Gasta Tech Update : Investments

When Your Business Needs Money: Angel Investors

If your growing business needs capital, but your personal resources are tapped out, don't despair - you can put your faith in angel investors. According to the University of New Hampshire's Center for Venture Research, there were more 234,000 active angel investors in the United States at the end of 2006 who invested in 51,000 private companies in the same year. You probably already know some of these people - they may even be your friends or neighbors.

In this article, we'll show you who these angels are and how they can save your company from financial ruin.

Who Are These People?
Active angel investors are a mix of the working wealthy and the retired rich. Some dabble in these private investments, while others manage their money full time. Like the businesses they invest in, angels come in all shapes and sizes.

Angels are diverse, but they are not always commonplace, so it would be a mistake to go door to door selling your company's stock. In fact, the Securities and Exchange Commission (SEC) has strict rules about selling the stock of a private company to angels. In many cases, a business owner should accept investment dollars only from people who meet the SEC definition of an accredited investor - namely, a person with at least $1 million in net worth, or an annual income of more than $200,000 ($300,000, if married). There are, of course, many considerations to finding an angel investor, so make sure to check with a qualified securities attorney before accepting an investment from anyone.

Find Your Piece of Heaven
Even though an angel investor may live right next door, most prefer to fly under the radar. Start any angel hunt by networking through your legal or financial advisors. These professionals usually know who the players are and where they hide. Other business owners are also a good source of leads and introductions: there are probably hundreds of entrepreneurs in your city that have partnered with angels in the past.

Fortunately, finding angels is starting to get a little easier because they are joining clubs or networks. A new industry association of angel groups has even emerged, called the Angel Capital Association (ACA). The ACA keeps tabs on angel groups and estimates that there are 265 of them nationwide.

Take a Leap of Faith
Although finding an angel partner can be tough, living with one can be even tougher. Before you jump into a deal with an angel, be sure the fit is right. The wrong angel investor can be a pesky partner. Once you take an angel's money, be prepared to provide regular reports and to listen carefully to offered advice. And they will offer advice. An angel investor often expects to become your business partner and may even want to play an active role in the company. The more your company relies on this person's money, the more closely he or she will watch your every move.

Of course, a nosy investor can be a curse or a blessing, depending on how you develop the relationship. Work with your investor(s) to take advantage of their wisdom and support. Luckily, angels tend to invest in the industries that they know the most about. A retired software executive will invest primarily in software, for example. Use this to your advantage by hooking up with angels that can lend their expertise to your business challenges. (For more see, Cashing In On The Venture Capital Cycle.)

What's In It for the Good Guys?
Make no mistake: all angels invest for just one primary reason - to increase their wealth. Their money is not free, and they will expect a sizable return in the long run. Many will be willing to wait four or five years to get their money back, but by then they will expect a return of two or three times their original investment.

Even if it's not clear to you at the beginning, an angel will always be looking for an exit strategy, and it's your job to provide one. Angel capital is flexible but expensive. Even though angels will give you several years to generate a return, they will expect to be well compensated for their patience. Rates of return north of 30% compounded per year are not uncommon targets.

Maximizing Value
The most difficult part of any angel negotiation is likely to be setting the valuation for your business. How much will they invest and what stake in your company will you give up? It's not uncommon for both parties to be unhappy with the final outcome of this negotiation. One way to satisfy everyone is to have a third party weigh in on the valuation process. Professional business valuation consultants are available to help with this process, but there are also financial tools to help you bridge this thorny problem.

One aptly named solution is a bridge loan. This financial structure allows an angel to loan capital to the business, and then allows him or her to convert that loan to stock at a future time (and a future valuation). Typically, the loan converts when a larger investor comes on board. The angel receives the same, or slightly better, valuation as the new investor. This works best when the business plans on seeking institutional venture capital or private equity.

Getting to Heaven
Finding an angel investor can be a great way to dip your foot into the private equity pool, but it is not an automatic pass to financial heaven. Fortunately, angel investing is not new, and you don't need to be afraid of the process. After all, angel investors have been around since Christopher Columbus convinced Queen Isabella I of Spain to pay for his voyage to America. With common sense and sound legal advice, an angel investor can help you turn a risky venture into a rich voyage of discovery.

by David Worrell (Contact Author | Biography)

An accomplished entrepreneur, author and consultant, David specializes in helping emerging companies solve tough financial and strategic issues. Worrell is currently CFO of his third startup, AmeriStart.