- Operating costs
- Employee wages and salaries
- Office space
Achieving funding for your startup isn’t easy. You have to reach out to potential investors and pitch your idea in a way that is appealing and can provide advantages and show potential. Securing funding from investors is essential to paying upfront costs for materials, space, and a team to help you get your startup off the ground. One funding source that startups can leverage is by pitching to angel investors.
Angel investors are wealthy individuals who finance small business ventures and startups with their funds. Angel Investors often were former founders and entrepreneurs who seek out small businesses and startups during the beginning stages of growth. When you secure an angel investor, you secure much more than just their money. You secure their expertise and their network.
While working with Angel investors can be beneficial, they come at a cost. Angel investors will invest a healthy sum of money but expect a stake or equity in your company in return. Giving up a sizable stake in your company can be difficult, but it’s expected when working with angel investors. Figuring out a fair sum is dependent on a lot of factors. This article will give you a good idea of how much equity you should offer your Angel investors to encourage them to move forward with their investment.
Funding from an angel investor can be one of the more beneficial ways to take on funding as you’re working on getting your startup off the ground. Angel investors are less risky than taking out a small business loan, and you don’t have to take on debt to partner with an angel investor. If your startup fails, you don’t have to worry about paying the debt back, as most angel investors understand their risks and know the long-term returns if the startup is successful.
Not only do you benefit from their financial backing without taking on debt, but you also get to utilize their wealth of knowledge and experience running a business in your industry, as many angel investors are former founders and business owners. You also get access to their network of connections to help you learn more about running your startup and potentially give you partnerships that can help you transform your startup into a profitable business.
Angel investors place a high value on your startup’s strength based on your company’s evaluation. They understand that investing is a long-term commitment. The funding provided by angels often comes from an individual, and the money is from a business entity, trust, investment fund, and other sources.
They are investors who understand the risks of investing in startups and expect a decent return in the form of equity. There is no hard rule on the amount of equity they receive in exchange for financial support. The amount of equity angel investors typically seek averages around 20 percent, with some backers asking for as high as 50 percent stake in your startup.
The risk is high for angel investors with over 90% of startups failing, and to help mitigate that risk, these experienced entrepreneurs will often ask for more to safeguard their investment. It can be in the form of a seat on the board of directors or by bringing in professional consultants and executives to help manage and grow the business.
These safeguards expand the angel investors’ control over the startup, and while there are many benefits, it can be hard to hand over control and can cause issues down the line. Negotiations are key to developing a strong relationship with your angel investors while setting boundaries to ensure you can build your startup as you want with little interference.
Every investment from an angel investor is as unique as the startup itself. Before seeking out angel investors, you’ll want to value your company during the seed round of funding. It can be difficult during the initial stages of a startup if there are no trackable growth rates, cash flow, or other metrics that could potentially help determine your startup’s worth.
There are multiple methods of determining your startup’s value without any cash flow. The most commonly used method is the scorecard valuation, which is usually what angel investors use to determine how much to invest. The method compares the startup to similar angel-funded startups during whichever stage of development the interesting startup is in to establish a pre-money valuation.
Angel investors are more interested in startups during their initial stages or pre-seed or seed stages of financing. They invest in companies that show promise and potential to provide a significant return on investment. Angel investors will usually receive a higher return during these stages, making the investment more profitable.
Before you begin contacting investors, you need to determine how much you need to cover your expenses during this stage of your business. You’ll need to work out calculations on how much you’ll need to cover expenses such as:
You’ll need to calculate the period you expect funding to cover, whether it’s 12 months or longer. Include a contingency amount to account for emergencies to evaluate what you need for your business and operations to present to angel investors.
The equity in your startup is negotiated once you’ve presented your business plan to a potential angel investor, along with your company’s valuation. The equity stake varies between every angel investor, but it comes down to their investment size and what they would like to see in return based on the numbers you provide them with your pitch deck.
Angel investors look for enough equity to get a significant return on their investment; usually, their involvement is minimal. While the investment is long-term, Angel investors will require an exit strategy for them to take what they’ve earned and leave the company in the hands of the founders once it’s profitable.
Exit strategies are the most common way that angel investors make their money. The exit is when an investor decides to end their involvement with a startup and can be done a few different ways. The exit allows the investor to sell their stakes in the company and move on. The exit is usually pre-planned during the negotiation period of investing in a startup.
The most common ways angel investors get their exit and receive their return on their investment are:
Buyback – Once the startup is successful and profitable, the founders will repurchase the shares from the investors at market value.
Larger Investors – As the startup shows signs of success and begins to raise funds in later rounds, angel investors can begin their exit. Larger investors could potentially buy the shares in the company if they want more stake, but it must be approved by the founders and the company board of the startup.
Acquisitions – Startups often end up being acquired by larger companies in their industry. Larger companies look for smaller startups to help grow their business inorganically and remove potential competitors. Angels will usually end their involvement when this occurs by receiving equity in the new organization or by a cashout.
Initial Public Offering (IPO) – When the startup goes public and offers shares and stocks for the public to buy, the IPO allows angel investors to sell their equity to the public. Although this stage is rare to meet, it’s an easy exit strategy for the angel investor to get their returns and move on to their next venture.
Angel investors take a large risk in investing, and the time for them to see a return is often lengthy, if ever. If the startup venture fails, angel investors will not see a profit at all. Early investors usually can expect to see returns within an average of five to seven years. Some investments can take as long as ten years to see a return. Angel investors typically seek to recoup their initial investment at least and earn a return profit.
Receiving funding from angel investors usually requires giving them a percentage of your company in return for their financial backing. Be sure you know your company’s valuation to help you determine a fair share between you and your investors. You can expect, on average, to provide angels with at least 20 percent of your startup during the initial stages of building your business. While the investment may seem like a lot in the beginning stages, you’re receiving valuable money that can help you turn your idea into a reality.