Angel investors are those affluent individuals who invest in a small-scale business, usually a start-up. They are dissimilar to venture capitalists because they spend from their own pockets. In contrast, venture capitalists invest using the sum of money pooled from investment companies, pension funds, and big corporations.
Angel Funding is similar to Equity Financing because the investor takes up an equity position (stocks) in the company against the fund invested. The companies that opt for equity financing neither have adequate cash nor collateral to secure debt from banks or any other financial institution.
They usually come from the following sources:
Friends and family are one of the most common sources of finance for start-ups. It may be easy to acquire. However, it could dent relationships with the investors in case the business idea does not prosper. According to research, many start-ups are not able to survive. This makes this source extremely risky.
Successful business people or other professionals like doctors, analysts, and lawyers having high net worth can be a source of funding for new or small businesses. But, they are not always willing to invest in a risky venture.
Investors may also form an angel syndicate. The syndicate raises funds by contributing money as per the collective risk appetite. A professional syndicate management team approves the investment.
Crowdfunding is an online investing group. Many individuals contribute small amounts to raise the sum of money.
A distinct advantage of angel funding is that the money invested will not have to be repaid, unlike in debt financing. Debt repayment sucks up working capital, worsening the already unstable cash flows of a new or small venture.
Angel investors take a pragmatic and long-term approach because they understand the nature of business. These investors often seek personal opportunities together with investment. They are seasoned professionals who supplement a small or new business venture with their experience and expertise.
However, nothing comes without a cost. Angel funding requires an entrepreneur to compromise on the part of ownership to the angel investor who will have a representation in how the business will be run. He will also receive his/her due share of profit annually. On the contrary, the financial institutions providing debt have neither control over business operations, nor receive a portion of the profit.
Moreover, it isn’t easy to research and contact an angel investor. It is because the amount these individuals invest in seed funding does not trigger the Securities and Exchange Commission (SEC) regulations. At the same time, venture capitalists are required to register with the Securities and Exchange Commission (SEC).
Angel funding covers up the gap between low-level financing provided by friends and family and venture capitalists. However, attracting angel investors can prove to be an uphill task. They typically invest in a privately held company for the following reason:
Angel investors risk their spare sum of money on a new or small venture instead of making a secured investment in a bank. Therefore, they seek an extraordinary return on their investment. It is believed that because they invest at an earlier stage of business, they can earn a hundred times their money back. Research states that angel investors expect an annual return of about 25%. But, they believe that one-third of their money might lose a considerable loss.
Angel investors are likely to invest in a venture where they have an understanding of the entrepreneur. This is usually the case when such individuals invest in the business of either a friend or a family member who they blindly trust and wish to help.
Many angel investors only invest in a firm where they feel they can add value. These investors might have relevant work experience in a similar type of business they are considering investing in. They may also know critical people in the industry, such as wholesalers or major bulk buyers. Their aim is to help businesses to gain supremacy over their competitors.
Lastly, some angel investors are intrigued to take high risks for a possible high reward so they invest in a small or new firm. These individuals invest to satisfy their need for action.
In a nutshell, angel investors befit those start-ups that are in dire need of money to survive. The owner must be willing to give away a part of his ownership to save him/her from a more significant loss. Angel investors are likely to complement the business with their expertise, knowledge, and ideas. To attract them, owners must have a comprehensive business plan.
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