What is an angel investor?
An angel investor is a wealthy person who provides capital to a business start-up. This is usually in exchange for convertible debt (which can be exchanged for a specified share of the business) or for an immediate ownership share of the business.
Angel investors bring much more than money to a new business. As successful business people, they bring their expertise along with their networks. Angel investors are often retired entrepreneurs and executives who pursue angel investment for other reasons in addition to financial return. Some want to act as mentors while others want to stay current on the latest business trends.
Angel investment doesn’t take place in one or a few markets, such as with investing in the share market. For this reason, new businesses connect with angel investors through business or angel investment networks. One of these is the Australian Investment Network which connects entrepreneurs in Australia with angel investors.
Angel investors typically get involved in the early stage of high-growth ventures that also are high risk – so they expect a high return on investment. They also want to see a sound exit strategy which could include getting acquired by another business or completing an initial public offering.
Unlike venture capital, the angel investor will use their own funds, not pool funds from other investors, when making an angel investment. Often a start-up will rely on bootstrapping and family and friends for initial funding. After this stage, angel investment can fill the gap before the business is large enough for other forms of investment, such as venture capital.
Angel investing is usually focused on innovative and high-tech industries such as medical/healthcare, software and biotech. A smaller amount of angel investing occurs in other sectors such as industrial/energy and retail.
Angel investment – a hypothetical case study
A business established by Ms Startup has been growing for several years and now has a large list of clients around the globe. The product they have developed is an innovative investment management software used by financial advisors. The business has reached a point where it needs additional investment to achieve its next stage of development. Ms Startup meets Mr Bucks, a professional angel investor, who is looking for investment opportunities, through an angel investment network.
They meet to discuss the business, including how it has grown and what are the next stages for growth. Mr Bucks sees the potential of the business and asks to see the company business plan and financial statements. Conducting due diligence, he analyses the business documentation.
Mr Bucks likes what he sees. They meet again and he proposes investing in the business in exchange for a 25% equity share. He outlines his strategy for growth and a timeframe for an exit strategy to sell the business to a single buyer or go public on the share market through an initial public offering (IPO).
Ms Startup agrees with the proposal. Legal documents are drawn up and Mr Bucks makes his investment in the business. He acts as a mentor to Ms Startup and takes an active role in the strategic direction of the business which is growing at a rapid rate. After five years, they are approached by a large multinational software company which wants to add to their software to their portfolio of products.
After negotiations, they agree to sell the business to the larger company. Ms Startup receives a portion of the sale money as the business founder and majority owner. Mr Bucks gets part of the proceeds of the sale as an investor in the business.
Pros and cons of using angel investment for your business
Angel investment is a way to get access to capital at a stage when it can be difficult to get approved for other forms of finance. In addition, an angel investor will usually act as a mentor to the business as it strives to grow.
With angel investing, you will have to give up part of the ownership and control of your business. This might not be suitable for some entrepreneurs who want to be the final decision maker. By giving up ownership, you are also giving up part of the ongoing profits and a portion of the potential windfall from selling the business.
It’s also important to consider that angel investors look for certain types of businesses. These are usually innovative and/high-tech companies with a strong potential for fast growth. So angel investment won’t be an option for many new enterprises that aren’t in high-growth sectors.
For information on other types of loans for start-ups, read What You Need to Know About Start-Up Business Loans.