Angel/Private InvestorsWhen an entrepreneur says, "I need to go out and get venture capital," what does that really mean? In one sense, 'venture capital' could be defined as any type of financing for an early stage company. But entrepreneurs who believe that they need to go out and contact Venture Capital Firms for their capital needs, can be starting down a long and frustrating path. Many of these firms are not terribly interested in seed stage or pure start-up companies, preferring to jump on board when the company has achieved a certain number of milestones in product development and securing customers for the product. And no amount of persuasion by the entrepreneur can get the Venture Capital Firm's partners to deviate from their investment focus.
So who does assist the usually cash strapped start-up entrepreneur?
Wealthy individuals, often termed angel investors, are by far the most important source of equity capital for early-stage companies. Typically, these individuals have been successful entrepreneurs themselves, and as such have a keen understanding of the trials and tribulations of building a company. In the ideal situation, an angel investor, or a group of angels, can provide much more than financing for an entrepreneur: the angels can often bring organizational, technical, marketing, and financial expertise. And of critical importance, the angels often have valuable contacts with potential customers, vendors, and even sources of capital for the next stage in the company's development.
Angels vary widely in their investment experience and their approach to working with companies they invest in. Some invest only in companies related to there area of expertise; in other words, an angel who built and sold an enterprise software company would look for other enterprise software companies. In general, however, angels are willing to consider investments in a broad range of companies: high-tech, traditional or "old economy" companies, distribution, manufacturing, service.
From the entrepreneur's standpoint, there are two major difficulties with obtaining angel financing: how to find the angels in their local community, and how to handle the negotiations. Finding them is difficult because, in the past angel, investing has been done on an extremely informal basis. The entrepreneur's company was referred to the angel through a mutual friend or business acquaintance. And angels do not seek publicity for their investment activities, for fear they will be overwhelmed with entrepreneurs seeking capital. There are no reliable directories of individual angels as there are for venture capital firms. For the entrepreneur, this means that the best way to find angel investing is through diligent networking in their local business community, attending events and letting people know that the company is seeking financing. Contacting angel networks, and participating in angel online matching services, both described below, are additional ways to meet angel investors.
It has often been stated that angels do not have as much expertise with negotiations, especially with establishing a value for the company's equity, as venture capital firms might. They may not have standard contracts or terms to present to the entrepreneur. It is important that the entrepreneur has an experienced attorney to consult with during the negotiation process.
Angels are remarkable in that they invest in companies at the riskiest stage of all, before the company has reached enough milestones to be able to say with confidence it will survive, let alone become a thriving, valuable business. Experienced angels know that they will likely not make money with the majority of businesses they invest in. But finding a "winner" can mean extraordinarily high returns on their invested capital, along with the satisfaction of watching a company they assisted grow and become a force in the marketplace.
Angels want both types of "returns": financial plus a feeling of making a positive contribution. Entrepreneurs who wish to entice angels into investing must make sure they appeal to both these needs.
It is a mistake to not view angels as professional investors. They did not become millionaires by making naive investment decisions. Entrepreneurs approaching angels need to be as thoroughly prepared as they would when approaching "professional" venture capital firms.
Another mistake is believing that there is an angel investor for every conceivable business idea. A business that will never be able to do more than provide a good living for the owners is not a suitable candidate for angel investment. They seek companies that have a good chance of growing rapidly, gaining significant market share, and have barriers to competitive entry - pretty much the same thing venture capitalists look for.
Angels do not want to invest in a yogurt shop in the strip mall. Now if you came up with a new formula for yogurt that could be franchised, it might be a different story.