Startups need capital to grow and succeed, and one of the most common sources of funding is through angel investors. But who exactly are these benefactors? Angel investors are individuals who invest their personal funds in start-up companies in exchange for equity.
They can provide startups with much-needed financial support, mentorship and networking opportunities, helping them navigate the turbulent waters of entrepreneurship.
Angel investors are also willing to provide support to establish key business contacts or help improve the business model, and many are willing to become 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 to startups in establishing industry relationships, final product version (MVP) development as well as entry on the market.
Angel investors can invest at different stages and often during the early stages of a company’s development in investments. varying from approximately $25,000 to $100,000 or more, depending on the individual investor’s ability and interest in the business.
When it comes to decision-making, unlike venture capitalists 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 takes place mainly outside the institutional framework, which can be seen as a positive aspect, but also negative in some respects,” Krzysztof Knopp, M&A Executive at KPMG and angel investor in several deep tech startups, tells The Recursive.
So, like any form of financing, using an angel investor has its own advantages and disadvantages. In this article, we’ll 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 major advantages of angel investors is their willingness to take risks on early-stage companies. Unlike traditional lenders who may be hesitant to lend to small businesses without a proven track record, angel investors are more willing to invest in promising but unproven businesses.
Additionally, 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 be a game-changer for startups seeking financial support to launch their business.
“An active business angel guarantees smart financing, which at the initial stage of business development can be as important as the financing provided,” adds Knopp.
Pro #2: Money is not a loan
Unlike a business loan, angel investments do not need to be repaid on a fixed schedule with interest. This is a significant advantage for startups that may not have established stable revenue streams or cash flow early on.
Angel investments are typically made in exchange for equity, meaning the investor gains partial ownership of the company. Therefore, the investor’s success is now linked to the growth of the startup, which encourages them to actively support the company in various ways.
“If we talk about our experience, we are a mission-driven startup. Our goal is to protect the cognitive security of people, businesses and governments using 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 mission “match” can be the only solid basis for cooperation and building lasting relationships,” said Maksym Tereshchenko, CEO from the startup Mantis Analytics, based in Kiev. The recursive.
Advantage #3: Chances of success increase
Startups backed by angel investors often have a more chances of success compared to those without financial support. In addition to financial resources, angel investors also bring invaluable expertise and experience.
“An additional benefit of having a business angel is ensuring the credibility of the company – ultimately, the startup’s lack of liquidity is a secondary problem (it is possible to quickly recapitalize the company through a bridge). The main problem of a startup is most often the lack of status, commercial position and low credibility – a business angel with a meaningful name often makes such a company credible,” explains Knopp.
Their mentoring and guidance can help entrepreneurs avoid common pitfalls, make better business decisions, and build a stronger foundation for their business. Additionally, angel investors’ network of contacts can open doors to potential clients, partners, and future investors, giving startups a competitive advantage.
“Startups need to remember that if there is no “match,” there is nothing wrong with you or the investor, you have different missions. But this orientation is also a “pro”, because if you find the right person, it will really help you. An investor who supports your mission, and likely has some experience in your field or a relevant field, will be of tremendous help to you not only as a source of money for you, but also as a mentor, expert, point of contact with his network, etc.,” underlines Tereshchenko.
Disadvantage #1: An angel investor could raise the bar
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 can expect the same level of growth and financial rewards from their investments.
This can put immense pressure on founders to achieve rapid growth and profitability, which does 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 on your side is an angel entrepreneur who can support you early on with their funding, but who can also teach you how to build a business and leverage their social capital. From my personal experience, I will stick to serial angel investors or groups of angel investors because sometimes new uneducated angel investors can stifle the business by creating wrong expectations,” said the investor Skopje-based angel and ecosystem builder Igor Madzov at The Recursive.
Disadvantage #2: Conditions will be attached
Angel investments are not strings-free, as investors often negotiate terms such as ownership percentage, voting rights, and exit strategy before providing funding. While this can be a positive aspect because it aligns the interests of both parties, it can also potentially result in a loss of control for the startup founders.
“Regarding the negative problems associated with the presence of a business angel in the shareholder structure, a business angel who does not bring additional value to the company (does not provide smart money) and only counts on a return on rapid investment is unfavorable for the company because it breaks the ownership structure. Often international Venture capital fundsusing clauses in investment agreements, buy out such a small investor in order to “clean up” the ownership structure,” Knopp points out.
For some entrepreneurs, giving up control of their vision can also be difficult and hinder their ability to freely execute their ideas.
Disadvantage #3: You don’t have full control
When using angel investors to finance a startup, the founder is no longer the sole decision-maker. Because ownership is shared, major decisions may require approval or consensus from the angel investor.
In turn, this can lead to conflict if there are divergent opinions on crucial issues, which can be destabilizing for some entrepreneurs used to running business independently.
Conclusion
There are many pros and cons to using an angel investor to fund a startup: Angel investors not only provide 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 conditions attached to the investment are key factors that entrepreneurs should consider carefully.
“Not all business angels are really smart money. A poorly structured relationship with the wrong people is a big problem for founders, which can often be difficult to resolve. In summary, it seems to me that having an active business angel brings more advantages to a startup than the absence of such support,” emphasizes Knopp.
So, before seeking angel investments, entrepreneurs should carefully evaluate the needs of their startup, the investors they are approaching, and the terms of the investment. Ultimately, finding the right angel investor who fits the startup’s vision and goals can have a significant impact on the success of the business, making angel investing very attractive to many early-stage startups.