The Pros and Cons of Using Angel Investors for Your Startup

Submitted by Betty White on Tue, 05/18/2021 - 09:34

You’ve got the idea, the fire in your belly, the know-how - but how about the capital? Funding a new business venture and fueling its growth is likely to entail bringing in outside money at one point. Luckily, the clever and industrious bunch that are entrepreneurs are spoilt for choice. One possible way to achieve this is by using angel investors for your startup. Angel Capital Association (ACA) typically defines angels as high-net-worth individuals or groups who specialize in supporting startups by offering them financial backing. In exchange, angels make a return on their investment and get to partake in the entrepreneurial process. What is more, some might see it as a chance to catalyze economic growth and, in this way, give back to their communities. All funding comes with some risks; however, angel investors carry their pros and cons. Let’s take a look.

Pro: They don’t shy away from taking risks

The fact that roughly 20% of startups fail in their first year makes the whole investment a high-risk venture. However, angels understand the world of startups. They realize that innovation requires risks, and they aren’t afraid to back an idea if they believe in its potential. This is usually the result of several things:

● They’ve built a strong investor network;

● They are established entrepreneurs and thus well-versed in business development;

● They can recognize a good investment opportunity;

● Since they have private equity to spare, they don’t have the same concerns as banks.

However, for experienced angel investors, the potential of an organization’s initial idea is important. However, an even greater emphasis is placed on the potential and quality of the team. If your angel investor has no doubts about your resilience, talent, and excellence as founders, they’ll see no problem in backing your idea, despite the high degree of risk.

Con: Higher expectations

With high-risk tolerance comes high expectations. Using angel investment funding for your biz is a two-way street. Angels usually know a venture worthy of their investment when they see one. So, they’ll choose to back your idea. However, don’t forget that one of the main reasons they’re here is to make money. When there’s a considerable capital sum on the line, all angels will expect to see a payoff. Sometimes, they might expect a rate of return to be ten times their initial investment within a specific period. The pressure to deliver placed on a founder is intense, but it’s simply the tradeoff you are expected to make when you opt for this way of funding.

Pro: Lower-risk financing

One big advantage of using angel investors for your startup is that it’s much less of a risk than debt financing. Angels operate under a different set of rules from banks. They fund your startup, and if it takes off, both parties reap the financial rewards. If not, the invested capital doesn’t have to be paid back. When you take out a small-business loan, on the other hand, you have to pay them back – with interest.

Con: Future profit is limited

Yes, technically, you’ll not be obligated to repay your angel investor any money they’d chipped in. But, of course, there’s a catch. Investors typically take a percentage of ownership in your company in return for providing capital. So, trading equity in your company is part of the deal. But, by doing so, you are essentially waiving a portion of your future net earnings. The percentage you will be giving in exchange typically depends on how much an angel is investing. It’s crucial that you carefully review the terms of the offer to ensure that the amount of ownership the investor is asking for doesn’t infringe on your ability to make a profit.

Pro: Networking opportunities

“It’s not what you know – it’s who you know”, right? This adage is especially true for the business sphere and even more for young companies and their founders. Angel investors could create opportunities for your startup beyond the capital. A few timely introductions from an angel investor and your probability of success can change drastically. This applies not only to getting more funding but also to building strategic partnerships and making more information and resources available.

This is especially important if you need to change the address of your company and move your office at some point. Sure, you’ll need to notify your clients where they would be able to find you after you’ve moved but welcoming an angel investor on board means meeting more potential clients in the new city. Moreover, most startups often don’t have the resources to relocate their entire workforce to the new location. Luckily, you can expect valuable introductions to future members of your team from your investor.

Con: Finding a suitable angel investor may take longer

Finding angel investors isn’t the hard part; you can find them everywhere. In fact, some groups of angels actively explore local and regional opportunities that may be available. The hard part is finding a good fit. Choosing the wrong angel investor will not only waste your time but also hurt your business. Here’s the reality: Some angels look beyond the promise of financial returns and are genuinely interested in promoting the startups. Some, however, are motivated solely by money. In case such as latter, it’s best to obtain complete information about an angel investor’s character and reputation before proceeding.

Pro: Mentorship is included

Yes, guidance and support come as a side dish alongside the funding. When your business takes on angel investment, your investor brings a wealth of valuable knowledge and years of experience to the table. For starters, you can pick their brain when faced with dilemmas and difficult decisions. Next, it not only reduces uncertainty for a founder to a large degree but also increases your odds of success. With their insight, practical experience, resources, as well as support and guidance, chances are that your business will grow swiftly.

Con: Founder control is reduced

Receiving mentorship from your investor is an undisputed advantage of using angel investors for your startup. But the fact that some angel investors will want to own part of the business is a whole different thing. When they see a great opportunity in your idea, they’ll want more say in the matter. This, in turn, means that you’ll no longer have full control over how things operate. ACA recommends that you ask yourself whether you’re willing to give up a part of ownership and control of your company before you pursue an angel investor. This is especially important if you’re someone who likes to have the reins in their own hands.