It’s a tough time to start a business, but many major household names set up during a recession, including Apple GM and CNN.
However, sourcing capital to get the ball rolling can be even more robust. Still, there are various methods of doing this, such as self-financing, loans or crowdfunding, but plenty of businesses still struggle.
According to Investopedia, funding comes in at number two of the top five challenges for new businesses. The top problem is said to be client dependence, i.e. setting up with more than 80 per cent of your revenue from one client. Should anything happen to that one client the business will need deep pockets to invest in marketing to attract new customers quick-smart!
However, seasoned entrepreneurs know you don’t what for the worst to happen you prepare for worst while aiming for the best, and that’s why receiving a capital investment from angel investors can be appealing.
An angel investor is an individual who provides capital for a startup, usually in exchange for convertible debt or ownership equity. This can be an opportunity to jumpstart your company’s success. However, things don’t always go as smoothly as the name suggests.
In this article, are the positives and negatives of accepting capital from an angel investor. Given the tumultuous state of the market, it could be the difference between boom or bust for your startup. Read on.
What Are The Advantages?
If you have a clearly articulated pitch, a prototype or working model of your product or service, as well as some early users, investors will be chomping at the bit for a stake in your company. But, as nine out of ten startups fail, you may want to consider the pros and cons first.
Andrew Dixon, is an angel investor and founder of ARC InterCapital. He says that “these challenging times will test the founder-investor relationship in ways it may not have been tested before“, so it’s important to know what you’re getting yourself into.
No need for collateral
Funding from an angel investor opens you up to a world of opportunity. For starters, there is no need for collateral, i.e. personal assets. Bank loans most often require personal guarantees and security and this can often cause problems in growing businesses when the owner is also young and hasn’t acquired the high ticket items like the family home.
Whereas with angel investor funding, at least some of the risks are transferred from the company to the angel.
Angel investors typically provide capital in exchange for a percentage of ownership, usually starting at 10%. Unlike with debt financing, invested capital does not have to be paid back in the event of business failure.
Differing from traditional lenders, this negates the possibility of being charged interest. Both the investor and the business benefit in this scenario if the business takes off, as the former can cash out, and the latter can continue to grow.
Mentoring and Guidance
Angel investors are usually seasoned entrepreneurs who understand the risks involved when establishing a new business. As reported by the Kaufman Foundation, startups receiving angel investment are 20-25% more likely to survive after four years and 16-19% more likely to have grown to 75 employees than those receiving traditional methods of funding.
The capital is essential, but the value of having someone on board who can provide guidance cannot be overstated.
Active not passive
Angel investing differs from traditional forms of funding insofar as it’s active, rather than passive. Many angels take a hands-on approach with the business. Here are some of the ways they get involved:
- Provide you with excellent networking opportunities for sales and collaborations
- Introduce you to industry contacts
- Give advice and recommendations, and assist in strategy
However, receiving capital in this way isn’t entirely advantageous. The most obvious downside is that you must relinquish some control of the business, as well as give up a portion of the profits if the company is sold.
Many entrepreneurs find this difficult, as it can prevent them from being as agile in the market or making decisions personally. Giving up shares at such an early stage can seem unattractive to many business owners.
Involvement in the business
With debt financing, the lender has no say in the day to day running of the business, which is not the case here. This means angel investors have much higher expectations than normal lenders. They may require you to jump through hoops, so to speak, while trying to run your startup. An angel investor expects a business to have good growth potential, a solid business plan and a strong team.
They might want frequent reports or status updates about the company, which can result in capacity taken away from already small teams. You do not want to be in a position where you are forced to hire new staff just to keep investors happy. Even if your relationship is excellent initially, it may sour as your company develops.
Angels are also more difficult to contact than traditional lenders. This may require networking, which can take resources away from the running of the company. Similarly, angels often operate independently, so attracting one won’t necessarily bring in any others unlike loans, where lenders won’t be deterred by others investing.
Weighing It Up
Receiving funding in this way has its pros and cons. If you want quick access to funds and are prepared to sacrifice equity to for it, then this looks like the solution for your startup. An angel investor can provide essential advice to set your business along the right track for growth, as well as provide excellent networking opportunities within the industry.
However, having to find an investor in the first place can be difficult. Those who do not want to give up control, share profits or answer to an investor may find traditional lenders more appealing. Every owner is different, and you must decide what’s right for you and your startup so you can focus on connecting with your customers.