Startups require capital to grow and succeed, and one of the common sources of funding is through angel investors. But who exactly are these benefactors? Angel investors are individuals who invest their personal funds into early-stage businesses in exchange for an ownership stake.
They can provide much-needed financial backing, mentorship, and networking opportunities to startups, helping them navigate the turbulent waters of entrepreneurship.
Angel investors are also ready to provide support in establishing key business contacts or help in improving the business model, and many of them are willing to get involved to some extent in co-management of the business.
Their significant business and investment experience, in addition to financial resources, also provides active support for startups in building industry relationships, developing the final version of the product (MVP), as well as entering the market.
Angel investors might invest at various stages and often during the early stages of a company’s development witn investments ranging from around $25K to $100K or even more, depending on the individual investor’s capacity and interest in the venture.
When it comes to decision making, unlike VCs and their more structured decision-making process, angel investors have a more informal and flexible approach to decision making.
“The cooperation of a startup with a business angel is also characterized by an informal approach and operates basically outside the institutional framework, which can be considered a positive, but in some aspects also a negative aspect,” Krzysztof Knopp, M&A executive at KPMG and angel investor in several deep tech startups, tells The Recursive.
Thus, like any form of funding, using an angel investor comes with its own set of advantages and disadvantages. In this article, we will explore the pros and cons of using an angel investor to fund a startup.
Pro #1: An Angel Investor is willing to take a risk
One of the significant advantages of angel investors is their willingness to take risks on early-stage businesses. Unlike traditional lenders who may be hesitant to provide a small business loan without a proven track record, angel investors are more open to investing in promising but unproven ventures.
Also, angel investors often have a keen eye for identifying market opportunities and are willing to back innovative ideas with high growth potential. This risk-taking propensity of angel investors can prove to be a game-changer for startups seeking financial support to kickstart their businesses.
“An active business angel guarantees smart money, which at the initial stage of the company’s development may be as important as the financing provided,” Knopp adds.
Pro #2: Money is not a loan
Unlike a business loan, angel investments do not need to be repaid on a set schedule with interest. This is a significant advantage for startups that may not have established revenue streams or steady cash flow in the early stages.
Angel investments are typically made in exchange for equity, meaning the investor becomes a partial owner of the company. Therefore, the investor’s success is now tied to the startup’s growth, encouraging them to actively support the business in various ways.
“If we talk about our experience, we are a mission-driven startup. We aim to protect the cognitive security of people, companies and governments with the help of modern technologies (ML, NLP, Big Data). This is our cause, and an angel investor should support it. Not because we are so capricious, but because every investment is a risk, and the mission “match” can be the only solid foundation for cooperation and building long-lasting relationships,” Maksym Tereshchenko, CEO of Kyiv-based startup Mantis Analytics, tells The Recursive.
Pro #3: Odds of success rise
Startups backed by angel investors often have a higher chance of success compared to those without financial support. Besides the financial resources, angel investors also bring invaluable expertise and experience to the table.
“An additional advantage of having a business angel is ensuring business credibility – ultimately, the startup’s lack of cash is a secondary problem (it is possible to recapitalize the company quickly through a bridge round). The primary problem of a startup is most often the lack of status, business position, low credibility – a business angel with a significant name often makes such a business credible,” Knopp explains.
Their mentorship and guidance can help entrepreneurs avoid common pitfalls, make better business decisions, and build stronger foundations for their ventures. Additionally, angel investors’ network of contacts can open doors to potential clients, partners, and future investors, giving startups a competitive edge.
“Startups should remember that if there is no “match”, there is nothing wrong with you or the investor, you have different missions. But this focus is also a “pro”, because if you find the right person, it will really help. Investor that supports your mission and, probably has some background in your or relevant field, will be of enormous help not only as a source of money for you, but also as a mentor, expert, a point of contact with his or her network, etc.,” Tereshchenko points out.
Con #1: An angel Investor might set the bar higher
While the expertise of angel investors can be advantageous, it can also lead to higher expectations and pressure on the startup. Angel investors typically have experience with successful businesses, and they may expect the same level of growth and financial rewards from their investments.
This can put immense pressure on the founders to achieve rapid growth and profitability, which may not always align with the startup’s long-term vision or market opportunities. Therefore, striking a balance between growth and sustainability often becomes crucial for startups to maintain a healthy relationship with angel investors.
“The best thing to have by your side is an angel entrepreneur that can support you very early with their funding, but also that can teach you how to build a business and leverage their social capital. From personal experience I would stick to serial angel investors or angel groups since sometimes first time non-educated angel investors can suffocate the business by setting the wrong expectation,” Skopje-based angel investor and ecosystem builder Igor Madzov tells The Recursive.
Con #2: There will be strings attached
Angel investments do not come without conditions, as investors often negotiate terms such as ownership percentage, voting rights, and exit strategy before providing funding. While this can be a positive aspect as it aligns the interests of both parties, it can also potentially result in a loss of control for the startup’s founders.
“On the negative issues of having a business angel in the ownership structure, a business angel who does not provide additional value to the company (does not provide smart money) and is counting only on a quick return on investment is unfavorable for the company because it breaks up the ownership structure. Often, international VC funds, using clauses in investment agreements, buy out such a small investor in order to “clean up” the ownership structure,” Knopp points out.
For some entrepreneurs, relinquishing control over their vision can also prove to be challenging and may hinder their ability to execute their ideas freely.
Con #3: You aren’t in full control
When using angel investors to fund a startup, the founder is no longer the sole decision-maker. As the ownership stake is shared, major decisions may require the approval or consensus of the angel investor.
In turn, this can lead to conflicts if there are differing opinions on crucial matters, and this can be unsettling for some entrepreneurs who are used to running the show independently.
There are many pros and cons of using an angel investor to fund a startup – angel investors bring not just financial support but also valuable expertise and networking opportunities that can make or break a new business. However, the potential loss of control, higher expectations, and strings attached to the investment are essential factors that entrepreneurs need to consider carefully.
“Not every business angel actually means smart money. A poorly structured relationship with the wrong people is a big problem for founders, which can often be difficult to solve. To sum up – in my opinion, it seems that having an active business angel brings more benefits to a startup than the lack of such support,” Knopp emphasizes.
Thus, before seeking angel investment, entrepreneurs should thoroughly evaluate their startup’s needs, the investors they approach, and the terms of the investment. Ultimately, finding the right angel investor who aligns with the startup’s vision and goals can significantly impact the success of the venture, making angel investments very attractive for many early-stage startups.