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Do you have an awesome business idea that solves a significant problem for customers in such a way that it has incredible value for them? Is the potential market that you’re addressing big and growing fast? Does your solution have a unique value proposition? Do you have real intellectual property, a strategy for defending and extending that IP, and a sustainable competitive advantage? Then you might need an Angel Investor to come and give your business a cash injection. Although, some business owners may not need an investor as much as they think, and it may just be the case of them getting a short term loan to have some cash at hand. This could potentially help them get the boost in marketing or sales that they need, or put in place a plan to help them get there. Either way, looking for More Information on what is best for your business would be a reasonable idea. However, if you are in need of and are lucky enough to get an investor, your business could shoot to stardom and start generating a lot of profit. Once you have achieved all of the goals set, you may want to pass that business off to someone else and start on a new venture, or perhaps become an Angel Investor yourself. Companies like Business Exits can help you decide what to do with a business once it has had the much-needed cash injections. Before we can start thinking about selling and profit though, let’s get started on the investments.
Then you may be at a stage where you need to raise outside capital to take your business to the next level. Read my blog What are the Typical Startup Funding Rounds? But when are Angel investors the right source of capital for your business? Let’s explore some Angel Investor basics and dive right into this!
What are Angel Investors?
Angel investors are high net worth individuals that invest in startup companies. They are frequently doctors, lawyers, and successful entrepreneurs. They can also be individuals that have inherited large sums of money. Technically, an Angel investor must have a minimum net worth of $1M, not including their primary residence, and an annual income of $200k (or $300k for a couple). They may decide to do a business wire transfer to get the money to these start-up companies so that the amount is safe and secure for their use.
A typical investment size from an individual Angel investor is $10,000 to $25,000. Super Angels may invest anywhere from $50,000 to over $1,000,000. And there are some ultra high net worth individuals and families that will invest even larger sums. As an entrepreneur, it is important that you establish “minimum investment levels” for Angel Investors interested in your deal. You will be asked, and you’ll need an answer. If you decide to do Crowdfunding or a syndicated Angel deal on something like Angel’s List, you’ll need to consider the costs of raising this money and make trade-offs. Stay tuned for other articles where I will discuss these topics in more detail.
When are Angel investors the Right Source of Capital for Your Business?
Angel financing has been the traditional mechanism for Seed Round funding of a business. In a technology or biotech company, it is frequently necessary to raise $500,000 to $1,000,000 to get to a demonstration vehicle or a minimum viable product into the marketplace. If you don’t have sufficient revenue to fund your product development, marketing and customer acquisition costs, then you’ll need to secure outside investment. It can be expensive for start-up companies to begin trading, especially if it’s the biotech industry. However, it’s possible to make a successful business. For some inspiration, you could always look at the success of companies like Fortress Bio and others. You may require some investment, but most of the biggest companies in the world probably had to seek investors to begin with.
Depending on the value of your business, you may need to give the Angel investors anywhere from 10 to 50 percent of your company, so you need to thoughtfully consider this. The further along you are in the validation of your product and the bigger the market opportunity, the smaller amount of the company you’ll have to give to outside investors.
When Should You Raise Outside Capital for Your Startup?
In an early stage startup, I always recommended that you avoid raising outside capital for as long as possible. The best way to fund your startup is through revenue, of course. In that case, you preserve all the equity for yourself, you co-founders, and your employees. However, if you cannot drive sufficient revenue to do the initial build-out of your business, then you’ll need a capital infusion.
It is always best to rely on your own savings and the money of the other founders to “bootstrap” the company for as long as possible. Another good source of early capital can be friends and family, if you are on good terms with them, and they have some money to invest into you and your company. They are sometimes willing to lend you money at a very small interest rate that will be converted into stock at a later time, which is also called convertible debt.
How Should You Structure Your Seed Investment Round?
Check out my article Startup Funding Basics: Alternatives and Deal Terms where I discuss this very topic with a renowned startup and VC attorney. It is worth watching if you’re considering raising a Seed Round from Angel Investors.
For Seed Round financing, it is almost always best to raise the capital through a convertible debt offering. This avoids the requirement to establish a company valuation that you need in a preferred stock offering. The valuation can be established in the Series A round of financing, or in a sales transaction. Convertible debt terms include an interest rate, a term, and a conversion discount, which is typically 20 – 25 percent off the subsequent rounds of equity financing. However, recently some Angel investors also want to incorporate other deal terms such as valuation caps. If it looks like the funding terms are getting too complicated in a convertible debt offering, and an “implicit valuation cap” is being set, it might be best to just do a “Series Seed” preferred stock offering. This is being done in Southern California about 20 percent of the time in seed financings, and it is even more frequent with Angel investors from the San Francisco Bay Area.
It is best if you can keep the terms of your “Series Seed” preferred stock offering simple, and have valuation and conversion preference as the sole or primary deal terms. In doing any outside financing for a company, you need to keep in mind that you will likely be doing later rounds of financing, and you want a market capitalization (cap table) that will be suitable for the later rounds of institutional financing.
If you are doing a “Series Seed” preferred stock offering, then there will typically be a lead investor, even if there is an investment syndicate, that will do additional due diligence and extra research. This individual should be able to invest more capital, and ideally have access to capital from other individuals that want to co-invest. The best circumstance, in my experience, is to get a “smart money” investor that has experience in your industry or vertical market. They may drive a harder bargain on valuation, but they will provide incremental value that can be crucial to the success of your business. Read my article Smart Money Startups: Why is it Important?
I hope you found this article helpful. Please share with us your thoughts and experiences about raising money from Angel investors. I’m also always interested in seeing interesting companies as investment opportunities.
This is Patrick Henry, the CEO of QuestFusion, with The Real Deal…What Matters.