Starting a company is a difficult task, but a few essential figures help entrepreneurs in this process. One of them is angel investors. Angel investors are individuals who offer capital investment or crowdfunding to startups and receive royalties, equity, or shares in the company in return for their investment.
The term “angel” was coined in 1978 by William Wetzel, a professor at the University of New Hampshire and founder of the center for venture research. In his study on seed capital fundraising by entrepreneurs in the United States, he used the term angel to refer to early-stage investors.
Anyone can become an angel investor as long as they clearly understand the complicated process of identifying possible business opportunities. Angel investors could be business professionals, company executives, small business owners and entrepreneurs who are ready to move up from launching their companies, investors who profit from investing in small businesses, and crowdfunding platforms that raise money as a group of investors.
To become a known, sought-after angel investor, angels must start to build up their reputation in the business world, research their local ecosystem, understand the local customer needs, and choose the best startup based on their assessments. But after investors build a reputation, entrepreneurs will find them, especially if they are better known or once they are part of an established group.
What is the angel investment process?
The angel investment process follows a set of steps: identifying the opportunities, screening process, pitch, Q&A, establishing the terms, syndication of the deal, and preparations for closing the deal.
Identification of the opportunities: Angel investors tend to look for specific areas of business based on their expertise or targets. Once an angel is established as a successful angel or becomes part of an established angel group, deals start to happen with startups. The identification process happens through extensive research on the angel’s part.
The screening process: Once potential startups are identified, angels go through a screening process to determine the companies they prefer to work with. These are typically startups with a higher return rate compared to the traditional investment return rates.
The pitch: In order to learn about a startup, angels need to hear their ideas, stories, and aims. This is called a business pitch in which the management team or the entrepreneur gives an overview of their business plan, ultimate goals, and financial needs. Pitches vary from formal meetings for a group of investors with a slideshow to informal meetings in a café.
Q&A: After the pitch, angel investors regroup to discuss the ideas and terms of each startup. This process involves a Q&A session which requires great business plans and preparations on the entrepreneurs’ part.
Establishment of the terms: If the angels’ issues are addressed properly, both parties will start discussing the deal terms. It is safer for angel investors to discuss the exact terms of their partnership with the entrepreneurs in a term sheet to prevent any future misunderstandings. Valuation, deal flow, and deal structure are determined in the term sheet to outline the major components of the deal and the diligence report. The term sheet is legally not binding.
Syndication of the deal: While determining the terms, the investors have to estimate how much they are willing to contribute at first, plus any additional expenses they are willing to cover. Since it is time-consuming and costly to discuss the terms of the agreement at each stage, the investors and the management team have to have alignment. This step is called deal syndication.
Preparations for closing the deal: After all the negotiations and arguments are done, the lawyers will draft a legally binding document based on the term sheet for both parties to sign before any money exchange. Law firms are experienced in these types of agreements, and based on the deal’s size, the legal documents could be completed in about one to two weeks.
Mentorship: Apart from funding, it is common for angels to get involved in the early stages of the business to help entrepreneurs in setting up the company. Angel investors can offer mentorship, advice, introductions, and board services at this stage.
What are the risks of angel investing?
Studies have shown that while successful angel investments have rewarded the investors with great returns, they have their risks. According to Marianne Hudson, angel investor and Executive Director of the Angel Capital Association, half of all angel investors lose a part or all of their investments. To avoid loss, it is important to choose the best business proposal and perform a thorough pre-money valuation of the company.