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The second most common source of capital for starting and growing a business is an angel, also known as a private investor. (The majority of entrepreneurs start their businesses with personal savings, credit cards, and other personal assets.) Angels are members of the informal risk capital market — the largest pool of capital in the U.S.
So, how do you find one of these gift-givers from heaven? Unfortunately, that's the hard part because angels tend to keep a lower profile than any other type of investor. Entrepreneurs typically find angels through referrals from someone else. That's why networking with people in your industry is so important when you begin thinking about starting a business. You need to build up a personal network to tap when it's time to look for private investment capital.
How to spot an angel
Today, angel investors look a lot like professional venture capitalists. Angels typically ask you for the same credentials that a venture capitalist wants:
- A significant equity stake in the business
- A seat on the board of directors
The similarity between an angel and a venture capitalist came about because of the long bull market in the late 1990s when venture capital funding reached astronomical levels. Flush with cash, the venture capitalist stopped looking at deals that were less than $3 million to $5 million, leaving the playing field wide open for angels to step in and do bigger deals than normal, with the promise of a quicker turnaround.
 | Venture capital is a professionally managed pool of funds that usually operates in the form of a limited partnership. Typically, venture capitalists invest at the second round of funding and are looking for fast growth and a quick turnaround of their investment. |
Angels used to be characterized as middle-aged, former entrepreneurs who generally operated solo and invested near their homes. They usually funded deals for less than a million dollars and stayed in the investment for several years. Today, angels come in all ages, even turning up among the twenty-something Internet crowd who hit it big with their first ventures.
Angels also band together to increase the size of their investment pools and take on larger deals. Networks like The Tech Coast Angels and Berkus Technology Ventures, based in Los Angeles, California, consider themselves to be seed venture capitalists. They have become as sophisticated in their investment methods as any professional venture capitalist — exercising more due diligence and sometimes looking for a quicker return on their investment, often to the detriment of the business. In other words, they need to be cashed out of their investment before the growing business is in a position to do so. Entrepreneurs typically work with longer growth and performance horizons than venture capitalists and many of the new breed of angels. So their goals are often in conflict.
How to deal with angels
In many ways, you deal with angels the same as you deal with professional venture capitalists. You start with a good referral from someone who knows the angel well. Then:
- Make sure your goals and your angel's goals are the same. Otherwise, you may risk the goals you've set for the business. Try to avoid an angel who wants to get in and out in three years or less. You can't build an enduring business in that timeframe. Besides, you need to find a way to buy out the investor at that point, and that may mean selling the business or offering an IPO, which may not have been your original plan.
- Exercise your own due diligence (investigation, background check) on the angel. Don't be afraid to ask for references from other companies the angel has invested in. Talk to those entrepreneurs to find out what their experience was.
- Look for an angel who provides more than money. You want contacts in the industry, potential board members, and strategic assistance for your business. These things are as important as money.
- Get the angel's commitment to help you meet certain business milestones that you both agree on.
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