How to find angel investors for your startup

What is angel investing?

Angel investing is a concept that originated on Broadway. Show producers would seek out individuals to fund production. The investors only got paid if and when the show was a success. Former Red Sox owner Harry Frazee was part of that. He sold Babe Ruth to the Yankees to raise funds for a Broadway musical called “No, No, Nanette.”  

This practice significantly differs from asking business banks or credit unions for a loan. Startups seek angel investors when they have a good business idea and little or no financial history. Angel investors will take a chance if the business plan is solid and the management team has a good track record in other ventures. 

An angel investor usually wants equity in the company or royalties on the product or service. Unlike other investors who may want to be on the board of directors, angel investors typically don’t get involved in the day-to-day operations. Many of them are high-net-worth individuals who have other ventures to manage. Some join angel groups to evaluate potential investments. 

Angel investors come from different backgrounds. Some are former entrepreneurs or business owners mentoring early-stage startups. Business angels don’t need to be accredited investors, but many are. This niche also includes lawyers, doctors, accountants, financial advisors, and crowdfunding platforms that raise pools of money in groups. 

Reasons to seek out angel investment

Startup companies with growth potential and a management team with a track record of success are great investment opportunities for an angel investor. Keep that in mind if your startup needs a new source of funding, even if you’ve already applied for business loans. The cost of the equity stake might be lower than the cost of debt.

Lenders have a vetting process for prospective borrowers. Angel investors have a due diligence process. Streamline your expenses, show the potential for profitability, and choose wisely when selecting directors and officers. Angel investors often look at companies in the earliest stages of development when their equity stake has the biggest upside.  

An entrepreneur could show a business plan to countless lenders and potential investors before securing the initial investment to launch a business. Founders need seed money before considering series A funding rounds or an IPO. An angel investor can provide that to a startup business. Their funds can help your startup get the necessary valuation to take the next step. 

Technology is the most popular industry for angel investors. Several fintech platforms, enterprise software developers, and hardware manufacturers have gotten their start with this type of funding. Since 2021, health and life sciences have also attracted some interest.       

How to find and work with an angel investor

Tech companies move to Silicon Valley to connect to the pool of developers and investors clustered there. The area where your business is geographically located may have those same resources. Start your search for an angel investor by focusing on your immediate vicinity. Most angel investments take place within a short distance from the source. 

Regarding technology, startups should use industry association websites and digital platforms to search for angel investors specializing in their industry. The Angel Capital Association (ACA) and Angel Messenger Forum (AMF) are good places to start. Another resource is LinkedIn, but it requires a more subtle approach. Focus on attraction rather than promotion to find prospects. 

Working with an angel investor is the same as interacting with any debt partner or equity investor. Understand that they’re in business with you because they feel the rate of return justifies the investment. If they offer mentorship, take advantage of it. Most angel investors have a wealth of business experience worth tapping into.  

That said, most angel investors take a hands-off approach to the companies they invest in. That means you won’t need to update them on day-to-day activities. Simply reassure them that your team is working diligently to ensure they get a return on their investment. Some may want regular progress reports, but they’re not likely to sit in board meetings or question business decisions.   

Angel investors vs venture capitalists

The equity component of an angel investment makes it easy to confuse it with a venture capital arrangement. The two are similar, but they are not identical. Both invest in startups, but angel investors typically come in earlier in the company’s development. Angels will fund an idea. VCs need proof of concept and interim financial statements before getting involved. 

Another difference is the source of the funding. Angel investors invest their own money. Venture capitalists manage other people’s funds. They’re entrusted as general partners to make decisions on behalf of the group. They might put in some of their own money, but it’s not necessarily required. The VC partnership agreement determines that. 

The funding amounts for angel investors are usually smaller than what a venture capital firm is willing or able to come up with. The difference could be between getting $10,000 to $100,000 or seeing a significant cash infusion in the millions. The downside is the amount of equity and control you’ll need to give up to get that larger sum into your bank account.   

Venture capitalists invest in businesses to acquire a controlling interest and a significant share of the profits. They typically restructure the business entity to have more input in the decision-making processes. Angel investors generally don’t do any of that. Their focus is usually on a required rate of return for their investment. 

Advantages and disadvantages of angel investing

There are pros and cons to every financial transaction. Angel investments are great when you need money to turn your idea into a functioning business. Unfortunately, there's a cost to doing that. Giving up equity or agreeing to pay royalties on a product or service before you go to market is risky. Here are some of the advantages and disadvantages of doing it:

Advantages of angel investing

• No debt obligation: An angel investment is not a loan, so it doesn’t create a debt obligation for the company. The funds are exchanged for equity in the business, so they don’t need to be paid back if the startup doesn’t make it.    
  

• Mentorship from seasoned entrepreneurs: Angels investors are often seasoned entrepreneurs. Founders can tap into their expertise when faced with challenging business decisions. This guidance can help eliminate early-stage mistakes.  

• Less administrative work: The US Securities and Exchange Commission (SEC) and state regulatory agencies don’t require you to file when you receive angel funding. Venture fund deals and initial public offerings are more heavily documented. 

• More funding later: Angel investors do extensive research on the companies they invest in, so they’re typically all-in when they agree to offer funding. That means you may be able to go back for more after the initial funding is gone. 

Disadvantages of angel investing

• Ownership dilution: Giving up equity to an outside investor dilutes the ownership stake for owners and shareholders. Common stock comes with voting rights, so awarding it to an angel investor could change the power dynamics of the company. 

• Cost of equity: Issuing or awarding common stock to angel investors reduces the value of existing shares. Substituting preferred stock can mitigate that, but liquidation preferences could prevent others from getting paid if the company fails.  

• Potentially experienced investors: Angel investors are not required to be accredited, so some have limited business experience. Connecting with someone with relative inexperience can put you in a bind if you heed their advice too closely.

Wrap up

Angel investments can be ideal for entrepreneurs looking to turn an idea into a functioning business. Founders can connect with an angel investor through digital platforms, investor networks, or crowdfunding platforms.   

Before you seek out an angel investment, consider its pros and cons to determine whether it’s right for you.