There is hardly a week that passes where I don’t receive numerous inquiries about using “Angel” investors to finance early stage companies. I entered the phrase “Angel Investor” into Google and received almost 6 million returned searches comprised of everything ranging from individual investors to various groups, clubs and syndicates purportedly looking for deals, to investment portals where investors seeking capital can advertise to the “Angels”. In today’s blog post I’ll address the pros and cons of dealing with high net worth individuals as investors. Let me begin by sharing my bias I come from the institutional world and prefer to deal with seasoned VC’s and private equity funds. In most cases I am not a big fan of Angel investors. Now that my disclaimer is out of the way let’s start by answering the question: “What is an “Angel” investor?” Answering that question is difficult as “Angel” investors are not a formal investment class and therefore the term means different things to different people. In my book an Angel investor is simply an individual investor nothing more. I know a hand full of Angel investors that are competent, well funded, thoughtful, experienced and savvy investors. An example of this type of Angel investor would be the Band of Angels in Palo Alto, California. This syndicate of Angel investors has more than 100 members, averages $600,000 per investment, and has invested close to $50 million dollars in total. The problem is that in my experience this is the exception not the rule. Regrettably there are many more low net worth posers who prey on businesses by calling themselves Angels who attempt to leverage themselves into opportunities at the expense of the entrepreneur.
Angel investors do have two distinct advantages in that they almost always have some presence in the market, and entrepreneurs can often times cut better deals with non-institutional investors. That being said, angel investors are rarely anything more than a band-aid solution to capital formation as they rarely have deep enough pockets to carry and enterprise through multiple rounds of financing through to sustainability. Furthermore early stage angel investors often muck-up a capital structure such that they actually create a barrier to entry for VC’s, private equity firms and other investors looking to make later stage investments. If you do seek capital from Angel investors I would strongly suggest that at a minimum you follow the guidelines listed below:
- Look past the immediate need: Request a copy of their financial statement and evaluate not only their net worth, but their liquidity. Ask them straight out if they have the ability to meet future capital calls or make later stage investments.
- Experience and connections can mean more than the capital: As for references from previous companies that they’ve funded. Talk to those entrepreneurs and ask if they received any assistance from the Angel other than the investment and if they would use them again.
- Make the Angel play by usual and customary industry practices: Demand a term sheet from them at the outset. If they can’t perform in the time between term sheet issuance and final documentation then they likely won’t perform later when you really need them. Make sure you always negotiate a buy-back provision so that you can unwind the deal for either non-performance or if it just turns out they are difficult to work with.
If you are currently seeking capital I would suggest reading the following two earlier posts as they will provide additional valuable information: The first piece entitled Private Equity vs. Venture Capital and the second piece entitled My Philosophy on Valuations.