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The myth is that venture capitalists invest in good people and good ideas. The reality is that they invest in good industries. Harvard Business Review
There are various options of funding available for those who wish to start their new businesses. One of them is finding an angel investor.
Angel investors (or business angels) are most often individuals (friends, relations or entrepreneurs) who want to help other entrepreneurs get their businesses off the ground - and earn a high return on their investment. They provide a one-time injection of seed money or ongoing support (between $150,000 to $1.5 million) to the person rather than the viability of the business to carry small start up companies.
The term "angel" comes from the practice in the early 1900s of wealthy businessmen investing in Broadway productions. Usually they are the bridge from the self-funded stage of the business to the point that the business needs true venture capital. They typically offer expertise, experience and contacts in addition to money.
Business angels are involved in high risk investments. An angel investor’s capital in a new business is considered to be a high-risk investment since the new company has not yet established a solid track record of success. Since they often provide the initial funding for a new company, it can be quite difficult to determine if their invested enterprise will be successful in the long run. Despite the fact that most new businesses fail in their initial years, angel investors tend to be quite optimistic about their investment choices and often request a large amount of returns to counterbalance the risk.
Angel investors can provide the basic capital for a new business in return for:
1. Capital in exchange for equity shares. Typically, the angel investor takes no more than 15-30 percent equity in their invested company.
2. Stock options. Common stocks represent a unit of ownership in which the holder has voting rights in company decisions, while preferred stockholders do not carry corporate voting privileges. With stock options, the angel investor would hold a seat on the board and have the power to postpone the dividend payments he would receive from his stock.
3. Assistance of associates. An angel investor may need to have one or two of his associates help out with regular company operations. The angel investor will make sure his invested company is performing at its optimal state.
Business angels have ability to raise capital in small amounts. Most early-stage ventures require small amounts of money, typically less than $500,000. Angel investors can provide this needed amount, using their own personal funds for the investment. Venture capitalists, on the other hand, typically pool money from different sources, generally invest in later-stage companies that have already established stability and success, and invest in enterprises in need of at least $500,000 to $1 million.
There are some distinct advantages of business angels. They are as follows:
- Business angles are characterized by flexible business agreements. Because they are investing their own money, their business deals can often be negotiable. Because of this flexibility, they are more likely to be excellent sources of capital for early-stage businesses.
- Angels can bring forth vast knowledge and experience to a new company. Many angel investors were once entrepreneurs themselves and can offer desired support, expertise, and contacts in making a business grow.
- Angels do not require high monthly fees.
- One more advantage of business angels is their community involvement. Many angel investors choose to invest locally, which creates employment opportunities and helps stimulate economic growth by encouraging consumers to purchase their products. Many angel investors take pride in using their expertise in giving back to their community.
- Angels are located everywhere, practically all industries. They invest in nearly all markets worldwide. Regardless of the market sector that an angel is involved in, what attracts an angel investor to a specific venture is the potential for a company’s profitability and growth.
However, business angels cannot be considered an ideal means of funding. They also have drawbacks for the entrepreneur. Among them are the following:
1. Can actually be deceptive. While the majority of angel investors truly look beyond the promise of monetary return, there are a few angel investors who are greedy and motivated by money rather than in promoting the good of the firm. They are less patient with new entrepreneurs and do not provide any mentoring or guidance during a company’s early stage of development. To avoid such complications, it is crucial that an entrepreneur obtain complete information about the character and reputation of any potential investors before pursuing and agreeing to any terms.
2. Can be costly. In exchange for providing the needed startup capital for a new company, many angel investors often require a certain percentage of stake in a company, starting at 10% or more, and expect a large ROI for their exit. From their perspective, this is a reasonable exchange since they are investing in very young and risky businesses that have not yet been established. In addition, angel investors may hire skilled professionals to ensure the day-to-day business operations.
3. Active company involvement can lead to problems. Each level of company involvement varies from investor to investor; however, it is not uncommon for an angel investor to have a certain amount of control in running a company. The entrepreneur may unwillingly be forced to give up some degree of control in order to meet their angel investor’s requirements, which can often lead to resentment on the part of the entrepreneur. Another problem that may arise is the angel investor’s lack of industry experience. This limited knowledge adds very little value to a company’s success. That is why entrepreneurs should only seek angel investors with proven experience in their industry.
5. Do not have national recognition. While there are well-documented directories of venture capital firms available, there is no national register for angel investors. Due to these differences, angel investors do not have the national recognition as their VC counterparts. They remain hidden and mysterious but choose to do so in order to have a degree of separation from entrepreneurs, who may pester them with their business plans and telephone calls.
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