Starting a new business often requires significant financial investment, and one common route for early-stage funding is through angel investors. These individuals are typically affluent and are willing to provide capital in exchange for ownership equity or convertible debt. While securing funding from angel investors can be a boon for startups, it’s essential to weigh the pros and cons carefully.
Pros and Cons of Using Angel Investors in Startup Funding
How Angel Investing Works:
Angel investors typically sought ownership in the companies they invested in, making it a form of equity financing. They might have offered capital in exchange for equity (stock in the company) or convertible debt, which was a loan that could later be converted to equity.
Usually, angel investors were attracted to high-growth, high-potential startups that had the potential to yield several times their initial investment. In essence, the potential rewards had to outweigh the considerable risks associated with investing in a startup.
Pros of Angel Investors:
- An angel investor is willing to take a risk:
Qualifying for a small-business loan can be a challenging process, with various hurdles to navigate. These challenges may not be encountered when dealing with an angel investor, as they are often experienced entrepreneurs themselves who understand the level of risk involved and are comfortable taking it on. Even if a bank agrees to lend you the money, they may limit the amount you can borrow to mitigate their potential losses. However, angel investors typically were more willing to make larger investments if they believed in the organization’s potential. - Money is not a loan:
When you obtain a small business loan from your bank, you are required to pay it back regardless of whether your business succeeds or not. However, if you get an angel investor, they will provide the capital needed to start your business and in return, they will receive a portion of ownership in your company. If your startup performs well, both parties will share in the financial profits. On the other hand, if your company fails, an angel investor will not require you to repay the invested funds. - The odds of success increase:
Angel investors typically bring years of expertise to the table of a startup, and they already understand the steps required to achieve success in starting a business. Many business researchers suggest that ventures backed by angel investors are more likely to stay in business longer, experience significant growth, and achieve a higher rate of return.
Cons of Angel Investors
- An angel investor may raise the standards:
The downside of an angel investor’s higher risk tolerance is that they typically have elevated expectations as well. They are in business to make money, and with a substantial amount of funds at stake, they anticipate a significant return, much like any other investor. It’s not uncommon for an angel investor to seek a return on investment equivalent to 10 times their initial investment within the first 5 to 7 years. When held to such a standard, the pressure to perform can be intense. If you’re contemplating angel investors, you must assess whether your startup is positioned to grow at the pace the investor anticipates. - There will be strings attached:
Although you’re not legally obliged to repay the capital offered by your investor, there’s a downside. By giving away equity in your business as part of the deal, you’re essentially relinquishing a portion of your future net earnings. The percentage of ownership the angel investor requests typically depends on the amount they’re investing. If you anticipate the startup to be highly successful, it could translate to a significant amount of money and you won’t be able to retain ownership. - You are not completely in control of the business:
An angel investor usually does not invest significant funds without having an interest in how the money is utilized. If you expect them to remain hands-off, you may be mistaken. It’s more likely that the angel investor will want to actively participate in decision-making that impacts the outcome of your organization. Even if they grant you control, you will still be responsible for justifying some of your decisions.Before you begin your search for an angel investor, you should ensure that you are comfortable allowing someone who is not intimately familiar with you or your business to play a role in its operation.
Conclusion
In conclusion, the decision to seek funding from angel investors for a startup involves careful consideration of both the benefits and drawbacks. On the positive side, angel investors offer the advantage of being willing to take on risk, providing capital without requiring repayment, and often bringing valuable expertise and connections to the table. These factors can significantly enhance the chances of success for a new venture.