What is angel investing?
It’s the name given to an investment from one or more individuals who can take your hand and lead you and your business to the gates of high-growth heaven.
These investors provide hugely valuable funding and support to startups and early stage companies in exchange for a small stake in your business.
In fact, given the general difficulty in obtaining bank loans, it’s often the only source of finance available to such firms.
What’s more, angel investing comes with the experience, connections and support of individual backers, which is often invaluable.
But there are potential pitfalls in exchanging shares in your company for funding this early in your growth journey. As a small business owner, you should consider the potential advantages and disadvantages of angel investment carefully before seeking it.
We talk about all of that and more in this article.
Here’s what we cover:
- What is angel investing?
- Why angel investors invest in startups
- How much angels invest and what returns they seek
- Advantages of angel investment
- Disadvantages of angel investment
- Angel investment terms to understand
- Angel investment versus venture capital
- Angel investment versus crowdfunding
- Angel investing: An early boost on an exciting journey
What is angel investing?
Angel investing is a way to provide finance for a business.
How does it work?
An individual known as a business angel invests their own money directly into startups and small, high-growth businesses.
Angels can also usually provide valuable experience, skills and introductions – including to other investors, customers, suppliers and advisers – to help you grow your business.
Angels want to profit from their investment but they are patient and don’t expect a rapid return or exit. They’re usually happy to wait between five and 15 years.
While angels can invest independently, they often join together and invest via a syndicate. This enables them to pool their funds, spread the risks, and share other investors’ due diligence and experience.
Why angel investors invest in startups
Rod Beer, managing director of the UK Business Angels Association (UKBAA), says angels often invest in small companies or startups because they want to support businesses in communities and sectors they believe in.
They may be interested in a specific industry or sub-sector, such as biotechnology, or in companies that strongly emphasise ethical causes such as financial inclusion, fair trade or green energy.
“It’s fun for angels to support exciting, high-growth businesses,” says Rod. “They enjoy being part of a team that can deliver innovation.
“And they want to encourage the next generation of entrepreneurs.”
How much angels invest and what returns they seek
Angel investors typically provide between £20,000 and £40,000 of funding per deal. But via a syndicate, they can collectively invest up to about £3m in a single company.
Angels know they’re taking large risks by investing in such early stage businesses, and many will fail or flounder.
According to UK BAA research, 80% to 90% of returns come from just 10% to 20% of an average angel portfolio.
However, they spread this risk by investing in many companies, which helps experienced angels achieve a 14% average annual return on investment over 6.6 years, according to 2021 research by Envestors.
But it does mean angels are looking for investees that have the potential to deliver stellar returns – ideally around 10 times the original investment over seven to 10 years, says Rod.
Advantages of angel investment
Andrew Shepperd, director and co-founder of Entrepreneurs Hub, says the companies most likely to attract angel investing are disruptors with low capital costs; credible, patentable ideas; and strong plans and leaders.
Capital intensive businesses, such as in manufacturing or catering, are less popular, he adds.
Attracting angel investment provides you with a source of capital often unavailable through other means such as loans, especially in your early growth stages. It gives your company credibility that can help it through to further funding rounds.
Angel investors usually have deep experience in your sector and can provide valuable advice and connections. These factors often combine to spark exponential growth in successful investees.
Angels don’t seek a large chunk of your company in return – it’s usually no more than 25% and much less for most deals.
Disadvantages of angel investment
However, angel investors do have a stake in your company and may want to influence decisions, such as trying to stop you paying yourself too much, as they see it, rather than investing more in the company.
You’ll have to maintain a good relationship with them and consider their views and interests as shareholders.
They will likely push you to keep growing the business and hitting milestones, and you may feel pressured to prioritise this growth over other aspects of the business.
However, Rod says angels are more likely to be observers or advisers and would only join your board if you invited them because of the value they can bring.
Though angels take a small percentage of shares, one risk is that this will become further diluted in later funding rounds.
Andrew says: “If you raise too early and get your dilutions wrong, you can get diluted out completely in later rounds.”
That could be the right thing to do if you end up with a smaller slice of a much bigger pie.
“But if you can delay the dilution, that can work better,” says Andrew. “It’s a balance between not raising too early, and having an idea that never gets going because you have no capital.”
Rod says: “Sometimes founders don’t have many shares left because they’ve raised too much or undervalued themselves.
“That can kill the business because they’re no longer adequately incentivised to grow.
“But we’ve seen an increasing understanding in the investment community about the importance of ensuring a good equity stake for the founding team, and the operational team, through the use of share options, for example.”
Your reporting might change after taking on angel investors, as they may demand extra information such as management accounts or environmental, social and governance (ESG) factors.
“The long-term commitment and relationship with angel investors are akin to a marriage, and can be challenging at times,” adds Rod. “Founders must ensure the investors’ vision and goals for the company aligns with theirs.”
Not all startups are suitable for angel investment, as some may benefit more from bootstrapping, which means funding yourself from the ground up, and growing at your own pace.
“Also, some founders grow to a certain size then take their foot off the accelerator because they’re happy with their earnings,” says Rod.
“In the angel world, they’re called zombie companies.
“If you want to keep grow quickly, go for angel investing. If you want to build over a longer period, there’s no harm in bootstrapping.”
Andrew says another challenge is that no investor will back an idea on its own – you need independent proof to show them your idea works commercially.
But because angel investing is so early stage, you often don’t have much proof yet.
It’s therefore critical to find ways to convince investors about your ability to execute the idea, including your team’s experience and credibility in your sector. For example, if you’ve done a PhD on the subject, include that in your pitch.
Angel investment terms to understand
An angel shareholder agreement will include many terms and conditions to protect all parties and incentivise the company to meet its milestones.
There could be hundreds of terms in your agreement, so it’s critical to get a good lawyer who understands early stage investing and will protect your long-term interests.
Andrew says you should be wary of any unreasonable terms, including anything that gives away too much decision-making control, dilutes your shares too quickly, or sets unreasonable or unrealistic timing or targets.
“For example, what happens if the investor is working on a five-year cycle and you’re on a 10-year cycle?” he says.
“What pressures and expectations will they put on you? What are their voting rights? What are their preconditions for further funding rounds?
“There may be different share classes created. If another investor comes in later, do all shares get diluted equally or are the investor’s shares diluted less than yours? And what’s the process of mediation or arbitration if there is a dispute?”
Never assume anything, and don’t rush.
Take time to get to know your angels, what they want to achieve, and how it worked with previous investees. Ask the investors to put you in contact with those companies, and try to find others they don’t put you in contact with.
Angel investment versus venture capital
It’s common for companies to start with angel investors, then look for venture capital (VC) funding as they grow.
Angels tend to invest earlier and in smaller amounts.
VCs usually invest much larger sums in more established companies with a track record of revenue, market share, and reduced risk.
In return for these larger sums, VC investors often expect you to meet shorter-term growth milestones.
They are more likely to want a position on your board to ensure good corporate governance and strategic decision-making, and could look to exert more control and influence over your firm compared to angels.
Angel investment versus crowdfunding
Another alternative is a crowdfunding platform, which can help you raise funds from individual investors.
They can be a good option for business owners who are happy to raise funds quickly from a large group of people – but you may not meet or know them as well compared to angels.
Rod says crowdfunding tends to focus more on consumer-facing businesses as it works well with a product or service that can easily capture the public imagination or seeks to build a large community or customer base.
It can work in non-consumer industries, but is less common.
The control and involvement of angel investors in the business tend to be less than that of VCs, but more than with crowdfunding contributors.
Andrew adds that another alternative to angel investing is to join a small business incubator, also known as an accelerator, such as those run by Google and Microsoft.
Incubators can provide mentoring, networking with other startup owners, and access to professionals such as lawyers, who sometimes work pro bono. An incubator can also have a community of investors attached to it.
Angel investing: An early boost on an exciting journey
Angel investing has helped drive growth in the UK economy by supporting thousands of dynamic, early stage companies with finance, expertise and connections.
But it’s not for everyone and it comes with many potential pitfalls and challenges.
You should spend time getting to know your angels and their goals before committing, and get a good lawyer to check the terms and conditions too.
However, if you can overcome these hurdles, angel investing could be the first step on the stairway to a higher place for you and your business.
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