Angel Investors: Money from Heaven

Angel investors are individuals who invest large amounts of capital—usually their own funds—in one or more startup ventures. The investments made by angel investors are typically considered high …

Angel investors are individuals who invest large amounts of capital—usually their own funds—in one or more startup ventures. The investments made by angel investors are typically considered high risk and, as such, the returns have the potential to be extremely high. Because angel investors are investing their own funds and will shoulder a large amount of risk, entrepreneurs need to structure and present their business plans as solidly as possible in order to convince potential angel investors that their ventures are worth the gamble.

Approximately $26 billion was invested by angel investors in 2007, according to the Center for Venture Research at the University of New Hampshire (UNH). The average angel investment is between $10,000 and $250,000 while venture capital firms typically won’t invest less than $500,000, according to BusinessFinance.com. Angel investors may be a good option for entrepreneurs who require more seed capital than friends and family can provide, but not enough that a venture capital firm would be willing to make the investment. But entrepreneurs should be aware that angel investors will require a large percentage of the company’s equity in exchange for the risk they are taking—anywhere from 10 to 50 percent, according to Entrepreneur.com.

The uncertain nature of the market may be making angel investors nervous. From 2006 to 2007 the number of angel investors in the U.S. increased 10.3 percent and the number of entrepreneurial ventures receiving funding increased 12 percent, while the actual dollars invested increased a mere 1.8 percent, according to UNH. This implies that individual angel investors are investing less money and are being more cautious about their investment decisions.

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How can entrepreneurs make a good impression on angel investors? Harvard Business School (HBS) offers a framework for angel investors to assess opportunities and entrepreneurs should study this framework and others like it to prepare for questions angel investors may ask. According to HBS’s framework, the potential success of any business investment opportunity relies on the cohesion of the people involved, the business opportunity itself and the structure of the deal, all within the proper context. HBS advises that each element should be examined with relation to the others.

For example: In April 2000, “a Web developer with $5 million in sales was raising its first round of capital on a $10 million valuation….However, NASDAQ had just dropped about 20 [percent] (April, 2000), and voices predicting the end of the tech stocks’ ride were appearing daily in the press….Therefore, the context was that the potential existed to sell the company soon for a substantial return to one of its competitors. However, if the market turned in a big way, the potential valuation could come screaming down….In this case, a deal structure with a note convertible to common would allow the investors to convert if the company sold or went public, thus getting their upside, or call the note after two years if the company was not able to exit but was generating positive cash flow,” according to HBS.

The context of the situation had to be taken into account for the investors and the entrepreneur to come up with an appropriate deal structure that made the angel investors feel comfortable investing their funds. Entrepreneurs seeking investments from angel investors should evaluate their own business plans to anticipate terms, conditions and concerns that investors are likely to voice.

HBS also outlines the three “bases” that angel investors should cover when evaluating business plans: knowledge, capabilities and goals. Entrepreneurs must display a thorough understanding of the industry, market and customers, have a proven track record or display a reliable indication that they can make the project happen and have a firm grasp of their goals for the business’s future.

But before entrepreneurs can pitch their business plan, they need to find their angel investors. The local chamber of commerce or small business development center can provide guidance. Entrepreneurs can also inquire with an attorney or banker, or make connections by networking with other business owners. There are many angel investor networks throughout the country that can help connect entrepreneurs with like-minded angel investors. National networks of angel investors include RAIN Source Capital, Investors’ Circle and Gathering of Angels. Many other networks operate on a regional basis and entrepreneurs would be wise to seek out these local angel investor groups as well.

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