We spoke to Xero founder, Rod Drury, to find out what a business owner needs to know about angel investment.
A quicker route to business investment
The big problem facing most new businesses is funding. How do you get the money you need in order to make your business grow? We've discussed some of the options in our guide to financing your business, but an increasingly popular choice is angel investment.
Angel investors are different to banks or venture capitalists. They invest their own money – either personal wealth or business funds. With fewer people to consult and signatures to obtain, angel investment offers a quick route to funding.
So what do you have to do to take advantage of this method of funding and what are the disadvantages? In this guide we'll explain how to get the best out of angel investment and give your new business a boost.
Who are angel investors?
Angel investors are usually wealthy professionals or serial entrepreneurs. They provide business funding, often to startups because of the potentially high rate of return.
Angel investors can be found everywhere, not just in Silicon Valley. They invest in businesses whose products or market sectors they understand. They also look for a good business team – because sometimes the people are more important than the proposition.
Five benefits of angel funding
There are several advantages to angel investment compared with other types of business funding:
- Speed of approval: Angel investors aren't weighed down by institutional investors, stockholders and board members. They tend to move quickly through the approval and due diligence stages.
- Access to experience: If an angel investor is willing to fund your business, it probably means they know your market sector well. That knowledge can be useful to you – the angel investor can provide advice, not just money.
- Personal involvement: The angel investor has a vested interest in your business's ongoing performance because they're investing their own money. They will try to help your business succeed.
- Cash access: Angel funding can be given in a lump sum, which is great for quickly growing your business. Other forms of investment are more likely to be spread over time.
- Independence: Angel investors don't usually want board seats or control of future funding. Most of them want a simpler structure, such as capital in exchange for equity. They tend to be more 'hands-off' than venture capital investors, giving you more independence.
Three disadvantages of angel funding
Angel investment isn't money for nothing – it's important to go into an angel funding deal with your eyes open. Be aware of the downsides:
- Loss of equity: It's your business at the moment, but it won't be entirely yours if you get angel funding. The investor will want a chunk of your business in exchange for their money, and it might be a big chunk. Take independent advice to get an idea of what's reasonable and set your limits before negotiations begin.
- Loss of control: Although you're unlikely to be sidelined as much as you could be with venture capital funding, you may still lose some control. In extreme cases you could even be fired at a later date by the angel investor. It all depends on how the deal is structured.
- Pressure to perform: From the angel investor's point of view, they've given you money and they want it back – with interest. Expect your business to be monitored and metrics to be analyzed in detail. This isn't always a bad thing, as other people's high expectations can help you work harder and smarter.
Choosing the right angel
If you run a retail business then it makes little sense to approach an angel investor who specializes in funding engineering companies. Find someone who understands your market so they can understand and relate to your business proposition.
But remember, an investment deal is a two-way arrangement. Make sure you're happy with any angel investors you contact:
- Check their references carefully.
- Make sure they aren't already investing in one of your competitors.
- Could you work with them? Personality clashes can be a problem.
- Investigate their previous investments: did they succeed or fail?
- Does their planned level of business involvement suit you?
- Do they have a history of sticking with businesses through thick and thin?
- Do they have useful contacts for business partners and future investors?
Making the deal
We've discussed investment pitches in one of our other guides but here are some important considerations when dealing with angel investors:
- Practice your presentation: Your "elevator pitch" will stand you in good stead here. Practice until you can explain your business plan clearly – including forecast costs and revenues – in less than a minute.
- How much do you need – and why? Don't pluck random figures out of the air. Be specific, for example: "We need $100k because we plan to open three new stores. We have the rent covered but need capital funding for fit-out and stock. This spreadsheet shows the numbers in detail, with projections over three, six and twelve months."
- Be direct: Angel investors are likely to see through any omissions in your presentation. They will know when you're holding back important information. So don't – it will all come out during due diligence anyway. Be honest about the pitfalls of your business plan, because no strategy is perfect.
- Be prepared for scrutiny: Nobody likes giving away money. Your ideas will be carefully examined and every assumption questioned. The angel investor will check, both informally and through the due diligence process, that your business plan has merit. Don't be offended by this – just be ready to answer a lot of questions.
- Negotiate terms: It's your business, your idea, your vision. So don't give it all away. You will have to accept some loss of ownership or control in order to get your business off the ground – but only some. From ownership percentage to investment type, board seats to share types, intellectual property protection to anti-competition clauses, everything is negotiable.
- Structure the funding: You'll need help with this, so get financial and legal advice, and talk to friends and business partners. Funding contracts can be structured in all sorts of ways, such as stock purchase, secured or unsecured loans, or convertible promissory notes (which is like a formal IOU). Make sure you understand the options and do your research.
- Check the big picture: Before the deal goes through, take a step back and do a 'sanity check' to make sure it all looks right. Get advice from an accountant and a lawyer. Do they think the deal is a good one? Don't be afraid to trust your gut instinct here. If it feels wrong for you, it probably is.
Funding with fewer strings attached
Angel investment isn't ideal for every business. If you don't want to give away any ownership then it's probably not for you.
But compared with some of the more traditional forms of business investment, such as bank loans and venture capital, angel funding can be simpler and less expensive in the long term. Make sure you do your homework before signing any deals, and take legal and financial advice before committing yourself to angel investment.
Once your angel funding is in place, make the most of it. Most angel investors take an active interest in their chosen companies, because they want to see their investment perform well. So you've not only gained funding for your business – you've gained a mentor too.
Disclaimer: Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the provided content.