Pros and Cons of Using Angel Investors to Fund Your Startup

by Rebecca Lake

3 min read

    If you’ve been unsuccessful in your efforts to secure funding for your new venture, an angel investor may be the answer. Angel investors specialize in providing financial backing for small-business owners and entrepreneurs during the startup phase and beyond. While the money they bring to the table can make the difference in whether your idea ever materializes, there are some trade-offs you need to be aware of.

    Pro: Angel Investors Are Willing to Take Risks

    Qualifying for a small-business loan usually entails jumping through quite a few hoops — obstacles you may not face when dealing with an angel investor. That’s because they’re often established entrepreneurs who understand the degree of risk involved and are comfortable taking it on. Even if a bank is agreeable to providing you with funding, they may limit the amount you can borrow to curb the potential for loss. Angel investors, on the other hand, typically don’t balk at making a larger investment if they believe in the business’s potential.

    Con: Angel Investors May Set the Bar Higher

    The downside of an angel investor’s higher risk tolerance is that they also tend to have higher expectations. They’re in business to make money, and when there’s a substantial amount of capital on the line, they’re going to want to see the payoff. It’s not unusual for angel investors to expect a rate of return equaling 10 times their initial investment within the first five to seven years. When you’re being held to such a high standard, the pressure to deliver can be intense. If you’re considering an angel investor, you need to gauge whether your startup is in a position to grow at the rate your investor expects.

    Pro: The Money Isn’t a Loan

    When you take out a small-business loan, the bank expects you to pay it back, regardless of whether your venture actually succeeds. Angel investors operate within a different framework. They provide you with the money you need to get going and, in exchange, they get an ownership stake in the business. If your startup takes off, then you both reap the rewards financially. On the other hand, if your business falls flat, the angel investor isn’t going to expect you to repay the money they offered up.

    Con: There Are Strings Attached

    Even though you’re not technically obligated to repay the investor the money they chip in, there’s a catch. When you hand over equity in your company as part of the deal, you’re essentially giving away part of your future net earnings. The percentage of ownership an angel investor asks for typically depends on how much they’re investing. If you expect your business to be wildly successful, it could add up to a lot of money you won’t be able to lay claim to. When you’ve got an offer on the table, review the terms carefully to make sure the amount of ownership the investor is requesting doesn’t eat into your own ability to realize a profit.

    Pro: Your Odds of Success Increase

    Typically, angel investors bring years of experience to the table and they already know the ropes when it comes to starting a company. In fact, researchers from the Harvard Business School found that ventures funded by angel investors are much more likely to stay in business longer, experience significant growth, and see a higher rate of return. If you’re seeking advice and guidance in addition to funding, an angel investor can offer a wealth of valuable knowledge.

    Con: You’re Not in Total Control

    Angel investors aren’t going to shell out big bucks without taking an interest in how the money is used. If you’re expecting them to take a completely hands-off approach, you may be in for a rude awakening. It’s more likely that your angel will want to take an active role in making decisions that affect the outcome of your business. Even if they leave the reins in your hands, you’ll still be accountable for explaining the reasoning behind your choices. Before you start looking for an angel investor, you have to make sure you’re comfortable allowing someone who’s not intimately familiar with your startup to play a part in how it’s run.

    Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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