If taking your idea to the next level requires seed money, here’s how to seek, attract and secure a funder for your startup.
By Joanna L. Krotz (Host, The Woman’s Playbook)
As a rule, angel investors are wealthy people who like to bet on early-stage startups.
They offer first-round financing in exchange for equity shares, bridging the gap between bootstrapping and institutional capital, with the hope that their high-risk seed money will return big rewards.
Numbering nearly 300,000 nationwide, according to the Center for Venture Research (CVR) at the University of New Hampshire, angels work on their own or by joining private networks that pool money, share expertise and divvy the due diligence tasks.
The range of individual investments runs $10,000 to $1 million, with deals typical at $25,000 to $100,000. Group or network ventures usually run $250,000 to $750,000 each. In 2013, roughly 71,000 ventures found angel funding to the tune of almost $25 billion.
Yet only a quarter (23 percent) of entrepreneurs looking for angel funding in 2013 were women-owned – and a healthy fifth of that group (19 percent) secured angel investment.
Angel Investors vs. Venture Capitalists
Angels will quickly admit that most of their flyers never get off the ground. But they know one or two seedlings are all it takes to yield juicy fruit.
Most aren’t fazed by businesses with negative cash flow, either. In fact, they expect it. Better yet, they can pull the trigger on investment decisions all on their lonesome. By contrast, VC firms and lenders must appease partners or shareholders before placing any bets.
How to Find an Angel Who Will Likely Be Interested in Your Startup
Your first stops should be two of the best online listings of active angel individuals and networks in the US and Canada: the Angel Capital Association (ACA), a professional alliance of angel groups and the Angel Resource Institute (ARI), a nonprofit supported by the Kauffmann Foundation of Entrepreneurship. For background data, average deal sizes and profiles of angel characteristics and demographics, head for the CVR.
Step 1: Location, location, location
Your first scan should be a regional breakdown. Usually successful entrepreneurs or former executives themselves, angels make decisions not only on a startup’s need for cash but, more importantly, on how the angel’s own skills, experience and professional networks can help.
That means they mostly stay close to home to make meetings convenient and resources count. There are over 350 angel groups across the US and you can identify those near you on the ARI site.
Step 2: Previous investing history
Next, look at an angel’s preferences and previous investments. Many specialize in specific sectors, say, life sciences or software. Others are open to any good opportunity. You won’t get far with a product that doesn’t hit nerves with the angel.
How to Pitch an Angel
Once you’ve identified likely individuals or networks, invest in research. Work your contacts, such as vendors, customers or colleagues, to learn what makes the angel tick. Why does he or she invest? How does the network operate? What kinds of investments have they made in the past and what were the results?
The idea is to audition the potential fit, so you don’t waste time or resources (either yours or theirs) going forward. If it does look right, the next step is to get acquainted. And like any pitch, you’re ahead of the game with a personal introduction rather than a cold call. So, again, leverage contacts to gain some profile with the angel. Best-case scenario is when two or three people have already spoken to an angel on your behalf before you contact them.
Of course, that first meeting is all about defining your business for a potential investor, so you want your elevator speech to be sharp. But it’s equally about testing rapport. Angels are engaged partners, weighing in on decisions and operations. You want to make sure you and the angel can build work together.
When you do forge a bond, your odds improve. The angel will be receptive before even seeing your business plan or will personally refer you to his or her network.
What Your Pitch Should Emphasize
Like VC partners, angels are often swayed by experienced management. But if an idea is fabulous and management lacking, angels will tap outside leaders. So if an angel wants to import some hired guns, don’t fight it.
The real skinny on what gets angels juiced is all about potential return. Angels rarely hear entrepreneurs focus on their exit or rate of return, but that’s the key. Says one seasoned angel, to get an angel to read a plan or pitch to the end, one out of every 20 words — 5 percent of the plan — ought to talk about reward, not risk. Entrepreneurs usually identify risks and how their team will manage them, but they don’t cover rewards.
Angels look for a reward that’s about four times their investment within about three years. In other words, your business should demonstrate potential to grow rapidly in a short time.
The Biggest Mistake Entrepreneurs Make When Pitching Angels
The most frequent pitfall is the inflated way entrepreneurs value their companies. Their business valuation — the process that calculates the economic value of an owner’s interest — is set way too high, even while the company is eating cash and hasn’t thrown off a penny in income.
If you’re asking an angel to invest $250,000, in exchange for 10 percent ownership of the company, that means you think the company will be worth $2.5 million after the investment, or $2.25 million before the investment. But angels have looked at many startups just like yours, and know it’s probably not worth more than $500,000. They might not even bother having a conversation with you.
Worse, if you’ve already raised money from friends and family at the higher valuation, you’ve now put yourself in a real bind; you may never attract professional investors.
If you do head out to find an angel, the smart approach is to be honest and realistic whether you’re describing valuations, risk-rewards or your company’s competitive set. Be upfront about your business. Don’t forget: Angels are the investors who typically have started and sold companies themselves. They’ve truly been there and done it.