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Beyond the balance sheet

Everything you need to know about Angel Investors

Joe Lennon 12/7/2019 7 minute read

Joe Lennon FCCA explains what angel investors are and how they can help your early stage business.

You've hit a brick wall!

A particularly challenging time for any entrepreneur.

You may have an exciting early stage business but now you need an injection of finance. This could be for any number of things. The point is you need investment to get the business growing!

You'll then be faced with which funding option to choose from. Do you borrow money in the form of debt that you have to pay back with interest? Or, do you sell a stake in the business?

For this post we're dealing with the option of selling equity in your start-up to angel investors. The better you understand an investor, the better equiped you'll be to appeal to their motivations and pitch to them successfully.

Angel investors or bank finance? Find the best funding option for your start-up

Read on to:

  • Comprehend what they look for in a business
  • The rationale behind their investment decisions
  • How angels make money
  • The different types of angel investors and the skills they bring to a start-up

They are also referred to as angel funders, business angels, private investors, seed investors, and informal investors. There are more than 15,000 angels in the UK who account for several thousand fundraising deals every year.

 

 

What are their motivations for investing?

Angel investors will put money into small businesses to help them grow so that they can generate a decent return. Angel investing is often the primary source of funding for a business and typically lasts around 8 years. The angel will then expect to sell their shares at a profit. Their motivation is usually profit driven.

Investing in small businesses comes with a high level or risk. In accepting the risk, angels may expect a better return than if they put their money in other investments, such as listed organisations on the stock market.

What sort of return does an angel investor look for? 

Angels will typically invest £10k - £500k. Some have made larger sum investments. They'll typically judge the success of an investment based on the exit multiple and the Internal Rate of Return (IRR).

An exit multiple looks at the total money taken out of an investment divided by the total that originally went in. If an angel invested £50k in a business and took out £200k just 5 years later then the exit multiple would be 4X or, 400%. 

IRR is more complicated as it takes the passage of time into account. It provides the rate at which an investment will break even. The Angel could compare what their money could have done over the 5 years if they'd invested elsewhere. 

IRR is the interest rate that makes the Net Present Value zero. Net Present Value is how much the investment is worth in today's money. The bigger the IRR the better. You can find out more about exactly how IRR is calculated at Maths Is Fun.

Let's say just for example an investor receieves 10% interest on their investment. This means if they invest £2,000 they would earn £200 in a year (£2,000 x 10%).

Start on Purpose states that angels will expect an annualised IRR of 20% - 40%. 

What an angel investor can bring to your business

Having an angel investor on board in your business brings many benefits. Typically angels provide funding through equity finance. This means your business doesn't become weighed down with debt. Consequently there isn't the need to provide security to secure the funding, and there isn't the pressure of interest and repayments.

Angels tend to be individuals, they're not part of a corporate entity. Their decision making tends to be simple and quick unlike a venture capital trust for example. They will bring:

  • Experience to draw upon on the operational side, having run their own business
  • Strategic insight through their knowledge of particular sectors
  • A network of contacts and suppliers to help grow the business 

Things to be aware of

Being an equity investment means you're diluting some of your ownership and even giving up a bit of control in your business. Should you eventually look to sell up, you may therefore receive less value than if you'd continued alone.

Of course you have to realise that the business might not reach such value without the help of an angel and their money through fundraising! Angels tend not to take a majority share in the business. They will however, probably expect a voice in decision making and how things are run.

 

 

What angels look for in a potential investment opportunity:

 

Size of the opportunity

Angels will look at the issue your addressing with your solution and how big the market of potential buyers is. Will the market get bigger and will they make repeat purchases? They'll consider competitors and why people would purchase your solution over others out there.

If you're dealing with a new market then the question will be how big it can get and what are the factors driving its growth. Does your solution appeal to the market, is it a scalable business model?

 

The leadership team

A large pool of potential buyers is all well and good. However, the angel will look to see if you have the leadership team to develop a strategy and implement a business plan to seize the opportunity.

They'll consider your experience, skills, and team chemistry to ascertain if you have the commercial acumen and resilience to make a success of the opportunity. 

 

Evidence of growth

A great way to convince angel investors of the opportunity is to provide them with evidence. Show them that the business is already on the initial rungs of growth. They'll then have proof that you're expanding and gaining traction in the market.   

Data that supports claims and shows that you're making things happen can be very convincing and preferable to an opportunity that is untested and based on assumptions.

 

Tax benefits

When raising investor finance, you should be aware of the potential tax benefits angels will want to take advantage of. The Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS) exist to make investments in small businesses tax advantageous. 

EIS and SEIS help investors manage the risk of funding early stage enterprises. You should therefore look to structure any fundraising in such a manner that it qualifies for these tax reliefs.

The different types of angels

From what we've described so far, angel investors sound very professional and akin to a full time career. That's not necessarily always the case. There are several different types which we cover briefly below:

 

The super angel

They are professional investors with many different organisations forming their portfolio. Bringing this kind of investor on board can bring real kudos that leads to further introductions and investment from their network potentially including venture capitalists.

With so many investments however, they may be too busy to provide real useful input into the strategy and running of your start-up.

 

The founder angel

These are fellow founders of start-ups who have made money doing so. Their motivation from an investment perspective is they want to give back by helping fellow entrepreneurs. They hope to make money while doing so.

They may in time make a sufficient number of investments to become super angels. They've run a successful start-up before and have much useful knowledge to impart with you. A danger is their motivation may not be as an investor but more from a philanthropic mindset. 

 

The speciality angel

These angels have a long history working in an industry. They invest in opportunities they see in that specific sector. They'll have a great network of connections and much knowledge built up  from their work over the years. 

Despite all their knowledge they may be used to certain ways of doing things meaning they lack a truly disruptive mindset embraced by start-ups.

 

The wealthy and bored angel

These tend to be professionals but can be any number of people in work. They're likely to be both wealthy and somewhat bored of their day job. Think lawyers, doctors, dentists, and surveyors to name a few.

They're seeking some excitement in their working lives. They'll live some of that by investing in a start-up. They'll have a lot of money to invest but may struggle to add any value to your business. They may also prove quite demanding for progress updates.

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The content of this post is up to date and relevant as at 10/07/2019.

Please be aware that information provided by this blog is subject to regular legal and regulatory change. We recommend that you do not take any information held within our website or guides (eBooks) as a definitive guide to the law on the relevant matter being discussed. We suggest your course of action should be to seek legal or professional advice where necessary rather than relying on the content supplied by the author(s) of this blog.

 

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