Pros and cons: Angel investor for your startup

It is exciting to see more and more people dabbling in angel investing these days. The initial seed funding that you get from an angel could make all the difference so that you can get your idea off the ground.

With more and more news covering startups around the world, you can also now also find more and more professionals like doctors, engineers, and lawyers asking questions to founders seeking for fundings during the monthly pitching sessions hosted by angel investment clubs.

They are seeking to invest their hard earned savings in your venture in hope of cashing out if your company ends up being a future unicorn. But there are a number of trade offs you must consider before taking an angel investor’s money.

Pro: Higher risk tolerance

An angel is usually an established entrepreneur or a professional that has the necessary risk appetite to put in cash in a new venture. They know that investing in an early stage venture is highly risky so many of them invest with a mindset that not all of their investment will turn out a winner. But, what’s the catch?

Con: An angel may have higher expectations

The downside of an angel’s higher tolerance for risk also means that they may expect a lot more from you . Like venture capitals, angels are also investing to earn significant returns, either when your company is sold or listed on a stock market in an initial public offering. What does this mean then?

If there is a huge amount of capital invested, angels may want to see an “exit” or “payoff” down the line. As a founder, you will be under constant pressure to generate growth for your startup. To mitigate this, sit down with the potential angel and have an honest chat with him or her so that you are both aligned in terms of expectations.

Unfortunately, many first time entrepreneurs get too excited when an angel wants to give them money. So they may end up taking the cash without considering other non-financial reasons that may be attached with the investment.

Pro: Investment is not a loan

When you are just starting out, you may be bootstrapping with your limited savings. A founder may even take up a personal loan from the bank to finance your initial business journey. The bank will expect you to repay the loan whether or not you’d end up successful in your new venture. But what if it’s an angel?

An angel investor usually approaches an investment with a different mindset. They’ll offer you the cash to get your venture started. In exchange for the cash invested, they’ll get a piece of ownership in your company by owning shares as equity interest.

If your business takes off, then you both will get the financial rewards. If your company goes bust, an angel investor won’t expect you to refund the capital invested. But, what’s the downside?

Con: Equity is expensive

“Equity is the most expensive form of financing.”

Getting money into your company by selling equity (eg, shares) is the most expensive of finance in the long run especially if you are a new business.

Let’s say you’ve agreed to give away 10% of the equity in your company to an angel in return for an investment, you’ve given away a portion of your future net earnings which is also your ownership. The percentage of the stake that the angel gets usually depends on how much they are putting in your company.

When it comes to giving out equity, you should sit down carefully and understand the implications of giving away equity to an investor. If you get an offer from an angel, sit down and carefully understand the equity and percentage that you are giving away to such an angel so that it won’t eat up into your own chances of getting a good exit down the line.

Pro: Increase chances for success

An angel may have some domain expertise in a technical or professional area. Startups backed by angels tend to remain in business longer and have better exit potentials with better growth prospects. An angel can serve dual functions. First, a valuable capital provider c to run your business. Secondly, an angel can also value in terms of giving you strategic advice and business development like opening doors to future customers, clients and other investors in his network. But what’s the negative side?

Con: You may not be in control

Unlike a venture capitalist that usually invests other people’s money, an angel invests his hard earned cash in your venture. To manage his downside risks, he may have a strong interest in how his money is used by your company.

In other words, if you’re hoping that the angel will take a passive approach after investing in your company, you may be disappointed. Chances are an angel may want to play an active role in the decision making process (eg, business directions and strategies, deciding on key hires, pricing models).

Even if you may have control over the board, the angel may need you to give detailed disclosures and reasonings behind your decisions through an onerous reporting regime.

So before you want to accept an angel’s money, have an upfront discussion with him so that you are on the same page as to what role he wants to play in your business and how it should be run.

Get a good startup lawyer to draft a shareholders agreement so that it is “watertight” covering the angel’s rights and obligations in the company.

Can’t find the article covering the topic that you’re currently finding for your startup? I’m always figuring out new topics to write about on this blog. Feel free to drop me a note using the contact form, so that I know what to write about next time.