When a business needs capital, they usually have two choices: debt financing or equity financing. With debt, you’re borrowing money from a lending agency and making a promise to repay the amount by a specific timeframe, along with interest incurred. On the other hand, equity financing comes in the form of cash or assets to help a business get started or stay afloat, for partial ownership in the company. One example of an equity investor is an angel investor. Depending on your company’s situation, this can either be a good or bad decision.
The term “angel” originated on Broadway when wealthy individuals offered financial backing for theatrical productions. The name has been adopted into our mainstream lexicon ever since. Other names for angel investors are informal investors, angel funders, private investors, seed investors, or business angels. While they are a massive benefit to many small businesses, it’s essential to research this option since there are advantages and disadvantages to going this route when asking for business financing.
The existence of angel investors is a blessing to CEOs looking for investors to fill in the gap between friends and family and venture capitalists. People who are close to you might be supportive but not have the resources required to help. Venture capitalists have the resources but have the debt financier mentality of wanting the company to be viable as soon as possible.
Unlike debt financing, angel investors are taking on most of the risk. Most angel investors’ portfolios don’t dedicate more than 10% for start-ups. For the most part, these individuals have a surplus of discretionary income and understand most start-ups’ failure rate. They are also aware that many businesses take time to get on their feet. This makes them far less predatory than debt financiers. If a company fails, the money that was invested does not need to be paid back. Another advantage is that it’s often a symbiotic relationship, with the investor also gaining a unique opportunity out of the project.
The primary disadvantage of using angel investors is getting a person and their opinions along with their financial support. It is essential to know you share the same values and goals for the company. Have a clear business plan to share, and make sure you explore it together thoroughly before making any commitment. With a loan, the lender has no interest in the company’s day-to-day operations, as long as the loan terms are met. An angel investor, on the other hand, has the right to get involved. Your angel investor will have a voice regarding how the business is run and receive a portion of the profits if it is sold. Since they are assuming more of the risk, they also look for a higher return rate, between 25 to 60 percent.