Angels invest in businesses for a variety of reasons, from social responsibility to discovering a new market. However, the one common reason they all share is to use their money to make money.
Angel investments are often aimed at high-risk ventures and thus the expected return an angel seeks is correspondingly high. To make investing worthwhile, they need successes to more than make up for any failures.
Given that a large number of early stage deals fail and that the angel’s capital is tied up for several years before the deals ’exit’, most angels look to make at least ten times the value of their initial investment over a three to five year term, to cover their exposure.
This can make angel funding seem very expensive to the budding entrepreneur. The entrepreneur needs to appreciate the risk an angel is taking by investing in an often unproven idea. It is commonly the only funding option available to early stage ventures once the friends and family option has been exhausted.
Obviously, if the angel makes ten times their money, so will the entrepreneur. Therefore the fact that the cost of capital is high, is mitigated by the chance to make supra-profits at the end of the day. Without the investment, the start-up would have a much more modest company or possibly none at all. An additional issue is that they may allow properly-funded competitors to move in on the market.
Normally only high growth businesses or sectors can sustain the returns that angels need to make. For example; software or technology companies are much sought after as investment options, whereas a ‘one man band’ home knitting or cake baking venture would find it more difficult to attract funds. Scalability, or the ability to take what you have and wring ten times the value out of it, does not suit every business.
The management of the company is key to most angels. You can have the best product or idea but without the right team in place, it will be difficult to convince an investor that you have the skills to see it through and make it a success.. The reverse is also true; that you can have a mediocre product but an amazing team behind you and go on to make it succeed. You don’t necessarily have to have done something completely new; you just need to do it better!
At the next funding level up, the venture capitalist level, one of the major benefits that is brought to the table is the pool of high flyers who have already been highly successful in previous businesses. They will normally want to install at least one of these in the management team or as CEO as a condition of funding.
Interestingly, many angels in the US have differing views on the value of failure to those of their UK cousins. They like to see some mention of failure in the team and more importantly, they like to see how this failure has been overcome. On top of this, a group of entrepreneurs who have ‘not yet failed’ are an accident waiting to happen and they would prefer it did not happen on their watch.
Give thought to how your team is composed, exploit your strengths, and be honest about weaknesses. For instance you might say, “We are brilliant scientists but really need some sales experience.” A business angel may well be attracted to your circumstances (he certainly will be attracted by your honesty) and could very possibly be the sales arm that you need. If not, he will know where to source what you need.
This help will probably be the key discriminator between business angels and say, bank funding. Banks are unlikely to give you practical help or guidance in running your business. Of course the bank has security in place should the worst happen so they are covered if you fail. The angel is playing with his own money and is strongly motivated to ensure that you succeed.
Human nature dictates that an angel is going to be more attracted to a team with which he has a good relationship and where key values are shared in common. A large proportion of investment is made on the basis of ‘gut feel’. If one accepts that angel investing is as much about being a lifestyle as it is about business, wouldn’t you rather spend your day with people you liked, if you could choose? You also need to think that you will have to see this person for the next five years, through thick and thin. Is this something you can stomach?
Angels are often also looking for more than a monetary return; they could also be looking for any of the following:
- an entry point into a new market which interests them
- an outlet for exploiting their considerable contacts and experience for mutual gain
- mentoring a younger generation of entrepreneurs, to prevent them making the same mistakes that they did
- keeping in touch with their industry after retirement
A further generation of angels is beginning to emerge; one which is looking to give something back or ‘do something’ for society. They could incorporate all or some of the above reasons for investing, but also have an altruistic bent, which could lead them to be more charitable on the returns they seek - however do not bet on it!
How then does the above help you when you are striving to be one of the two percent who actually gains angel funding? Hopefully you will now appreciate that you need to have a business plan, which clearly shows an exit strategy, which delivers a minimum of ten times capital. Moreover, let me reiterate you DO NEED a plan. Of the much vaunted three year attrition rate amongst SME’s, the chances of survival can be increased by a factor of five by simply writing a plan, updating it as things change, and by following it.
Finally, passion for what you do is imperative. If you are not passionate and convinced by your own ideas, angels will not invest. As well as being able to choose who they hang out with angels can smell the passion they seek. They are looking for like-minded people who will not only nurture their hard-earned cash, but people who have the drive to make it work. Much of the investment decision comes down to emotion and feel. Once the numbers have been verified and the assumptions checked, the real work begins.
For more information please visit www.angelsden.co.uk