Understanding Angel Investors: What They Look For In A Startup

Starting a new business venture can be an exciting yet daunting endeavor. While passion and a great idea are excellent starting points, most startups require capital to get off the ground and start scaling. Raising funds from angel investors is a popular route many founders take when seeking startup financing. But attracting angels requires understanding what motivates them and tailoring your pitch accordingly. This guide covers key strategies for securing angel investment in your early-stage company.

What is an Angel Investor?

An angel investor is a high-net-worth individual who provides capital to startups in exchange for convertible debt or equity. Angels are usually successful entrepreneurs themselves looking to support the next generation of innovators. Unlike venture capital firms, angels invest their own money and do so at earlier stages of business growth.

Some key traits of angel investors include:

• Worth over $1 million in assets
• Seek high-risk, high-reward investment opportunities
• Invest smaller amounts than VCs – usually $25K to $100K
• Provide capital as well as mentorship

For startups, angels offer more than just funds. Their experience, knowledge, and connections can be invaluable in helping guide businesses through the early phases. That’s why building relationships with angels is so important.

Key Criteria Angels Look For

When evaluating investment opportunities, angel investors focus on a few key criteria. Understanding these can help you tailor your startup to attract angel capital.

Strong Team

A startup’s team is one of the most important factors for angels. They want to invest in founders who demonstrate commitment, passion, and the necessary skills to drive growth. Key qualities angels look for include:

• Domain expertise & experience – Deep knowledge of the industry and market the startup operates in.
• Technical capabilities – Engineering and product development skills to build and improve offerings.
• Business acumen – Financial, sales, marketing experience to operate and scale the company.
• Drive & determination – Relentless work ethic and focus on achieving goals.

Assembling a well-rounded team that covers these areas can give angels confidence in your ability to succeed.

Large, Growing Market

Angels need to see evidence that your startup is targeting a sizable market opportunity. Conducting market research and compiling data that shows:

• Total market size
• Growth trends
• Target customers
• Competitive landscape

This provides tangible proof for angels that your business can scale sustainably over time.

Traction & Revenue

Startups don’t necessarily need full-scale commercialization before securing angel investment. However, demonstrating traction and early revenue gives investors more assurance. Ways to show initial progress include:

• Active users and customer growth
• Increasing sales and transactions
• Partnerships with key companies
• MVP development and testing

Even modest traction indicates your startup is executing and gaining momentum.

Clear Exit Strategy

Angels invest for financial returns. So you need to map out how the startup can provide those returns through a future exit. Common exit strategies include:

• Acquisition by a larger company
• Buyout from a private equity firm
• An initial public offering (IPO)

Outlining the exit strategy shows angels how their investment will eventually translate to a payout.

By understanding these four criteria, you can better position your startup to align with what angel investors look for. Now let’s examine tactics to find, connect with, and pitch to potential angels.

Finding Prospective Angel Investors

There are thousands of angel investors scattered across the world looking for promising startups to fund. Here are some proven ways to identify relevant angels for your company:

• Angel investor networks – Many angels are members of associations like AngelList or regional angel groups. These organizations let you connect with numerous angels at once.
• Startup events – Attending pitch competitions, demo days, and industry conferences puts you face-to-face with active angel investors.
• Accelerators/incubators – Top startup accelerator programs have strong connections to angel groups that they leverage to help companies raise capital.
• LinkedIn – Use LinkedIn filters and advanced searches to find angel investors by location, industry, job titles, skills, groups, and more.
• Your connections – Ask entrepreneurial friends, advisors, or colleagues if they have relationships with potential angel investors to connect you.

Thoroughly researching angels beforehand is vital. Focus on investors with a track record in your industry who provide both funds and strategic support.

Building Relationships With Angels

Once you’ve identified prospective angels, you need to build rapport with them before asking for investment. Ways to organically establish relationships include:

• Networking – Attend industry/startup events where you can interact with angels face-to-face. Focus on relationship building.
• Set informational meetings – Request a short meeting to get advice/insights about your business or industry, not directly pitch them yet.
• Leverage your connections – Have mutual contacts make quality introductions between you and angels.
• Create value – Provide angels with something useful like market research insights without expecting anything in return.
• Get social – Follow angels on Twitter and engage with their content to stay top of mind. LinkedIn is great too.
• Stay in touch – Periodically send angels quick updates or interesting articles without constantly pestering them.

Angel investing is often just as much about the people as it is the business opportunity. Taking a thoughtful approach to connecting with angels can help form lasting partnerships.

Crafting an Effective Pitch Deck

When it comes time to give your full pitch, have a polished deck ready to communicate why your startup is worth investing in. Essential slides to include are:

• Problem – Explain the specific big problem or pain point your startup solves.
• Solution – Provide an overview of your product, service or technology that solves the problem.
• Market potential – Quantify market/industry size, growth projections, and competitive analysis.
• Business model – Details on how the company actually generates revenue and makes money.
• Traction – Charts showing important KPIs like user growth, sales, partnerships over time.
• Team – Bios on founders and key team members highlighting experience.
• Funding needs & uses – Amount of capital you are seeking to raise now and exactly how it will be used.
• Financial projections – Key forecasts like revenue, costs, profitability, cash flow for the next 3-5 years.
• Exit strategy – How you plan to eventually provide a return to investors through a liquidity event.

The pitch deck tells a compelling story about your startup and gives angels the information they need to evaluate the investment opportunity. Focus on concise text and visuals that quickly get your message across.

Negotiating Investment Terms

If angels express interest after your pitch, the next step is negotiating investment terms. Key components to discuss are:

Valuation – The agreed upon pre-money valuation sets the value of the company before additional capital is injected. The valuation sets the share price angels pay for equity.

Equity stake – The percent of company ownership angels receive in return for their investment. Typical ranges are 10-25%.

Liquidation preferences – Terms that determine payout order and amounts for angels if the company eventually gets sold or goes public.

Voting rights – What corporate decisions angels can have voting power over like new stock issuance or future fundraising.

**Information rights **- What financial statements and corporate data you need to provide angels with on an ongoing basis.

Both sides want terms that are fair and aligned on objectives. Being flexible and reasonable with angels facilitates the negotiation and shows you are grateful for the opportunity.

Moving Forward Post-Funding

Once investment terms are finalized, there are still a few steps required before securing the financing:

• Conduct due diligence – Angels will conduct in-depth analysis of financials, operations, legal records to confirm details.
• Get corporate documents in order – Official paperwork like stock purchase agreements and shareholder agreements need formalization.
• Close the transaction – Angels will wire their committed capital and the deal will officially close.
• Build investor relations – Provide frequent updates to keep angels engaged and aware of company progress after the deal.

Bringing angels onboard is just the beginning. Setting clear expectations for involvement and communication post-funding keeps the relationship strong.

Alternative Routes to Raise Capital

Angel investors are one option, but here are a few other common sources startups leverage to raise capital:

• Bootstrap funding – Self-funding your company through founder savings, cash flow, or taking out loans.
• Crowdfunding – Raising smaller amounts of capital from a large group of individuals using an online crowdfunding platform.
• Revenue-based financing – Providers give you capital in return for a percentage of your future revenue until repayment.
• Grants and competitions – Government and nonprofit grants don’t take equity and startup competitions provide capital as prize money.
• Venture capital – Institutional VC firms focused on investing in high-growth-potential companies in exchange for equity.

Assessing all available funding routes and choosing the right blend for your needs is crucial. Angel investors are often an integral piece of that puzzle.

Other things to note

Return Expectations

Most angels target an average internal rate of return between 25-30% over the lifetime of their investment. However, they know investing in startups is high-risk. The top 10% of investments will make the majority of an angel’s returns. Given the volatility, angels diversify investments across multiple startups.

Sectorial Interests

Software, healthcare, and financial services are historically the sectors that attract the most angel investment dollars. However, angels will consider compelling opportunities across all industries. Unique innovations that solve real problems grab their attention regardless of the specific industry.

Investment Hold Timeframe

Angels plan to hold their startup investments for 5-7 years on average. However, they understand timing the exit depends on many factors like market conditions, competition, and company maturity that are hard to predict. Angels focus on building long-term value Creation which allows for flexibility on eventual exit timing.

Control Over Startups

Relative to venture capitalists, angels want fairly minimal control and involvement in startup operations. Beyond board observer rights and voting on major decisions, angels let founders and leadership teams manage the company. Offering too much control upfront can deter angels who seek investment opportunities, not full-time commitments.

Connections and Partnerships?

Yes, angels can be invaluable for opening up new partnerships and growth opportunities. Their personal networks and connections with other investors, channel partners, and media outlets allow startups to expand much faster. Gaining access to an angel’s web of contacts is a huge value-add beyond just capital.

Understanding common angel investor questions is key to crafting your pitch and fundraising strategy. Aligning with investor goals and expectations ultimately gives your startup the greatest chance of securing startup financing.

Conclusion

Attracting funding from angel investors provides startups with fuel to transform ideas into growth companies. While raising capital is never easy, following proven strategies around assembling the right team, demonstrating traction, mapping exit scenarios, and pitching effectively can put your startup on angels’ radars. Building relationships over time and having patience is important. If you target relevant investors and make a compelling case, your startup can gain angels’ interest. Their backing can be a launching pad to take your entrepreneurial dreams to the next level.

Frequently Asked Questions

What are the main risks angel investors face?

Angel investing carries significant risks, including:

• Investment in unproven startups – High failure rates for early-stage companies make angel investing very speculative. There are no guarantees a startup will survive long enough to provide a return.
• Illiquidity – Angel investments are very illiquid since startups are private companies. Angels usually must hold shares for years before realizing any returns.
• Inability to diversify – Many angels cannot invest in enough deals to properly mitigate risk through diversification. This amplifies the downside if a few investments underperform.
• Inexperience founders – Investing in first-time entrepreneurs with unproven track records is inherently more risky versus serial entrepreneurs.
• Follow-on financing – Startups need additional rounds of funding to continue growing. If they cannot secure follow-on financing, angels’ investments could be wiped out.
• Fraud – There are always bad actors looking to deceive investors for their money without intending to build a real business. This is an unfortunate risk in angel investing.
• Lack of oversight – Unlike venture capital firms, angels have minimal operational oversight of startups after investing. This can lead to mismanagement of funds.

Considering these risks, angels must conduct in-depth due diligence and diversify wisely. Patience and proper portfolio management help mitigate risks and enhance returns.

How do angel investors find deals?

Angels leverage numerous methods to find promising investment opportunities, including:

• Attending startup pitch events and demo days
• Getting referrals from other angel investors in their networks
• Participating in angel investor groups where deals are shared
• Connecting with accelerators and incubators that source deals
• Subscribing to curated deal flow newsletters and sites to find pre-vetted startups
• Developing referral relationships with VC firms who pass on some deals
• Utilizing online angel investment platforms like AngelList that provide deal access
• Investing alongside trusted lead investors who discover deals
• Scouting LinkedIn, Twitter, and industry events to connect with founders
• Registering as an accredited investor on equity crowdfunding portals

Having strong deal pipelines and sources is essential for angels to deploy capital efficiently across multiple promising startups. Multi-channel sourcing strategies enable angels to uncover the best opportunities.

What steps are involved in angels performing due diligence?

Angel investors conduct thorough due diligence before investing to uncover any red flags or risks. Key aspects examined include:

Financials: Carefully reviewing past financial statements, tax returns, revenue projections, cash burn rates, etc. forensic accountants are often leveraged.

Operations: Assessing production processes, supply chains, systems, and operational scalability.

Products: Critically evaluating product development roadmaps, feature sets, testing data and rollout plans.

Industry dynamics: Researching markets, competitive forces, regulatory factors and technological shifts that may impact the business.

Team: Running background checks on founders and interviewing key managers to gauge skills, experience and culture.

Legal: Reviewing all legal filings, shareholder agreements, insurance coverage, patents, trademarks, potential lawsuits and other documentation for red flags.

Due diligence processes give angels greater certainty about the health and viability of the startup. Anything uncovered negatively during this phase may lead an angel to abandon the potential investment or renegotiate terms.

How involved are angel investors in startups post-investment?

Unlike venture capital firms, most angel investors take a fairly hands-off approach with their portfolio startups after investing. Typical involvement includes:

• Providing advice and mentorship when sought out by founders
• Leveraging their networks to make strategic introductions that support growth
• Participating in regular board meetings to stay updated on performance
• Monitoring financials and operating metrics quarterly
• Providing feedback on key strategic decisions like budgets or executive hires
• Rallying additional support from their network if the startup nears critical milestones

While angels want their portfolio to thrive, they don’t desire day-to-day management authority. Maintaining clear communication channels and gathering input at pivotal moments keeps relationships strong post-investment.

What are the different ways angels can exit investments?

The main liquidity options angels aim for to exit their investments include:

• Acquisition: The startup is acquired by a larger company in the space. This provides angels with a payout based on the valuation of the acquisition deal.
• Buyout: A private equity or institutional investor buys out existing angel investor shares along with founders/management shares.
• Secondary sale: Angels sell their equity stakes to another private investor rather than holding until an ultimate liquidity event. This allows earlier access to returns.
• IPO: The startup undergoes an initial public offering, allowing angels to sell shares on public markets often for significant returns compared to investment cost.
• Company dividends: If the startup reaches profitability and issues dividends to investors, angels can realize returns through these ongoing dividend payments.
• Company share repurchases: The company might repurchase angel-held shares as part of a share buyback program, providing partial liquidity.

Understanding potential exit trajectories helps angels evaluate expected investment timelines and likely