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Angel investors are high net worth individuals who invest their money in startups and start-ups. Unlike venture capitalists, angel investors fund startups at a very early stage, making these unproven investments riskier — and potentially more lucrative if they pay off. Many angel investors offer mentoring and guidance in addition to their financial assets. According to ACA Angel Founders Reportin 2020, angel-funded companies raised $2 billion in total capital from multiple sources, roughly seven times increasing their initial angel investments.
Angel investors are often your first investors. Their investments can be as small as $25,000 or as large as $200,000, but they are essential to the success of a young business. In addition, once a company has received an investment from an angel, it is easier to convince others of the company’s value and then convince them to invest as well.
Angel investors know that startups have a high failure rate. Nearly one in five U.S. companies goes bankrupt within the first year, according to the latest data from the US Bureau of Labor Statistics (BLS). Ultimately, an angel investor needs to be confident that the potential benefits/benefits of investing outweigh the downside risks. Before investing in a startup, angel investors assess several essential issues and conduct due diligence. Below are the top five angel investors look for before deciding whether or not to invest in a startup:
Related: Where to Meet Angel Investors and How to Pitch Them When You Do?
1. Founder/Management Team
The management team behind a startup is often considered more important than the idea or product. Investors want to know that the team has the skills, drive, experience and temperament needed to grow the business. The investor must decide whether the founder and team are fun to work with. How confident is the investor in the team? Does the CEO have experience and is he/she willing to listen? How reliable is the CEO? Involving experienced advisors in the early stages can also be very helpful in building a bridge to an early stage team that is still growing.
In addition to company commitment and the ability to add value, investors want to see smooth and risk-free interaction between startup team members to ensure long-term success.
2. Business Potential and Returns
Angel investors are looking for companies that are scalable and able to grow. Be sure to explain in advance why your business has the potential to be significant. Avoid small ideas. Investors will want to know how much of the addressable market you plan to capture over time. The investor must believe that the opportunity has a clear value proposition, that there is a large and growing market (TAM, Total Addressable Market), that your solution is unique, that now is the time to build it, that you and your team are the ones be who can build it, and that you will make a lot of money from it. A good rule of thumb is the 7-to-1 rule: a return of seven (after-tax) dollars for every dollar of capital invested by an angel investor within seven years.
3. What makes your product/service great?
Angel investors are not afraid to invest in risky ventures as long as they think the idea is excellent. First, demonstrate the uniqueness of your product. Having a Minimum Viable Product (MVP) is important when pitching to angels – or at least a really good framework of what it will look like once you’ve used the funding to build it.
Describe the unique problems it solves and why users care. Is it a groundbreaking piece of technology? And what sets it apart?
Related: What You Can Learn From This Angel Investor’s 5 Investment Rules
4. Positive Early Momentum
Angel investors are looking for early signs of traction or customers. Companies that have gained traction early on are likely to be able to achieve better terms with investors. In addition, investors are likely to wonder how early traction can be accelerated. Is there a particular reason for the trek? Can this traction be scaled?
5. A viable exit strategy
By making sure you have several good exit strategies in place, you can reduce their risk and predict how they will be paid out. Regardless of the success or failure of the company, an exit strategy provides the investor with certainty. They should be informed about when to expect returns, and more importantly, how to minimize their losses.
Angels do not want to invest in companies that cannot guarantee returns. As Carleton University professor Allan Riding put it, “For every dollar an angel puts into a business, he or she wants to take off seven dollars, after taxes, in seven years.”
Related: Exit Strategy Through the Eyes of an Angel Investor
While almost every angel investor will consider at least some of the above factors, you should also realize that every angel investor will be unique – they will all have different goals, values, and priorities. Angel investors can find something that appeals to one, but can turn off another. A financial plan that appeals to one person may seem too ambitious to another. Therefore, while you can optimize your business to be as attractive as possible, you should also prioritize finding the right fit.