In their book Start Your Own Business, the staff of Entrepreneur Media Inc. guides you through the critical steps to starting your business, then supports you in surviving the first three years as a business owner. In this edited excerpt, the authors offer a crash course on how to track down and attract angel investors.
If you're seeking financing for your startup, the unpleasant reality is that getting money from venture capital firms is an extreme long shot. The pleasant reality is, there are plenty of other sources you can tap for equity financing—typically with far fewer strings attached than an institutional venture capital deal. One such source is an investment angel.
“Angel” refers to anyone who invests their money in an entrepreneurial company (unlike institutional venture capitalists, who invest other people’s money). Contrary to popular belief, most angels aren't millionaires. Typically, they earn between $60,000 and $200,000 a year—which means there are likely to be plenty of them right in your backyard.
Angels can be classified into two groups: affiliated and nonaffiliated. An affiliated angel is someone who has some sort of contact with you or your business but isn't necessarily related to or acquainted with you. A nonaffiliated angel has no connection with either you or your business.
It makes sense to start your investor search by seeking an affiliated angel since they're already familiar with you or your business and have a vested interest in the relationship. Here are a few ideas:
Professionals. These include professional providers of services you now use—doctors, dentists, lawyers, accountants, and so on. Professionals usually have discretionary income available to invest in outside projects, and if they’re not interested, they may be able to recommend a colleague who is.
Business associates. These are people you come in contact with during the normal course of your business day. They can be divided into four subgroups:
1. Suppliers/vendors. The owners of companies who supply your inventory and other needs have a vital interest in your company’s success and make excellent angels. A supplier’s investment may not come in the form of cash but in the form of better payment terms or cheaper prices. Suppliers might even use their credit to help you get a loan.
2. Customers. These are especially good contacts if they use your product or service to make or sell their own goods.
3. Employees. Some of your key employees might be sitting on unused equity in their homes that would make excellent collateral for a business loan to your business. There's no greater incentive to an employee than to share ownership in the company for which they work.
4. Competitors. These include owners of similar companies you don’t directly compete with. If a competitor is doing business in another part of the country and doesn't infringe on your territory, they may be an empathetic investor and share not only capital but information as well.
The nonaffiliated angels category includes:
1. Professionals. This group includes lawyers, accountants, consultants, and brokers whom you don’t know personally or do business with.
2. Middle managers. Angels in middle management positions start investing in small businesses for two major reasons—either they’re bored with their jobs and are looking for outside interests, or they're nearing retirement or afraid of being phased out.
3. Entrepreneurs. Successful business owners often like investing in other entrepreneurial ventures. Entrepreneurs who are familiar with your industry make excellent investors.
To look for nonaffiliated angels, try these proven methods:
Advertising. The business opportunity section of your local newspaper or The Wall Street Journal is an excellent place to advertise for investors. Classified advertising is inexpensive, simple, quick, and effective.
Business brokers. Business brokers know hundreds of people with money who are interested in buying businesses. Even though you don’t want to sell your business, you might be willing to sell part of it. Since many brokers aren't open to the idea of their clients buying just part of a business, you might have to use some persuasion to get the broker to give you contact names. You’ll find a list of local business brokers in the Yellow Pages under “Business Brokers.”
Telemarketing. This approach has been called “dialing for dollars.” First you get a list of wealthy individuals in your area. Then you begin calling them. Obviously, you have to be highly motivated to try this approach, and a good list is your most important tool. Look up mailing-list brokers in the Yellow Pages. If you don’t feel comfortable making cold calls yourself, you can always hire someone to do it for you.
Networking. Attending local venture capital group meetings and other business associations to make contacts is a time-consuming approach but can be effective. Most newspapers contain an events calendar that lists when and where these types of meetings take place.
Intermediaries. These are firms that find angels for entrepreneurial companies. They're usually called “boutique investment bankers.” This means they're small firms that focus primarily on small financing deals. These firms typically charge a percentage of the amount of money they raise for you. Ask your lawyer or accountant for the name of a reputable firm in your area.
Matchmaking services. Matchmakers run the gamut from services that offer face time with investors to websites that post business plans for companies seeking investments. Fundraising success often hinges on the matchmaker’s screening process. In other words: Does the matchmaker have a rigorous selection process, or does it take money from anyone regardless of funding prospects? While rates vary, a matchmaking service may charge as much as $25,000 to locate investors, in addition to a percentage of funds raised. Before using any matchmaker, obtain a list of clients to assess recent successes and failures. A good place to start is Angel List or Google “investor matchmaking.”
Once you’ve found potential angels, how do you win them over? Angels look for many of the same things professional venture capitalists look for:
- Strong management. Does your management team have a track record of success and experience?
- Proprietary strength. Proprietary doesn't necessarily mean you must have patents, copyrights, or trademarks on all your products. It just means your product or service should be unusual enough to grab consumers’ attention.
- Window of opportunity. Investors look for a window of opportunity when your company can be the first in a market and grab the lion’s share of business before others.
- Market potential. Investors prefer businesses with strong market potential. That means a restaurateur with plans to franchise stands a better chance than one who simply wants to open one local site.
- Return on investment. Most angels will expect a return of 20 to 25 percent over five years. However, they may accept a lower rate of return if your business has a lower risk.
The good news is, angels are more likely than venture capitalists to be persuaded by an entrepreneur’s drive to succeed, persistence, and mental discipline. That's why it's important that your business plan convey a good sense of your background, experience, and drive, and spell out the financing you expect to need from startup to maturity.
What if your plan's rejected? Ask the angel if they know someone else your business might appeal to. If your plan is accepted, you have some negotiating to do. Be sure to spell out all the terms of the investment in a written agreement; get your lawyer’s assistance here. How long will the investment last? How will return be calculated? How will the investment be cashed out? Detail the amount of involvement each angel will have in the business and how the investment will be legalized.
Examine the deal carefully for the possibility of the investor parlaying current equity or future loans to your business into controlling interest. Such a deal isn't made in heaven and could indicate you're working with a devil in angel’s garb.