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Should you consider an angel investor?

Don Sadler   November 27, 2007

Obtaining financing is one of the biggest challenges for new and startup companies. One possible solution is a unique kind of funding from what are known as "angel" investors.

Angel financing is similar to venture capital, but with some key differences, says Karen Rands, managing director of the Atlanta-based Network of Business Angels and Investors (NBAI) and author of the Learn To Be An Angel Investor book series.

"Angels are primarily wealthy individual investors who are putting money into early-stage companies in exchange for ownership shares," Rands says. "They have many different choices of alternative investments, so investing in businesses is an emotional decision for them." For example, angels often invest in companies or entrepreneurs they have a personal connection with, such as those seeking to cure a specific disease or address social or environmental issues or that satisfies a fundamental need in the marketplace that they believe needs to be addressed.

Rands says about 18 percent of all angel money nationwide is going to life sciences and bio-med companies, but that Atlanta isn't so tech-heavy. "A lot of investors here made their money in traditional manufacturing and distribution, so there are more opportunities for companies with a good widget, whether it's technology related or not."
Investing With a Mission

Conversely, venture capital firms have a mission to invest the money they've raised in private equity transactions. "VCs have very specific criteria for investing in companies," says Rands, "and the decision to invest is much less emotional." In addition, VC firms tend to make much larger investments than angels – "typically millions of dollars at a time" – while angel investments average between $25,000 and $35,000 per investor, per company, Rands says.

Of course, this isn't to say that angel investors don't have expectations for high returns on their investment. "Angels typically expect at least a 40 percent return on their money, but hope for a 200 percent or higher return, just like a VC firm," she explains. They realize that not every company will be a home run, though, which is why most spread their investments out among a number of different companies.

Angels may invest individually on their own, or they may band together informally or in investor clubs and networks like the NBAI. Since each investor is contributing a relatively small amount of money, angel networks tend to work well for both investors and entrepreneurs. "It might take 40 angels participating in an offering to raise $1 million," Rands says.

Michael Valverde is the CEO of Chain Reaction E-Commerce, a leading supplier of commercial open source e-commerce software in Atlanta that has received about $500,000 in angel financing via NBAI thus far. "We thought about going the venture capital route at first, but soon realized that an angel round made more sense for our initial round of funding," he says. "Angel funding has a much shorter life-cycle than VC and requires less due diligence and fewer legal requirements.

"Atlanta is a ripe place to do business right now, and there's a tremendous amount of angel money out there," Valverde continues. "But getting angel financing takes persistence and patience – it doesn't happen overnight."

Connecting With Angels

How do you connect with angel investors? Many angel networks and clubs host invitation-only gatherings where entrepreneurs have the opportunity to make a brief presentation to a captive audience of angel investors – "think speed dating for business owners and potential investors.

"We carefully analyze entrepreneurs' business plans and usually invite from three to five to make presentations at our Private Equity Investor Forums," Rands says. "Investors get a high-level overview of the companies and an opportunity to decide if they want to talk with them further" and explore investing opportunities in more detail. (Click here for more details on t he next NBAI Private Equity Investor Forum).

Catching An Angel's Eye

What are angel investors looking for when analyzing potential companies to invest in? Here are three key things:

1. Management and industry experience –The management team should have in-depth knowledge of the industry niche they are planning to enter.

2. Relevance of and need for the product – Is there a clear demand for the product in the marketplace? Does the product meet a well-defined need or serve an under-served market and have the potential for explosive growth?

3. A well-thought-out business plan –The business plan should detail exactly how the product will be launched and marketed and include realistic financial projections for the first few years, including specifically how the angel money will be used. "There should be a detailed action plan describing how this money will be used during the first 90 to 120 days after it's received," Rands says.

Ultimately, however, the decision whether or not to invest in a company comes down to the terms that are negotiated between entrepreneur and investor. "I have seen a lot of attractive deals not get funded due the inability of the entrepreneur and investor to agree on term structure," Rands says.

Valuation of the business is often the sticking point, since valuing early-stage companies can be tricky and uncertain. Entrepreneurs, understandably, often believe their company is worth more than an objective outsider does. "Investors will hedge if they think the valuation is too high," Rands explains, "but entrepreneurs are reluctant to give up too many share to angels because they know they may need additional rounds of financing down the road."

More Than Money

While financial terms and return on investment are obviously important, remember that angels are often driven by more than money – they may desire an emotional and intellectual reward as much as a financial one. Angels may also want to provide input and advice when it comes to running the business, which you may or may not welcome, making this one more factor you should think about as you consider angel financing.

"Angel money tends to be smart money," Valverde says. "Angels usually come with ideas – we listened to them as much as we talked, and their input was valuable in the shaping of our business model."

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