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Angel Investors: A Guide for Entrepreneurs

By Spodek Law Group | February 20, 2024

 

 

Angel Investors: A Guide for Entrepreneurs

What are Angel Investors and Why are They Important?

Angel investors are wealthy individuals who provide capital to startups and small businesses in exchange for equity or convertible debt. They are an important source of funding for entrepreneurs and startups who may not qualify for bank loans or other traditional financing.

Some key things to know about angel investors:

  • They typically invest between $25,000 to $100,000 initially, with potential follow-on investing up to $1 million(https://www.reddit.com/r/startups/comments/atkdeg/how_much_do_angel_investors_typically_invest/)
  • They invest their own money, unlike venture capitalists who manage pools of other investors’ money
  • They provide more than just money – they often provide advice, contacts, and mentoring to the entrepreneurs they invest in
  • They allow startups to get off the ground before approaching VCs for larger rounds of funding

Why Angel Investors Invest in Startups

There are a few key reasons angels invest in startups(https://www.quora.com/Why-do-angel-investors-invest-in-startups):

  • Financial returns – While risky, startup investments can provide high returns if successful. Angels aim for 5-10x their investment or more in the long run.
  • Fun and learning – Angels often enjoy working with entrepreneurs, learning about new technologies, markets etc.
  • Giving back – Many angels like paying-it-forward and helping the next generation of entrepreneurs succeed.

Where Entrepreneurs Can Find Angel Investors

There are several ways entrepreneurs can connect with angels(https://www.avvo.com/legal-guides/ugc/a-startup-guide-to-finding-an-investor):

  • Angel investor networks – Most cities have angel groups entrepreneurs can pitch to, like AngelList and Gust.
  • Accelerators/incubators – These programs often have strong ties to angel investors in their community.
  • Introductions – Getting introduced to an angel through your network or advisor can help get a foot in the door.
  • Events – Attending startup/investor events, conferences and trade shows is a chance to connect.
Type Examples
Angel Groups AngelList, Gust, Local Networks
Accelerators/Incubators Y Combinator, TechStars, AngelPad
Events SXSW, Launch Festival, Industry Trade Shows

What Do Angel Investors Look for in Startups?

When evaluating investment opportunities, angel investors look for(https://www.findlaw.com/smallbusiness/business-finance/what-do-angel-investors-look-for-in-a-small-business.html):

  • Strong founders – The quality and experience of the founders is very important to angels. They want to invest in passionate, adaptable founders who can attract top talent.
  • Large market potential – Angels look for startups targeting markets large enough to support major growth down the line. Markets over $1 billion are most attractive.
  • Traction – Startups with initial customers, revenue, user or sales growth stand out. This demonstrates market demand.
  • Defensible technology/business model – Angels want to see proprietary technology, IP, network effects or other competitive advantages that can’t easily be copied.

What Do Angel Investors Get in Return?

In exchange for providing seed funding, angel investors receive equity in the companies they invest in. Typical angel deals include:

  • Equity stake – Angels may negotiate for 5-25% equity in the company, depending on valuation and amount invested. More successful startups means a larger potential payout.
  • Board seats – Angels sometimes take board seats to provide advice and oversight around major decisions.
  • Pro-rata rights – Angels often reserve the rights to participate in future fundraising rounds to avoid equity dilution over time.
  • Information/voting rights – Standard rights around receiving financial statements, attending shareholder meetings and voting may be negotiated.

Key Terms Entrepreneurs Should Understand Before Taking Angel Money

Before accepting angel funding, entrepreneurs should understand several key legal and financial concepts, including(https://www.lawinfo.com/resources/small-business/angel-investors/what-legal-protections-should-entrepreneurs-seek-w.html):

  • Valuation – What % equity will angels get based on current valuation? Make sure not to give up too much control/ownership early on.
  • Vesting schedules – How long until all angel shares fully vest? Industry standard is 3-5 years.
  • Liquidation preferences – In an exit, do angels get paid back first? Make sure preferences aren’t too high.
  • Future dilution – Understand how much equity you’ll lose in future rounds and set aside option pools for employees.
  • Control provisions – Pay attention to board seats, voting rights and protective provisions angels may request.

Key Takeaways for Entrepreneurs Looking for Angel Funding

Securing funding from angel investors provides capital for startups to get off the ground in exchange for equity ownership for angels. Key takeways include:

  • Identify angel investors through networks, events and accelerators/incubators
  • Perfect your pitch deck and be prepared to demonstrate major market potential
  • Understand valuation, equity splits, and control provision implications before accepting a deal
  • Look for angels who can provide strategic advice and connections in addition to capital

With the right angel investment and smart deal terms, entrepreneurs can propel their startup’s early growth while retaining enough equity to stay motivated for future success.

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