Angel investors are typically wealthy individuals who make private investments in
high-risk, early stage ventures. They often provide the first round of financing
for start-up companies before the business is established enough to attract venture
capital funding.
Individual angel investors usually contribute between US$25,000
to US$100,000, although they often act in groups to complete larger deals as well
as facilitate the due diligence process and spread investment risk. An angel financing
group may invest up to a total of US$1 million for a single round of financing.
As well as providing capital, angel investors also offer advice, expertise and business
contacts that can be beneficial to the new venture.
Before seeking angel financing,
a start-up must be prepared with a comprehensive business plan and a clear idea
of the financing terms it is seeking. Angel investors' decisions will depend largely
on their confidence in management as well as the market opportunities and profit
potential for the company. They seek high-growth prospects, although there is no
particular industry, geographic focus or business model that predominates in attracting
angel funding.
The major benefit of angel financing is that it provides access to
capital when other funding options are not available. This can allow a company to
hire key employees and develop its business model to the point where it can seek
larger scale, second-round financing.
The due diligence process is typically not
as involved, and funds are secured more quickly, than is the case with venture capital
firms or traditional lenders.
Other benefits to the entrepreneur include access
to the expertise and business networks of the angel investors involved. In addition,
the growing trend of angel investor groups means that an individual venture can
raise significant capital in a single financing deal without the need to negotiate
separately with each investor.
However, before entering into an agreement, management
should take into consideration some potential restrictions that angel funding may
impose. Angel investors usually receive an equity stake in return for their investment. In some cases the angel may ask for equity shares that give them preferential rights
over common stock holders or that include repayment provisions.
In these cases,
the company needs to be confident that it can meet any payment obligations and consider
the implications of the equity structure on raising future capital.
Other considerations
include angel investors' requests for Board representation, rights of first refusal
in subsequent funding rounds and negative covenants which require the company to
seek approval before taking certain actions (such as issuing more stock). Such terms
do not necessarily impede initial development of the business, but they should fall
away based on defined criteria so they do not unduly restrict future capital raising
or management operations.
Angel financing therefore represents an invaluable source
of first-round financing for start-ups and high-risk ventures. Benefits for both
the company and the investor can be great provided expectations are well outlined
and the financing agreement is structured to meet the needs of both sides.