many of them will also offer advice on to run the business, even if they’ve never done it themselves. Parents and friends tend to offer a lot of unsolicited advice, too. You’ll see.
They want to see returns, and they’ll take some of yours: Remember, an angel investment isn’t a loan. Those investors want their money back, and then some. Also, because their money gives them a stake in the business, you’ll be providing them a portion of your future net earnings.
It can get personal: There’s a reason why people caution never to do business with family or friends. If money is lost or the business goes sideways, the personal relationship can change forever. Avoiding friends and family may be easier said than done with startups, many of which can’t make it without the initial support and financial backing of loved ones.
But be warned, it can get emotional, says Jonathan Bixby, a serial entrepreneur, active angel investor and startup advisor. He recommends entrepreneurs think it through clearly: “Are you willing to look a friend or family member in the eye and take their money for your startup?” His advice, to keep the peace, especially when it’s in the family: “Never take money in an angel round that someone can’t afford to lose.”
Most startups would never survive without the support of angel investors. But unlike a loan, angel investors are getting a piece of the company and expect a return on their investment. There are also many strings attached, both business and personal. Unlike venture capital, angels are investing their own money, not a pool of someone else’s. Understand what you’re agreeing to with angel money and if you’re business is ready to take it on, use the proceeds wisely.