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Trying to determine the best source of investment for your start-up? There is a broad range of options to consider, from bootstrapping and bank loans to accelerators and crowdfunding. One of the most highly coveted forms of investment is referred to as angel financing. But how much do you really know about how angel financing for entrepreneurs works? Get a little more information with our comprehensive article, starting with our angel financing definition.
Angel financing definition
Angel financing refers to an investment model wherein "business angels" – essentially, high net worth individuals – provide financial backing for small businesses in exchange for equity in the company. Angel financing can be a one-time investment, or it can refer to ongoing support. Generally, angel financing is high risk, high reward, as angel investors tend to seek a more favourable return rate than would be provided via traditional investment opportunities.
How angel financing for entrepreneurs works
Angel financing for entrepreneurs is relatively straightforward, as it's another form of equity financing. Firstly, business angels find out about interesting start-ups from a broad range of sources, including other entrepreneurs, investors looking for partners, or other angels within the same network, fund, or group. After an initial screening process, they'll invite the prospective start-ups to pitch, and if the pitch goes well, they'll undertake a due diligence review. Assuming you make it this far in the angel financing process, you'll be offered a term sheet, and the deal will be closed.
Generally speaking, a business angel's objective is to sell their stake in your business several years down the line for a significant profit. However, when it comes to angel financing for entrepreneurs, it's important to note that the investor won't sit back and wait for you to get the ball rolling. Angel investors play a much more active role in the business. They'll provide the founders with advice, make introductions, build your network, and help guide you through any subsequent funding rounds (Series A, Series B, Series C, etc.).
Angel financing vs. venture capital
Although angel financing and venture capital may sound similar – you're essentially giving away partial ownership of your company in return for investment capital – there are a couple of important distinctions that you should bear in mind. Firstly, angel investors are individuals using their own capital to invest in businesses. In contrast, venture capital firms are professionally managed firms. When it comes to angel financing vs. venture capital, it's also important to remember that angel investors tend to focus on early-stage businesses and start-ups. In contrast, venture capitalists focus on companies with a greater foothold in the industry.
Angel financing advantages and disadvantages
There are many advantages associated with angel financing for entrepreneurs. Firstly, angel financing is far less risky than debt financing, because you won't need to repay the investment capital. It's also worth remembering that angel investors tend to think long-term, so they won't be looking for an immediate return. Finally, because business angels take a more active role, you'll receive access to their contacts and sector knowledge, which can help speed up your company's growth.
However, when it comes to angel financing advantages and disadvantages, there are a couple of drawbacks to consider. Think about the loss of control that you'll need to deal with. If you accept angel financing, you'll also need to be comfortable with the fact that your investor will have a say in how your business is run, as well as receiving a share of the profits when the company is sold. Also, angel financing for entrepreneurs tends to provide less structural/institutional support than would be available with standard equity investment firms.
"Fallen angel" finance
Now that you know a little more about angel financing, you may wonder what the term "fallen angel" means in reference to investments. It actually has very little to do with angel financing for entrepreneurs, so unless you're dealing with stocks and bonds, you probably don't have too much to worry about. Essentially, fallen angel finance is a bond that was initially given an investment-grade rating but has since been reduced to the status of a junk bond.
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