Are Angel Investors Right for your Hardware or Software Business?

As I’ve written before, obtaining VC funding is the holy grail among many early stage tech company founders. But with rare exceptions,  a startup company needs to hit some milestones, demonstrating proof of concept, product/market fit and usually significant revenue traction before VCs will seriously consider an investment.  In addition, for many companies VC funding isn’t realistic or even advisable. So oftentimes the outside capital in an early stage mobile software, SaaS or hardware company comes from an angel investor.  So what’s the difference between raising money from angel investors and from a VC? And how should you go about it?

Let’s take a quick look:

What are angel investors?

The term “angel” was first applied in the investment world to describe affluent individuals who provided capital to fund Broadway plays, which otherwise would have had to shut down. It was first used to describe financial backers of startup companies by William Wetzel, the founder of the Center for Venture Research. He did this in a study that he completed in 1978 while he was a college professor. The study was on how entrepreneurs raise seed capital.

A contemporary general definition for angel investors is a wealthy individual who provides capital for a business start-up or early stage company, most often in return for straight equity ownership or convertible debt. Other terms that are alternately used to describe angels investors are  informal investor, private investor, angel funder, angel financiers, angel capitalist, business angel and seed investor. The sheer number of active angel investors has increased steadily in recent years.

How do angels differ from VCs?

The biggest and most obvious difference is that angels are investing their own personal money, while VCs are investing from a fund that was raised from limited partners specifically for investment purposes. VCs do also put their own money on the line in their funds, but more of the money in funds come from the outside. Many angels are successful current or former entrepreneurs, but many others come from unrelated professional ranks such as lawyers and doctors.

Other differences between angels and VCs:

• Angels aren’t always in it “strictly for the money” like VCs are; they may be very interested in staying involved in an entrepreneurial endeavor, offering mentoring and providing advice
• Angels generally invest in much small increments and usually in smaller, earlier stage rounds
• Angels are much harder to find than VCs, but usually easier to get a meeting with once you find them
• Angels often invest in a more limited geographic region and/or market segment than VCs do
• In early rounds a single VC may be able to fund the entire round, while it usually takes many Angels to fill a round

Why you should seek an angel investor

Below are some of the common scenarios where an angel funding round makes sense:

• When you are bootstrapping but find you need JUUUSSST a little more capital to “get over the hump”
• When you know a potential angel very well who wishes to invest money, you are very comfortable in a good working relationship AND you have a use for the funds which will yield a very good return
• When you believe you will be able to attract VC money later and intend to do so, but need a bit of capital to establish the proof points necessary for institutional investment.

When you shouldn’t seek angel investment

Consider the points below before spending time on seeking angel financing:

• You are really doing business primarily for enjoyment/fun; if you make money it’s a bonus
• You just aren’t comfortable giving up ANY kind of control
• Want to “keep things simple” and grow the business in the manner that you wish and at your own pace
• Have no intention of selling the company within a reasonable time-frame for an outside investor to get a return on his/her investment
• The angel funding is unlikely to move the needle on the business, under ANY of many possible circumstance

Are you ready for outside investment?

Ask yourself the following questions:

• Are you willing and ready to take advice and maybe even direction from outsiders?
• Is your company positioned to generate significant profits in the next 3-5 years?
• Is the company structured legally for outside investment (or can it easily be made so)?
• Are you willing to have an exit strategy which provides a return, and may eliminate your involvement in the business, within 3-10 years?
•  Do you have a well-tuned business plan and pitch deck?

It’s important to be honest with yourself about the questions listed above. The siren song of outside investment is a powerful aphrodisiac which has colored the senses of many an entrepreneur. Make sure you are truly ready. I have witnessed far too many entrepreneurs very eager to take the money, who have convinced themselves these questions don’t bother them. But when things don’t go as ideally planned (which they almost never do), they are very unhappy with the “help” being forced upon them by their new financial partners. It can’t be understated how much taking outside investment will change your life as a tech company founder. Unfortunately, it’s often not for the better, although first time entrepreneurs seeking outside capital rarely think this will be true.

Where’s the best place to find angel investors?

A special (and often the very best first investor) category of angel investors is often referred to as “friends and family”. From this description it’s pretty self-evident that this means taking investment from relatives and other individuals already close to you in your circle. The upside to a “friends and family round” is that the money can often be raised more quickly and easily, due to the trust and familiarity of an existing relationship. This type of money can also be more patient. The downside to raising money from friends and family type angels is that you don’t have and “arms length relationship” if the company fails and you lose their money. Many a friendship has been ruined and family relationships fractured from a failed “friends and family” investment.

So friends and family angel investors may or may not be desirable for you business, but at least they are by definition easy to find. For many startup teams, friends an family financing doesn’t apply or there is a need for additional capital beyond what your close circle can provide. So how should you go about finding and attracting the great many angel investors that don’t fit the friends and family label?

• Present at pitch competitions, startup conferences and the like. Anyplace, anytime that you are able to get in front of an audience that at least could include SOME potential investors, take advantage of the opportunity to publicize you company. Some people are shy and will try to think of reasons not to do this. Do it anyway. You may be bad at it at first, but you will get valuable feedback to improve your pitch, and your presentation will get better every time you give it.
• Network, network, network. Do this both at every in-person tech event as well as events that include wealthy individuals (accredited investors) and successful entrepreneurs that you can attend personally. Complement this in-person networking by networking virtually on such platforms such as LinkedIn.
• Leverage the formal angel investor groups in your region. Although this is an obvious tactic, please note that this isn’t my favorite resource for obtaining angels, for the following reason. Many angel groups have formalized their operations to the extent that their investment process and deal requirement are more similar to VCs. This often means your company may need to be farther along than you would need to be  with individual angels.  You might even need to be at the significant revenue stage to have a realistic chance at investment. I’ve found angel groups to often be much worse than VCs in terms of the hoops you need to jump through to become a potential investment. Couple a higher maturity bar and more cumbersome process with the fact that you still have to raise the actual money one check at a time from individual angels. These checks usually are in small denominations of $25K or $50K, so you might need to get a LOT of checks. Put all of this together and you sometimes have the worst of both the typical angel and VC worlds. I find individual angels are usually easier and quicker to deal with outside of angel investor groups. this is obviously a generalization and not always true with every angel group. If you fare well in their process, angel groups can be a good source of early capital.
• List your company on AngelList and their competitors. This can bring surprising good results.
• Check out the Angel Capital Association (ACA), which has many resources including lists of organized angel groups throughout the country.

There’s my primer on how and when to go about seeking and obtaining angel financing. What has been your own experience?  Fill us in by use the comment field below.

Follow Phil Morettini and Morettini on Management via Twitter, Facebook, LinkedIn, RSS, or the PJM Consulting Quarterly Newsletter. To ask a question or discuss a consulting or interim engagement, contact Phil directly at info@pjmconsult.com

If you liked this post please share it with your colleagues using the “share” buttons below: